Business Associations Outline
The Economics of Agency/Creating an Agency Relationship
The agency relationship is central to all forms of business association, determines the legal consequences of acts by individuals with respect to business associations with which those individuals may be associated
Fiduciary relationship, permits one person (the agent) to act on behalf of another (the principal).
Depends on principal's consent (actual, apparent, or implied) to act on his behalf, as well as agent's consent to relationship
Can be based on express agreement, or inference based on surrounding facts.
Need not be known to third parties, but principal's words and actions vis-a-vis third parties can create apparent authority
The Principal/Agent Relationship
Five legal theories to bind a principal:
Actual Authority (both express and implied)
Any express agreement between principal and agent as well as any agreement that may be implied from surrounding circumstances.
Manifestations from the principal to a third party that the agent has the authority to perform the act in question.
Allowing an agent to conduct business in a particular way and thereby create an impression that actual authority exists.
“Catch-all” concept to impose liability as a matter of fairness or some other consideration
Follows general principles of estoppel.
§ §2.05: If a 3rd party is justifiably induced to make a detrimental change in position because a transaction is believed to be on the principal’s account, liability may be imposed if: (a) The person intentionally or carelessly caused such belief; AND (b) Having notice of such belief and that it might induce others to change their position, the principal did not take reasonable steps to notify them of the true facts
After the fact approval by the principal ratified a previously unauthorized act.
Right to control – the right of the principal to give interim instructions or directions (See e.g. Cyberheat, holding that right to control porn spammers dispositive and label not dispositive.
Duty to act primarily for the benefit of the principal
Power to alter legal relations of the principal
Pinding a relationship alone is insufficient to establish liability – the action must also be within the scope, etc!
Will the principal be bound by the agent’s torts?
Agent is subject to certain ensuing obligations:
Unless agreement to the contrary, the agent has a duty to act solely for the benefit of the principal
Agent may not deal with the principal as an adverse party (can't sit on both sides of the bargaining table)
Agent who makes profit whole working for a principal is under a duty to give any profit made to the principal.
(II) Non- Corporate Business Entities
Defined by UPA §6 as “an association of two or more persons to carry on as co-owners a business for profit”
Ownership defined by both profit-sharing and share of control (power to share in significant managerial tasks)
Determination of formation is highly factual inquiry, dependent upon written/oral understandings as well as conduct and surrounding circumstances
Fenwick v. Unemployment Compensation Commission: Court found girl to be employee, NOT a partner where: (1) she had stake in profits, (2) no control, (3) no capital, (4) no explicit rights on dissolution, (5) agreement called them partners, (6) filed taxes as partners
To establish partnership: (1) prior work as capital, (2) give her actual control, (3) give rights on dissolution, (4) Give her voting rights
To avoid partnership: 1-4, but opposite, (5) make Independent Contractor
Absent agreement otherwise, all partners have equal rights in management
Persons dealing with a partnership are not affected by private agreements between partners
Each partner has apparent authority to contract on behalf of the partnership.
All partners, no matter how small the interest, are liable jointly and severally for loss or injury caused by tortious or other wrongful act of any partner/employee who is acting in ordinary course of business
§ 20 Duty of Partners to Render Information
§ 21 Partner Accountable as a fiduciary
Meinhard v. Salmon: As a managing co-adventurer, Salmon owed Meinhardt a duty of disclosure, then they could (possibly) compete
RUPA (‘96) § 404(b)(1) suggests you have to share the profits if you missapropriate a partnership opportunity!
Singer v. Singer: Duty not to compete may be altered by partnership agreement.
Dissociation and Dissolution
UPA § 31(1)(d): Dissolution is caused (1) without violation of the agreement between the partners, (d) by the expulsion of any partner from the business bona fide in accordance with such a power conferred by the agreement between the partners.
Also dissolved by death, bankruptcy, or court decree declaring partner to be insane or guilty of serious misconduct relating to the partnership.
Under Revised UPA, these events cause partner's “dissociation,” terminating that partner's right to manage or conduct partnership business, ends duty to refrain from competing, limits duties of loyalty and care only as to matters occurring before dissociation.
Other Business Associations
Joint Ventures, LPs, LLPs, and LLCs
Joint Ventures: Business ventures of limited scope or duration conducted by two or more persons for profit
Limited to a single business transaction, or series of related transactions
Possible combination of property, money, skills, and knowledge
Most commonly stated elements: contract, common purpose, community of interest, equal right of control, and participation in profits and losses.
Limited Partnership (LP): Statutorily created method of profit-sharing by passive investors.
Share in profits, with risk of loss limited to investment if legal formalities complied with
Two classes of partners:
General Partners: Have complete control, manage the enterprise, subject to full liability.
Limited Partners: Similar to creditors but subordinated to creditors if firm is insolvent or liquidated. Do not take part in day-to-day control.
Formation requires statutory formalities similar to those required for incorporation.
If formalities substantially complied with, limited partners enjoy limited liability, but will be subject to liability to they exercise control of the business.
Revisions grant greater “safe harbor” latitude in which limited partners can act without giving up limited liability.
Can approve any matter related to the business as long as right to participate is specified in partnership agreement
Merely being “an officer, director, or shareholder” of corporate general partner of the limited partnership does not constitute control.
Limited liability limited partnership (LLLP) allows limited partners to become general partners and remain behind a limited liability shield.
Limited Liability Company (LLC): Means of securing the federal income tax advantages of partnership status while simultaneously preserving state law benefits of limited liability for the entity's owners.
Interests of LLC members not represented by stock, hold interests like partners in a partnership
LLC's existence may be terminated by dissolution, borrowed from partnership law
Default limitations on transfer shares of LLC interests, but can be provided for without jeopardizing tax entity status.
By default, LLCs are member-managed, with each member an agent with fiduciary duties. Nonmember managed LLCs are stipulated in agreement.
Choosing an Entity: See Handout 2 Chart
Partnerships are taxed by individual shares
Corporations are taxed as a separate entity
(III) Corporations: Formation and Financing
· The Incorporation Process
o Choosing a Jurisdiction
§ Jurisdiction determines not only relevant statutory law, but case law as well.
§ “Strong disposition to incorporate in the state where the corporation's principal business activity will be conducted”
§ Applied mostly to localized businesses, as taxes favor businesses domiciled within a state and frequently penalize “foreign” corporations
§ Larger businesses that will cross state lines freer to forum shop, with Delaware generally regarded as exceptionally permissive, though other states are following the same trend.
§ General Considerations:
§ Permit type of business desired?
§ Residence restrictions?
§ Special rules re: directors and management norms?
§ Shareholder rights and liabilities?
§ Permit desired capital structure?
§ Close corporation statute?
§ Organizational and annual fees and taxes?
o Promoter liability
§ Promoters act as representatives of the corporation to be during the incorporation process, but cannot be said to be agents because their principal at that point remains nonexistent, raising issues of liability and fiduciary duty.
§ Liability Issues
§ Theories of Liability:
§ Ratification: The corporation later approves a contract once it comes into existence
§ Adoption: The corporation takes on a contract held by the promoter
§ Acceptance of a continuing offer: Promoter makes offer, not accepted until the corporation comes into existence
§ Formation of a new contract: Promoter is a placeholder contract, ends and is replaced with corporate contract.
§ Novation: The contract is revised with corporation subbed in for promoter.
§ Upon a
veil and subjecting owners to personal liability
o Stock Issuance Mechanics
§ Statutory Authorization: Articles of Incorporation must specify the number and kind of shares that can be issued.
§ Any amendment to this later would be difficult, so sometimes corporations make provisions for noncommon stock with attricbutes to be determined (“blank check” stock)
§ Issuance: Three elements
§ Board Authorization: Board must approve the specific transaction in which statutorily authorized shares will be exchanged for consideration.
§ Subscription agreements are sometimes used to contract purchase in a future corporation's stock, providing contract agency issues
§ Consideration: Four specific problems
§ Ensuring equal payment by contemporaneous purchasers: par value used as common law agreement, undercut by judicial decisions that allowed for above-par payment, as well as par value being set extremely low so it could be sold at a higher price, case law now provides relief if disparate payment can be proven.
§ Ensuring consideration is received: Largely dealing with payment in future consideration, typically handled by putting shares in escrow until paid for, or marking them explicitly as partially paid for, with the remainder payable upon demand.
§ Later Issuance at Inadequate Price: Modern statutes dictate that board's judgement of consideration for newly issued shares is conclusive.
§ Noncash Consideration: Again, board's decision is conclusive, absent evidence of fraud
§ Delivery: Stock certificates must be delivered by the corporation to the person in question
§ Shares properly issued and authorized by the corporation and no longer in corporate hands are said to be outstanding, regardless of whether they're in the original owner's possession.
§ Doctrine of preemptive rights guaranteed that each current shareholder had the right to maintain his or her proportionate interest by purchasing the same percentage of to-be-issued shares on the same terms and conditions proposed by the Board of Directors
§ MBCA and DGCL do not promise preemptive rights unless granted by Articles of Incorporation
§ Preemptive rights are also not triggered if:
§ Consideration for new shares is in something other than cash
§ Newly issued shares issued pursuant to the corporation's initial plan of financing
§ More than one class or series of shares exists.
o Federal Securities Regulation
§ Securities Act and Exchange Act define securities almost identically, but both in nuanced ways
§ Both acts state their definitional list is “unless the context otherwise requires”
§ If something is called stock or debt, but does not meet the typical indica or “family resemblance” to those terms, it may be excluded by the court.
§ Conversely, if something is not conventionally debt or equity, it may be seen as an investment contract if it is:
§ An investment of money,
§ In a common enterprise,
§ With an expectation of profit,
§ To come solely from the efforts of others.
§ Securities also must be registered with the SEC before they can be offered through interstate commerce or sold
§ Government and charitable organization securities are excluded from this requirement
§ Securities issued only to residents of the incorporating state and state of business are excluded.
§ Private placement exemption:
§ Transactions not involving any public offering (if all offerees can fend for themselves and do not need the act's protection, it's exempt… sophisticated investors with adequate information)
§ Issue of securities for less than $5 million, or limited nature of the offering
§ Regulation D, Rule 504/505: Raise up to $1 million with few restrictions, or $5 million if there is no general advertising, and the purchasers are all accredited investors (rich people), and no more than 35 nonaccredited investors.