Partnerships,

1
Business Organizations2009-2010 Lectures

• Partnerships,
• Corporations
• And the variants
• PROF. BRUCE MCCANN
• LECTURE 14
• REVIEW

2
What are we talking about?

• Two Umbrella Types of Entities
• Limited personal liability for owners
• Limited partnership
• Limited Liability Company
• Corporation
• No protection from personal liability
• General partnership
• Sole proprietorship

3
Some Basic Terms

• Partnership
• Two or more persons (and by person we also mean
  other entities)
• Share power
• Share profits
• Share losses
• Partnership reports its profits and losses to the
  partners who each take their percentage on their
  own tax return (pass through)
• Partnership itself is not taxed
• Each partner personally liable
• Dissolves on death of partner or other
• No formal registration required with State

4
Corporation

• One or more owners
• No personal liability (assuming formalities met)
• Registered with Secretary of State
• Managed by its Board of Directors who are elected
  by the owners
• Board names officers who run day-to-day
  operations
• Separate existence from its owners (perpetual
  life)
• Pays taxes
• Distributes profits via dividends to owners

5
AGENCY

• Principals and agents

6
AGENCY

• Elements of relationship
• 1. Principal manifests assent that agent act for
  principal and be subject to principals control
• 2. Agent manifests consent or otherwise consents
  to act.

7
Scope of Authority of Agent Derived From

• Actual authority that authority which principal
  has expressly granted to the agent or which agent
  reasonably believes was granted.
• Apparent authority that authority which
  principal has informed third party has been
  vested in agent
• Implied authority that authority reasonably
  required to accomplish the objectives of the
  agency

8
Corp Code 313

• Subject to the provisions of subdivision (a) of
  Section 208, any note, mortgage, evidence of
  indebtedness, contract, share certificate,
  initial transaction statement or written
  statement, conveyance, or other instrument in
  writing, and any assignment or endorsement
  thereof, executed or entered into between any
  corporation and any other person, when signed by
  the chairman of the board, the president or any
  vice president and the secretary, any assistant
  secretary, the chief financial officer or any
  assistant treasurer of such corporation, is not
  invalidated as to the corporation by any lack of
  authority of the signing officers in the absence
  of actual knowledge on the part of the other
  person that the signing officers had no authority
  to execute the same.

9
Importance of Disclosure of Agency

• Example of Disclosed Principal
• Alpha Corporation, Inc.
•  
• By ____________________
• George Smith, Pres.
• Other party aware of agency and principal.
• Principal alone is liable to third party.

10
FYI California and Agent Liability

• California courts generally do not employ the
  Restatement analysis, but appear to hold the
  agent liable, regardless of his or her disclosure
  of the fact of agency, unless the name of the
  principal is disclosed so as to make it appear on
  the face of the instrument that the parties
  intended to bind the principal and not the agent.
  (See Patterson v. John P. Mills Organization
  (1928) 203 C. 419, 421, Gambord Meat Co. v.
  Corbari (1952) 109 C.A.2d 161, 162, 240 P.2d 342
  agent liable on personal check sent in payment
  of principal's obligation
• And a disclosure only of the principal's trade
  name is not a sufficient disclosure of identity
  to relieve the agent of personal liability. (W.W.
  Leasing Unlimited v. Commercial Standard Title
  Ins. Co. (1983) 149 C.A.3d 792, 796.)
•  

11
Partially Disclosed Agency

• Aka unidentified principal in Restate. 3rd
  Agency
• Real estate agent represents anonymous purchaser.
  
• Why? To keep secret identity of purchaser
  because of publicity or in order to maintain
  negotiation advantage.
• Other party is aware of agency but not identity
  of principal.
• Both agent and principal liable to third party.

12
Undisclosed Agency

• Real estate agent represents that she is
  purchasing the property for herself.
• Why? Take advantage of personal relationship
  with seller to get better price.
• Other party unaware of agency or existence of
  principal.
• Both principal and agent liable.

13
Principals Liability for Torts of Agent

• Liable if agent has actual or apparent
  authority.
• Liable if principal ratifies the agents acts.
• Liable if negligent in selecting or
  supervising the agent
• Liable if agent negligent in performance of act
• Liable if agent is employee acting in course and
  scope.

14
Agent Is a Fiduciary

• A fiduciary duty is the highest standard of care
  at either equity or law. A fiduciary is expected
  to be extremely loyal to the person to whom he
  owes the duty (the "principal") he must not put
  his personal interests before the duty, and must
  not profit from his position as a fiduciary,
  unless the principal consents. The word itself
  comes originally from the Latin fides, meaning
  faith, and fiducia, trust.

15
PARTNERSHIP

• Entity v aggregate, etc

16
Aggregation vs Entity Theories

• Commonlaw (Aggregation)
• Partners held undivided but separate interests in
  property
• Partnership was not an entity distinct from its
  partners
• Withdrawing partner entitled to piece of each
  asset as is her estate
• Unanimous consent to admit new partner
• Partnership meant one exact constellation of
  partners. Any change resulted in dissolution.

17
Aggregation or Entity Theories

• Under Uniform Partnership Act, 1997
• Partnership is an entity distinct from the
  partners
• Withdrawing partner has no interest in
  partnership assets but only right to receive pro
  rata share of the value of assets
• Entity may continue on despite withdrawal or
  death of partner

18
Under Entity Theory

• CAL. CORP. CODE 16502 California Code -
  Section 16502
• The only transferable interest of a partner in
  the partnership is the partner's share of the
  profits and losses of the partnership and the
  partner's right to receive distributions. The
  interest is personal property.

19
Under UPA, Modern P/S a Hybrid

• Still an aggregation of partners in sense that
• Each partner individually (jointly and severally)
  liable for debts
• Pass through entity, invisible to taxing
  authorities each partner pays on her own income
  from the partnership

20
Formation

• CAL. CORP. CODE 16202
• (a)Except as otherwise provided in subdivision
  (b), the association of two or more persons to
  carry on as coowners a business for profit forms
  a partnership, whether or not the persons intend
  to form a partnership. (Emphasis added.)

21
Establishing a Partnership

• Majority Intent is key, as evidenced by conduct
  and circumstances.
• Minority Requires finding all of the following
• 1. A community of interest in the venture
• 2. An agreement to share profits
• 3. An agreement to share losses
• 4. A mutual right of control or management

22
RECAP OF PARTNER LIABILITY

• Restatement of Agency
• A Principal is liable for torts of employee if
  they are committed within the course and scope of
  employment
• Course and scope requires that there be some
  intent in the mind of the agent to serve the
  purposes of the principal
• Uniform Partnership Act
• Partnership is liable if partner is carrying on
  in the usual way the business of the partnership
  and has actual or apparent authority
• NO REQUIREMENT that the partner is motivated to
  benefit the partnership

23
The Usual Way

• American Rule partner must be acting
  consistently with the way that particular
  partnership operates.
• English Rule partner must be acting as do others
  in that type of business, whether or not usual
  for that particular partnership.
• UPA follows English Rule interpretation

24
California Corporations Code Section 16404
Excerpt

• The fiduciary duties a partner owes to the
  partnership and the other partners are the duty
  of loyalty and the duty of care set forth below
• A partner's duty of loyalty to the partnership
  and the other partners includes all of the
  following (3) To refrain from competing with
  the partnership in the conduct of the partnership
  business before the dissolution of the
  partnership.
• A partner shall discharge the duties to the
  partnership and the other partners under this
  chapter or under the partnership agreement and
  exercise any rights consistently with the
  obligation of good faith and fair dealing.
• A partner does not violate a duty or obligation
  under this chapter or under the partnership
  agreement merely because the partner' s conduct
  furthers the partner's own interest

25
The End Game of a Partnership

• Dissolution (or Dissociation)
• An event triggers the end of the partnership
• Winding Up
• The affairs of the partnership are concluded
• Assets liquidated or earmarked for distribution
• Taxes paid
• Creditors paid
• Partners are paid
• Termination
• All affairs are wound up

26
Dissociating Partner

• Within Rights Under Agreement
• Share as per agreement or per UPA
• Price if all assets sold as of date of
  dissociation at greater of liquidation value or
  going concern value, with interest
• In Violation of Agreement or Wrongful
• Same less
• Value of Goodwill (discretionary)
• Offsets for damage caused by wrongful
  dissociation
• Any other amounts owed by departing partner

27
LIMITED PARTNERSHIPS

• Form allows limited liability to limited partners
  provided they do not manage
• 1976 ULPA provided safe harbor if acts of
  limited confined to such things as
• Consulting with general partner re partnership
  affairs
• Requesting or attending meeting of partners
• Voting on matter relating to business affairs if
  subject of vote is one allowing approval or
  disapproval of limiteds
• Serving as agent or employee of LP

28
LLC

• liMITED Liability Companies

29
California Corporations Code Section 17153
The fiduciary duties a manager owes to the
limited liability company and to its members are
those of a partner to a partnership and to the
partners of the partnership.
30
California Corporations Code Section 17001

• (z) "Membership interest" means a member's rights
  in the limited liability company, collectively,
  including the member's economic interest, any
  right to vote or participate in management, and
  any right to information concerning the business
  and affairs of the limited liability company
  provided by this title.

31
California Corporations Code Section 17001

• (n) "Economic interest" means a person's right to
  share in the income, gains, losses, deductions,
  credit, or similar items of, and to receive
  distributions from, the limited liability
  company, but does not include any other rights of
  a member, including, without limitation, the
  right to vote or to participate in management,
  or, except as provided in Section 17106, any
  right to information concerning the business and
  affairs of the limited liability company.

32
LLC Re-Cap

• Creature of Contract
• Variation between states as to what the operating
  agreement can do with respect to
• Eliminating fiduciary duties, namely
• Duty of Care
• Duty of Loyalty
• California, for example,
• Cannot entirely eliminate duty of loyalty in
  operating agreement
• But can specify certain acts which will not
  constitute breach if not manifestly
  unreasonable.

33
Duty of Loyalty

• Duty to account for property or profit or benefit
  derived by the member from LLC property.
• Duty not to appropriate an LLC opportunity
• Duty to avoid conflicts of interest
• Duty to refrain from competing
• Acts in violation require consent of the members.

34
Duty of Care

• Duty to refrain from grossly negligent or
  reckless conduct, intentional misconduct, or a
  knowing violation of law.
• Agreement cannot unreasonably reduce this duty of
  care.

35
CORPORATIONS

• The rest of the story

36
Promoters and Pre-incorporation Liability

• Liability that of promoters until corporation
  adopts pre-incorporation agreements and other
  party agrees to novation, replacing promoter with
  corporation
• Contract language indicating promoter not to be
  personally liable may exonerate promoter

37
Overview of Corporate Structure
38
Incorporation Process Review
39
Incorporation Process Review

• Articles filed
• By laws prepared
• First meeting held of shareholders
• Elect Directors
• Make subchapter S election
• Directors meeting
• Adopt pre-existing agreements
• Appoint officers
• Authorize issuance of stock
• Authorize banking relationships

40
The Debt-Equity Relationship
41
Why Capitalize with Debt?

• You can keep (i.e., leverage) the cash you have.
• You retain ownership (control) of the business
• Interest payments are tax-deductible
• Generally easier to sell debt because you dont
  have to convince someone that the company will
  grow, only have to convince them that theyll get
  paid back (and they get paid first).
• Lender is first in line to get paid if must
  liquidate assets
• Have a good return on investment (ROI)

42
Advantages of Selling Equity

• Motivate buyer to pull for the success of the
  company
• Doesnt use precious cash
• No obligation to re-pay
• Can print more when needed

43
Disadvantages of Selling Equity

• Usually requires giving up at least some control
• Allows camels nose under the tent
• Dividends are not deductible from corporate tax

44
Types of Equity

• Common Stock
• Preferred Stock
• Convertible preferred stock
• Warrants

45
Status of Shares

• Validly Issued
• Board has authorized and Dept of Corporations has
  issued authorization
• Fully Paid
• All consideration has been received
• Non-assessable
• The holder of the shares has no obligation to
  honor any assessments against the shares

46
Common Stock

• Required to be issued
• Usually carries voting power
• May or may not have par value
• First in line in terms of control, last in line
  in terms of getting paid on liquidation

47
Preferred Stock

• Preference given as to
• Dividends
• Liquidation of the companys assets
• May also allow certain rights if the dividends
  are not paid (such as electing a number of
  directors)

48
Convertible Preferred Stock

• Preferred stock that carries with it right to
  convert to common stock

49
Warrants

• Are issued by the corporation
• Give the owner the right to acquire common stock
  in the future for a specified price
• Usually added as an enticement to lenders but may
  be sold independently

50
Capital Contribution Issues

• Watered Stock
• Shareholder liable to creditors to extent stock
  has not been paid for
• Measured by difference between shares value and
  what was (was not) paid
• Comes up where
• Did not pay par for the stock or
• Value of the consideration given was overstated

51
Concept of Par

• Originally a tool to control maximum and minimum
  capitalization of the corporation
• Evolved into baseline reserve to protect
  creditors
• Today largely meaningless

52
THE PLAYERS, REVISITED

• SHAREHOLDERS
• Elect directors
• Usually must ratify certain acts of directors
• Resolution to dissolve
• Resolution to merge with another entity
• Resolution to sell principal assets
• Resolution to change corporate purpose
• Resolution to amend by-laws or charter

53
VOTING

• Statutory (or Regular) Voting
• One vote per share, each directorship voted on
  independently
• i.e., Jim has 500 shares, there are 3
  directorships up for election. Jim can vote his
  500 shares for each of the 3, but cannot
  accumulate his 1500 votes and put all on one
  directorship.
• Cumulative Voting
• One vote per share multiplied by the number of
  directorships up for election. Total number of
  votes can be allocated as shareholder wishes
• i.e., Jim can cast all 1500 votes for one
  director.

54
THE PLAYERS, REVISITED

• DIRECTORS
• Charged with day-to-day operations of entity
• Hire and Fire Officers
• Bear ultimate responsibility for conduct and
  misconduct of the corporation

55
The Corporations Foundational Documents

• Articles (Charter)
• By Laws
• Shareholder Agreements Between Themselves
• Buy-sell Agreements
• Aka Cross-purchase Agreements
• Survivor Purchase Agreement
• Corporations Agreements To Repurchase Stock
• Stock purchase Agreement
• Aka Redemption Agreement

56
Closely Held vs Statutory Close Corporation

• Any corporation can be held by a small number of
  shareholders. One shareholder is not uncommon.
• A closely held corporation is a term with no
  particular legal significance other than to mean
• Few shareholders
• Most of whom participate in management
• No general market for the stock (because of
  limitations on control and liquidity) and
• Some limitations on transfer of the stock
• Courts now widely allow shareholders to control
  management via controlling directors powers.

57
Statutory Close Corporation

• Specifically so-identified in Articles
• Limited as to number of shareholders possible,
  usually 30 or 35.
• Stock certificates must bear legend detailing
  that there are restrictions on transfer
• Prohibited from making a public offering
• If adhere to rules, statutes allow exemption from
  claims regarding improper limits on directors
  powers
• Delaware allows shareholders to manage directly
  without a board of directors.

58
When You Need Shareholder Agreements

• To maintain exemption from securities
  registration requirements
• i.e., a restriction that shareholder cannot
  transfer to a citizen of another state
  (triggering interstate sales issue)
• To maintain subchapter S status
• i.e., a restriction that you cannot sell to a
  partnership or corporation which would exceed
  limit of 75 shareholders
• To maintain professional corporation status
• i.e., cannot sell to unlicensed person

59
When You Need Shareholder Agreements

• To Maintain Effectiveness of a Pooling Agreement
• i.e., if parties pool shares under agreement to
  keep X off the board, important no one conveys
  their shares to X.

60
Restrictions

• May be absolute
• Prohibits transfer altogether (usually
  unenforceable)
• May require others consent
• Typically requires director or shareholder
  approval
• May limit class of possible transferees
• Must be family members
• Must be CPA
• Must be non-competitor

61
Examples of Restrictions

• Buy-Out Agreements
• Whereby anyone desiring to sell must offer to
  designated others on same terms, so-called right
  of first refusal.
• Whereby someone who may lose control of stock in
  a divorce is obliged to sell to other
  shareholders or to the corporation
• Whereby the estate of a deceased shareholder must
  sell to the others

62
Pricing the Shares

• Three usual approaches
• Book Value
• What do the accounts show the shares are worth if
  you divide the number of outstanding shares into
  the number you get when you subtract the
  liabilities from the assets?
• Liquidation Value
• What would you get if you closed the doors, sold
  all the assets, paid all the debts, and divided
  the money up?
• Cash Flow or Earnings
• What would an investor be willing to pay today to
  own a company that generates the profits your
  company generates?

63
Recording the Corporate History

• All States Require Minutes be Maintained
• Calif Corps Code 314
• The original or a copy in writing or in any other
  form capable of being converted into clearly
  legible tangible form of the bylaws or of the
  minutes of any incorporators', shareholders',
  directors', committee or other meeting or of any
  resolution adopted by the board or a committee
  thereof, or shareholders, certified to be a true
  copy by a person purporting to be the secretary
  or an assistant secretary of the corporation, is
  prima facie evidence of the adoption of such
  bylaws or resolution or of the due holding of
  such meeting and of the matters stated therein.

64
By Laws

• Must conform to the Articles
• Must conform to the law
• e.g., by-law prohibiting any transfer of interest
  would be unenforceable

65
California Corps Code 204

• The articles of incorporation may set forth (a)
  Any or all of the following provisions, which
  shall not be effective unless expressly provided
  in the articles
• (5) A provision requiring, for any or all
  corporate actions the vote of a larger
  proportion or of all of the shares of any class
  or series, or the vote or quorum for taking
  action of a larger proportion or of all of the
  directors, than is otherwise required by this
  division.

66
Calif. Corporations Code Section 603(d)

• (d) Notwithstanding subdivision (a), directors
  may not be elected by written consent except by
  unanimous written consent of all shares entitled
  to vote for the election of directors provided
  that the shareholders may elect a director to
  fill a vacancy, other than a vacancy created by
  removal, by the written consent of a majority of
  the outstanding shares entitled to vote.

67
Postscript on Consents

• Model Act now allows electronic or other consents
  without unanimity and without notice to all
  shareholders if
• Articles of Incorporation provide for passage by
  majority vote, and
• The action is approved by consents signed, even
  electronically, by a majority of eligible voters
• By default, Directors are to be elected by
  plurality (rather than cumulative vote or
  majority vote)
• True both under Model Act and Delaware law
• BUT, bylaws may provide for majority or other
  constraint

68
Pillsbury v Honeywell

• Shareholders Rights
• Right to review corporate records is not
  unlimited
• Must be for a proper purpose germane to his
  interest as a stockholder Del. Code, Title 8,
  220.
• Proper purpose means a concern relating to
  investment return
• BUT investment return can include shareholder
  motivated by desire to take control of the
  corporation

69
Who Has the Power to Act for Shareholder?

• Shareholder of record
• Proxy
• Assignee (Pledgee) if assignment or pledge so
  allows

70
The Powers and Duties of the Board

• It is a Board, not a gathering of Generals
• No director has any power acting alone
• Their only power derives from decisions they make
  acting as a Board and which are recorded in the
  minutes of the corporation
• Power of directors is original and undelegated.
  Their powers are not granted by others but
  originate with their election to the Board.
• Directors power comes from the state, if
  anywhere.
• The relation of directors to shareholders is that
  of trustee to beneficiaries.

71
The Powers and Duties of the Board

• May Delegate Some of Its Duties
• Where large board, usual to allow for
  subcommittees to operate with relative autonomy
• Executive Committee is common device, organized
  to handle decisions or required resolutions (such
  as approval of significant contract) when full
  board cannot be readily convened.
• In Public Corporations, Usually See Inside and
  Outside Directors
• Inside are also officers of corporation
• Outside are recruited from other corporations,
  public service, etc.

72
The Powers and Duties of the Board

• Key Functions
• Provide advice and counsel
• Instill discipline in the decision-making of the
  corporation
• Oversee crises
• Monitor the conduct of Management

73
REMOVAL OF DIRECTORS

• Tension between treatment of shareholders who are
  also directors
• They want security against removal
• And treatment of directors who are not
  shareholders
• Shareholders do not want to have any impediment
  to voting such directors out.
• RULE Under Model Act statutes, cannot deny
  shareholders right to remove with or without
  cause.
• May require supermajority to remove
  shareholder-director without cause, however.

74
Tools for Dealing with Deadlock or Misconduct

• Judicial Dissolution
• Buyout of dissenting shareholder
• Appointment of custodial director or manager
• Arbitration provision in bylaws or other contract

75
VOTING TRUSTS

• Under Model Act, requires
• Writing
• Setting out provisions
• 10 yr limit (can be extended by some or all)
• Delivery to corporations principal office

76
POOLING AGREEMENTS

• Widely used to pool smaller stock holdings into
  a unit having power to influence Board or
  corporate actions
• Generally provide for process to pre-vote an
  issue put to the shareholders, then cast all
  shares in pool for winner of the internal vote.
• Agreements are contracts and enforced as such
• Equitable relief now available via statute
• Previously courts could only remedy breach by
  damages

77
Shareholder Agreements

• Liberally construed in closely held corporations
• BUT, under Model Act,
• Must be included in writing filed with the
  corporation
• Must be unanimously approved by all shareholders
  at time of creation
• Must be included in articles or bylaws or in a
  separate writing
• BUT
• Cannot eliminate fiduciary duties of officers and
  directors,
• Are not binding on creditors or third parties
• Are not binding on shareholders without knowledge

78
GALLER V GALLER

• Held Shareholder agreement not violative of
  public policy unless
• Violates an express statement of policy or
• Is manifestly injurious to public welfare and
• Where corrupt or dangerous tendency clearly
  appears on face of agreement or is part of a
  corrupt scheme and disguised to conceal true
  nature of the transaction

79
Sea-Land Rule

• Corporate entity will be disregarded and veil of
  limited liability pierced if
• There is a unity of interest and ownership such
  that the separateness of the personalities of the
  entity and the individual (or other entity) no
  longer exists
• Circumstances must be such that adherence to the
  fiction of separateness would
• SANCTION A FRAUD
• PROMOTE INJUSTICE

80
Sea-Land Rule Promote Injustice?

• Means more than that a creditor will go unpaid.
• There must be a wrong beyond creditors inability
  to correct, e.g.,
• Unjust enrichment to person or entity who looted
  corporation
• Scheme to move assets to one entity and
  liabilities to another
• Must be sufficient to merit the evocation of
  the courts equitable powers.

81
Piercing Based on Agency Analysis

• Where person uses a corporation as a shield to
  pursue the persons interests and activities,
  effectively same conduct as if used any other
  agent
• Therefore, liability imposed on principal via
  respondeat superior
• No matter if agents wrongdoing arises in
  contract or tort

82
Declaring Dividends

• Highlights the tension between creditors and
  shareholders
• CREDITORS do not want money taken out of the
  corporation until they have been paid
• SHAREHOLDERS like dividends because
• (a) represents a return on investment that is no
  longer subject to market forces
• (b) declaring a dividend signals optimism about
  the future and often drives the share price
  higher.

83
Basic Policy Objective Protect the Creditor

• Limit so that dividends can only be paid from
  surplus after sufficient capital held in
  reserve to pay debts.

84
Solely Within Authority of Directors

• Holders of common shares have no vested right to
  a dividend
• Some preferred shares carry right to a dividend
  and enforcement power (such as right to name
  directors) if required dividend is not paid to
  preferred shareholders
• Courts will not interfere with directors
  decision to declare or withhold dividend absent
  showing of fraud, bad faith or abuse of
  discretion by directors
• BUT once a dividend is declared, shareholders may
  enforce in court

85
TYPES OF SURPLUS

• Capital surplus
• Excess portion of price received by corporation
  for its stock after subtracting the par value
• Plus any amount directors deem necessary
  (sometimes required by creditors)
• Earned surplus
• Earning of the company from operations after
  subtracting liabilities and net of capital
  accounts
• Reduction surplus
• The amount directors vote to take out of Stated
  Capital (e.g., by reducing par or because
  augmented from capital surplus and now unwinding
• Revaluation surplus
• The amount of previously unrealized appreciation
  directors choose to recognize (and which moves
  into earned surplus)

86
Stock Dividends

• Issue additional shares in lieu of cash.
• Reasons
• Dont want to spend the cash but want to appease
  shareholders
• Want to increase voting rights of pro-board
  shareholders in case of takeover bid
• Need to issue more shares to make an offering
  work and must issue stock dividends to keep
  voting rights intact
• Drives down stock price somewhat (because more
  shares over which ratios operate, such as
  earnings per share)

87
Directors Duty of Care

• Francis v United Jersey Bank
• Director is fiduciary of the corporation and its
  shareholders
• And in the context of the business of the
  corporation, may be a fiduciary to its creditors
• Where there is constructive or actual trust
• Director must discharge duties in good faith and
  with that degree of diligence, care and skill
  which ordinarily prudent men would exercise under
  similar circumstances in like positions

88
Francis v United Jersey Bank

• Where director breaches duty, personally liable
  if negligence was a proximate cause of a loss to
  the creditor or shareholder or corporation
• Plaintiff has burden of showing loss would have
  been avoided if defendant had performed her
  duties
• Analysis includes determination of reasonable
  steps director should have taken
• BUT causation will be inferred where reasonable
  to conclude particular result from a failure to
  act and that result has occurred.

89
Caremark

• Director liability can be grounded on several
  theories
• Liability following poor decision by board
  because decision was negligent and ill advised
• Liability based on failure to act where due
  diligence would prevent the loss
• BUT, absent cause for suspicion there is no
  dutyto install and operate a system of corporate
  espionage to ferret out wrongdoing that they have
  no reason to suspect exists.

90
Caremark contd

• There must be a system in place adequate to
  assure the board that appropriate information
  will come to its attention in a timely manner
• Failure to insist upon and maintain such a system
  may render a director liable

91
Caremark contd

• Plaintiffs must show
• Director knew or
• Should have known were violations of law
• Took no steps to prevent or remedy
• Failure proximately caused the loss

92
The Business Judgment Rule

• Applies when what is at issue is a business
  decision made by the directors
• Does not come into play where directors are
  accused of failing to monitor or similar
  derelictions of the duty of care, only when
  making a business decision

93
The Rule

• Absent fraud, illegality or conflict of interest,
  a director who acts in good faith is not
  personally liable for mere errors of judgment
  short of CLEAR AND GROSS NEGLIGENCE
• Shlensky v Wrigley 237 N.E. 2d 776 (Ill. 1968)
• Unless director(s) had an interest in the subject
  of the decision or
• Unless decision constitutes illegal conduct
  (e.g., decision to pay a bribe)

94
ALI Version

• No liability for a business judgment reached in
  good faith provided
• 1. Director or officer was disinterested
• 2. Director or officer was informed as to the
  subject of the decision to a degree the director
  or officer reasonably believes appropriate and
• 3. Rationally believes decision is in the best
  interests of the corporation

95
SMITH V VAN GORKOM

• "Informed" within meaning of "due care" means
  board reviewed all material information
  reasonably available
• Liability under Business Judgment Rule arises
  only where there is a showing of gross
  negligence, meaning something more careless than
  ordinary negligence.
• E.g., failure to even read a report which was
  itself deficient

96
Delaware Gen Corp Law Sec. 141
(e) A member of the board of directors, or a
member of any committee designated by the board
of directors, shall, in the performance of such
member's duties, be fully protected in relying in
good faith upon the records of the corporation
and upon such information, opinions, reports or
statements presented to the corporation by any of
the corporation's officers or employees, or
committees of the board of directors, or by any
other person as to matters the member reasonably
believes are within such other person's
professional or expert competence and who has
been selected with reasonable care by or on
behalf of the corporation.
97
Shareholder Ratification

• Shareholders may ratify acts of even interested
  directors PROVIDED shareholders are fully
  informed
• Burden is on directors to establish shareholders
  were fully informed

98
Model Act

• SECTION 8.30. GENERAL STANDARDS FOR DIRECTORS
• (a) A director shall discharge his (sic) duties
  as a director, including his (sic) duties as a
  member of a committee
• (1) in good faith(2) with the care an
  ordinarily prudent person in a like position
  would exercise under similar circumstances
  and(3) in a manner he (sic) reasonably believes
  to be in the best interests of the corporation.
• (b) In discharging his (sic) duties a director is
  entitled to rely on information, opinions,
  reports, or statements, including financial
  statements and other financial data, if prepared
  or presented by
• (1) one or more officers or employees of the
  corporation whom the director reasonably believes
  to be reliable and competent in the matters
  presented(2) legal counsel, public accountants,
  or other persons as to matters the director
  reasonably believes are within the person's
  professional or expert competence or(3) a
  committee of the board of directors of which he
  (sic) is not a member if the director reasonably
  believes the committee merits confidence.
• (c) A director is not acting in good faith if he
  (sic) has knowledge concerning the matter in
  question that makes reliance otherwise permitted
  by subsection (b) unwarranted.
• (d) A director is not liable for any action taken
  as a director, or any failure to take any action,
  if he (sic) performed the duties of his (sic)
  office in compliance with this section.

99
Calif. Corp Code Sec. 309

• (a) A director shall perform the duties of a
  director, including duties as a member of any
  committee of the board upon which the director
  may serve, in good faith, in a manner such
  director believes to be in the best interests of
  the corporation and its shareholders and with
  such care, including reasonable inquiry, as an
  ordinarily prudent person in a like position
  would use under similar circumstances.
• (b) In performing the duties of a director, a
  director shall be entitled to rely on
  information, opinions, reports or statements,
  including financial statements and other
  financial data, in each case prepared or
  presented by officers, consultants, etc.
• (c) A person who performs the duties of a
  director in accordance with subdivisions (a) and
  (b) shall have no liability based upon any
  alleged failure to discharge the person's
  obligations as a director. In addition, the
  liability of a director for monetary damages may
  be eliminated or limited in a corporation's
  articles to the extent provided in paragraph (10)
  of subdivision (a) of Section 204.