Exam Answer Outline
1
Corporations
Professor Bradford
Fall 2006
Exam Answer Outline
The following answer outlines are not intended to be model answers, nor are they intended to include every issue students discussed. They merely attempt to identify the major issues in each question and some of the problems or questions arising under each issue. They should provide a pretty good idea of the kinds of things I was looking for. If you have any questions about the exam or your performance on the exam, feel free to contact me to talk about it.
I graded each question separately. Those grades appear on your printed exam. To determine your overall average, each question was then weighted in accordance with the time allocated to that question. The following distribution will give you some idea how you did in comparison to the rest of the class:
Question 1: Range 2-8; Average = 5.48
Question 2: Range 2-8; Average = 5.67
Question 3: Range 0-9; Average = 4.81
Question 4: Range 4-9; Average = 6.60
Question 5: Range 2-9; Average = 6.31
Question 6: Range 0-9; Average = 5.73
Total (of unadjusted exam scores, not final grades): Range 3.66-8.07; Average = 5.87
Question 1
Enforceability of the Exculpatory Provisions
Section 403(b) of the RULPA says a general partner has the same liabilities as a partner in a general partnership “[e]xcept as provided in this Act or in the partnership agreement.”
The RULPA doesn’t impose any limits on how the partnership agreement may limit fiduciary duties. Section 403(b) refers one to general partnership law, except as provided in the agreement; if the agreement provides for no liability, one doesn’t even get to RUPA and § 103(b). Therefore, the provision in the agreement that Gina shall not be liable for transactions in which she has a fiduciary duty is enforceable.
Alternatively, one might argue that, since RULPA does not specifically say what is allowable in the partnership agreement, one must go to RUPA under RULPA’s general incorporation provision. Under RUPA § 103(b)(3), the agreement may not eliminate the duty of loyalty, but may “identify specific types or categories of activities” that don’t violate the duty, if that is “not manifestly unreasonable.” The issue is whether eliminating all liability for self-dealing is really specific categories of activity and, if it is, whether such a broad provision is manifestly unreasonable. Under this incorporation argument, the provision in the partnership agreement might not be enforceable.
If the Exculpatory Clause is Not Enforceable
If the exculpatory provision is not enforceable, this transaction is a pretty clear violation of RUPA § 404(b)(2), which covers self-dealing. Gina would have the burden of proving that the transaction was fair to the partnership. Her honest belief that this equipment was the best would not suffice, and the cheaper transactions she considered creates a serious fairness issue. The approval by the limited partners would not protect her because they were not even aware of the self-dealing problem.
If the Exculpatory Clause is Enforceable
There is a potential problem even if the exculpatory provision is enforceable. The problem here arises from the required limited partner approval of the transaction. Limited partners generally have no rights to information except on demand. RULPA § 305. However, in a situation like this, where they are asked to approve a transaction in which the general partner has a personal interest, one could convincingly argue that the limited partners should at a minimum be informed of the conflict of interest.
The partnership agreement eliminates the fiduciary duty problem with the conflict of interest. It does not say that non-disclosure is not a potential fiduciary duty problem. As to anything not covered by the partnership agreement, § 403(b) refers us to the law of general partnerships.
Section 404(b) or RUPA incorporates a traditional duty of loyalty. Section (b)(2) covers the traditional self-dealing transaction, but the partnership agreement overrides that. Nothing in 404(b) appears to say anything about disclosure. Cases like Meinhard seem to find a breach of duty in non-disclosure, but 404(a) says the only fiduciary duties are those in the statute.
Perhaps a disclosure obligation arises from the 404(d) obligation of good faith and fair dealing. Alternatively, RUPA 403(c)(1) requires a partner to furnish to partners “without demand” any information “reasonably required for the proper exercise of the partner’s rights and duties” under the partnership agreement. Information about Gina’s conflict of interest would probably be necessary for the limited partners to exercise their approval rights effectively. The problem is that RULPA § 404(b) only refers to general partnership law “[except as provided in this Act,” and RULPA itself has an information provision that is not as broad. One could argue that the RULPA information provision applies, and therefore one does not refer to RUPA’s information requirements. Or perhaps you could argue that RULPA contemplates silent limited partners and, when the partnership agreement gives the limited partners additional rights, it contemplates they will receive the disclosure necessary for them to exercise those rights.
Question 2
As a director and officer, Farah owes fiduciary duties to PLUM. She breaches those duties if she takes an opportunity that belongs to PLUM.
Section 8.70 of the MBCA
The RMBCA has little to say about corporate opportunities. Section 8.70(a) says a director is not liable for taking an opportunity if the opportunity is approved by qualified directors pursuant to § 8.62 or by the shareholders pursuant to § 8.63. There was neither board nor shareholder approval here, so § 8.70(a) does not help. It’s not clear § 8.70 would help in any event as it only applies to directors, and Farah was probably acting as an officer when this opportunity came to her attention.
Section 8.70(b) says the failure to use the procedures specified in 8,70(a) does not create any inference that the opportunity should have been offered to the corporation and does not change the otherwise applicable burden of proof. Thus, we must look to case law to decide if Farah has taken a corporate opportunity and breached her fiduciary duties.
Corporate Opportunity Tests
1. ALI Principles of Corporate Governance § 5.05
Various tests have been used by courts to decide whether a director’s taking of a business opportunity is a breach of fiduciary duty. One approach is that in §5.05 of the ALI Principles of Corporate Governance. Under § 5.05(a)(1), in no case may a director or senior executive take advantage of a corporate opportunity unless it is first offered to the corporation. Farah did not offer the Turbo Toys contract to PLUM, so she has violated her duties if the contract is a corporate opportunity, as defined in § 5.05(b).
This could be a corporate opportunity within § 5.05(b)(1)(A) if Farah became aware of it “in connection with the performance of functions as a director or senior executive.” Farah found out about the opportunity while visiting Gretta concerning PLUM business, but it was during a golf outing that was not part of her original plans. However, it’s likely that PLUM paid for the extension of the trip, and Farah was socializing with Gretta only for purposes of client relations—they weren’t otherwise friends. This therefore seems to fall within subsection (b)(1)(A).
Another possibility is subsection (b)(1)(B). Farah used corporate property to pay for the trip, and the resulting opportunity is one she might reasonably expect PLUM to be interested in, given their need for cash, their expertise in distribution, and their discussions about going into other lines of business. But this may be stretching the “use of corporate property” requirement; she used corporate property to get there, but not really to become aware of the opportunity. The connection between the corporate property and the opportunity is rather remote.
Alternatively, subsection (b)(2) might apply. Farah is a senior executive, so this subsection applies to her, and her contract with Turbo is to distribute products, which is what PLUM does. However, PLUM distributes produce and Turbo distributes toys, so it’s not clearly if they’re “closely related.” Given the “expects to engage” language and PLUM’S discussions of going into other lines of business, perhaps “closely related” would be construed a little more broadly in this case. However, the fit is questionable.
2. The Guth v. Loft Test
Another corporate opportunity test we discussed was the Guth v. Loft test followed by Delaware. This test balances seven factors to determine whether a business opportunity belongs to the corporation or may be taken individually. PLUM has the financial ability to take advantage of the opportunity. (PLUM has little cash, but the opportunity appears to require little cash). Whether the opportunity is within the corporation’s line of business depends, as discussed above, on how broadly you define the line of business—is it marketing produce or marketing generally? The corporation has no interest or expectancy in this particular opportunity, although it is looking for new lines of business. Taking the opportunity arguably will put Farah in a position inimical to her duties with PLUM; she is forced to resign as vice-president to take the opportunity. It’s not clear whether the opportunity was presented to Farah in her corporate or individual capacity. Probably in her individual capacity, as Gretta addressed it to her personally and they were playing golf at the time. On the other hand, she was there on behalf of PLUM and that’s why she was playing golf with Gretta. The opportunity is arguably essential to the corporation; it is desperately looking for some way to generate more cash. The final factor is whether Farah wrongfully employed corporate resources in pursuing or exploiting the opportunity. The company paid for the trip on which she discovered the opportunity, although, as discussed previously, this is a fairly weak use of corporate resources.
Whether taking this opportunity is a breach of duty under the Guth v. Loft test depends on how the court balances these factors. No single factor is determinative and the ultimate resolution is really more a matter of equity.
Question 3
1. Rule 14e-3
Bob clearly would not violate Rule 14e-3 if he purchased Small’s shares. The information he possesses is not about a tender offer, which is all Rule 14e-3 covers.
2. Rule 10b-5
Rule 10b-5 itself doesn’t say much about insider trading. However, Chiarella said that, for trading on non-public information to violate Rule 10b-5, there must be some violation of fiduciary duty.
a. Classical insider trading: Texas Gulf Sulphur
Bob himself owes not fiduciary duty to Small; he is not an officer, director, or employee of Small, so there is no classical insider trading violation as in Texas Gulf Sulphur. Nor is Bob a “temporary insider” within the meaning of fn. 14 of Dirks. He is not working for Small, nor is there any expectation of confidentiality.
b. Tippee liability: Dirks
Bob is not a tippee with possible liability under Dirks. No insider of Small disclosed this information to him for personal gain or to give him a gift. Bob discovered the information through his involvement in the contract negotiations.
c. Misappropriation: O’Hagan
Bob owes a fiduciary duty to his employer, Giant. Bob can be liable under Rule 10b-5 if he uses information belonging to Giant in breach of his fiduciary duty without disclosure.
However, Bob’s use of the information does not affect Giant or Giant’s shareholders in any way. The information about the contract is probably not even material as to Giant; this contract is only a small percentage of its purchases. Giant has done nothing to show an expectation that Bob will keep the information confidential, nor has Bob expressly agreed to keep the information confidential. Bob may, however, have a duty arising out of past practice with Giant to keep nonpublic information confidential. Rule 10b5-2(b)(3).
If Bob is concerned about his duty to Giant, he can disclose to them that he is buying Small stock. With such disclosure, there will be no nondisclosure that any potential fiduciary duty to Giant would make fraudulent under Rule 10b-5.
Bob owes no duty of confidentiality to Small, as there is no agreement or understanding to keep the information confidential, nor have there been any prior dealings that might establish a relationship of confidence. See Rule 10b5-2(b). Therefore, his nondisclosure to Small does not result in fraud in violation of Rule 10b-5.
Question 4
Effect of Alpha’s Withdrawal
Design Unlimited is a term partnership; its term expires on July 1, 2007. Alpha’s withdrawal on Oct. 15 constitutes a dissociation—he expressed his will to withdraw as a partner. UPA § 601(1). He may dissociate even though the agreement provides for continuation. UPA § 602(a). However, his dissociation is wrongful because he withdrew before the term expired. UPA § 602(b)(2). He is therefore liable to the partnership and the other partners for any damages caused by the dissociation. UPA § 602(c). Alpha’s dissociation does not dissolve the partnership. See § UPA 801(2).
Effect of Beta’s Withdrawal
Beta’s withdrawal 10 days later is also a dissociation. UPA § 601(1). However, Beta’s dissociation is not wrongful, so he’s not liable for any damages. Section 602(b)(2)(i) says a withdrawal by express will before expiration of the term is wrongful unless it follows within 90 days after, among other things, another partner’s wrongful dissociation. Beta’s withdrawal was within 90 days of Alpha’s wrongful dissociation.
Beta’s dissociation does result in dissolution of the partnership. There are two partners remaining after Alpha’s wrongful dissociation; Beta is at least half of the remaining partners and he expressed his will to wind up through his § 602(b)(2)(i) rightful dissociation. Therefore, under § 801(2)(i), the partnership is dissolved and must be wound up.
Winding Up
There does not appear to be any remaining business to wind up; if there is, the partnership continues for the purpose of winding up that business. UPA § 802(a). Both Beta and Gamma may participate in the winding up process but not Alpha, because he wrongfully dissociated. UPA § 803(a).
Allocation of Profits and Losses
The creditors must first be paid. UPA § 807(a). Once the assets are liquidated and the creditors paid, that leaves a net of $1,000. There is now a total of $13,000 in the partners’ capital accounts, so this represents a net capital loss to the partnership of $12,000. This must be allocated among the partners. UPA § 807(b). The partnership agreement apparently says nothing about the allocation of losses; in that case, they are allocated in the same proportion as profits, 50% to Gamma, and 25% to the two others. UPA § 401(b). Thus, the amount in Alpha’s capital account will be $1,000 – (.25 x $12,000) = -$2,000. Beta’s capital account will be $4,000 – (.25 x $12,000) = +$1,000. Gamma’s capital account will be $8,000 – (.5 x $12,000) = +$2,000. Alpha is required to contribute $2,000 to the partners; Beta should receive $1,000; and Gamma should receive $2,000. Alpha’s contribution plus the $1,000 remaining will be just enough to pay Beta and Gamma.
Damages for Wrongful Dissociation
There remains, however, Alpha’s liability for wrongful dissociation. The only possible damage indicated in the problem is the lost Capital Construction contract. This presents an interesting causation problem because the loss really results when Beta withdraws. Alpha’s dissociation alone would not have lost the contract, so he can argue he’s not responsible for these lost profits. On the other hand, Beta could not withdraw without liability but for Alpha’s dissociation, so Alpha’s dissociation indirectly caused the loss. It’s a tough issue. If the court decides that Alpha’s dissociation caused the lost profits, Alpha must pay $7,500, to be split between Beta and Gamma in accordance with their respective percentages: 2/3 (50/75) to Gamma = $5,000 and 1/3 (25/75) to Beta = $2,500.
Question 5
Action by Written Consent
Del. § 228 says that any action that could be taken at an annual or special meeting may be taken through signed written consents executed by “the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action act a meeting” at which all the shares entitled to vote are present. Thus, assuming the consents are in proper form, Watson is removed if 76,000 votes would be sufficient to remove him at a meeting. Nothing is wrong with using the written consent procedure to do so.
Removal Generally
Del. § 141(k) deals with the removal of directors. Generally, it says that any director may be removed with or without cause by a majority of the voting shares. However, there are special provisions dealing with cumulative voting and directors elected only by a particular class of shares. Both of those special provisions apply here.
Removal Where Elected by Classes
First, the last paragraph of § 141(k) makes it clear that, when the holders of a particular class of shares elect a director, that director may be removed without cause only by a vote of that class. Thus, since removal here is without cause, only the Class X shareholders’ votes are considered.
Removal Where Cumulative Voting is Authorized
Second, if cumulative voting is authorized, as it is here, Watson may not be removed without cause if the votes against removal would have been sufficient to elect him at an election of the class of directors of which he is a part. Since Watson is being removed without cause, this provision also applies. (The fact that shareholders haven’t voted cumulatively in the past is irrelevant, as long as the articles authorize cumulative voting.) At a normal election of the three Class X directors, each share would be entitled to 3 votes (the number of directors being elected by the class). See Del. § 214. The total number of votes would be 300,000. The number of shares required to elect one director, using the formula, would be N = [S/(D + 1)] + 1, where S is the total number of shares voting and D is the number of directors to be elected. Therefore, N = [100,000/(3 +1)] + 1 = 25,001. Even if all the non-consenting voters voted to retain Watson, he would only have 24,000 votes. Therefore, § 141(k)(ii) does not protect him. He has been removed.
Question 6
Requirements for Dismissal
The Model Act requires the court to dismiss the action only if the corporation’s motion meets the requirements of § 7.44. For dismissal to be required, one of the groups specified in 7.44(b) or (e) must have decided that the derivative action is “not in the best interests of the corporation.” Moreover, that conclusion must be made in good faith after a reasonable inquiry.