Business Associations Spring 2007 Hauser

I. Types of Enterprises
I. Proprietorship
a. An individually owned business that has no separate legal status apart
from the owner.
i. Ex: A mom and pop grocery store
b. Formation No formalities required
c. Advantages
i. Control, simplicity
ii. Taxes the business is not taxed separately
d. Disadvantages
i. Unlimited liability
ii. Lack of independent management
II. Partnership
a. UPA 6(1); NCGS 59-36(a) An association of two or more persons to
carry on as co-owners of a business for profit
b. Formation No formalities required
c. Advantages
i. Taxes business not taxed separately
ii. Control, relative simplicity
d. Disadvantages
i. Partners are personally liable for contract or tort damages incurred
by other partners or agents
III. Limited Partnership
a. Entity with two classes of partners
i. At least one general partner unlimited liability
ii. At least one limited partner limited liability
b. Formation Must be organized under state law
c. Advantages
i. Separation of ownership and control
ii. Limited liability for limited partners
d. Disadvantages
i. Unlimited liability for general partners
ii. Taxes more complicated
IV. Limited Liability Company (LLC)
a. A hybrid business form, developed to protect from liability and from
double taxation
b. Formation
i. Must be organized under state law
c. Advantages
i. Limited liability for all owners
ii. Separation of ownership and control
iii. Taxes may be passed to members to avoid double taxation
d. Disadvantages
i. Transfer of ownership may be restricted to the terms of the
operating agreement

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Business Associations Spring 2007 Hauser

V. Limited Liability Partnership (LLP)

a. A hybrid business form, developed to protect from liability and from
double taxation
b. Formation
i. Must be organized under state law
c. Advantages
i. Allows partners to shield themselves from tort liability committed
by other partners
ii. Pass-through taxation
d. Disadvantages
i. Partner remains responsible for own torts
ii. Difficult to transfer partnership interests
VI. Corporations
a. A legal entity that is entirely separate from its owners
b. Formation
i. Must be organized under state law
c. Advantages
i. Limited liability for all owners (shareholders)
ii. Separation of ownership and control. Owners may invest capital
without assuming management or incurring risk of loss (beyond
their share value)
d. Disadvantages
i. Double taxation
ii. Management might have its own self-interest in mind
e. Double Taxation of a C Corp

PROFIT

TAXED
TO CORP

STARBUCKS,
INC.
$
$

TAXED TO
SH
SHAREHOLDER
S

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Business Associations Spring 2007 Hauser

VII. C corporation vs. S corporation

a. A C corp. is taxed under 26 USC 11 and Subchapter C of the IRC
i. Unlike an S corp., a C corp.s income is taxed
b. An S corp. is taxed under Subchapter S of the IRC
i. S corps dont pay income tax on its profits but the shareholders
pay taxes on their shares
ii. An S corp. cant have more than 100 shareholders

AGENCY
I. Restatement 2d Agency (RSA) 1
a. Agency is the
i. fiduciary relation which results from
ii. the manifestation of consent by one person to another that
iii. the other shall act on his behalf
iv. and subject to his control,
v. and consent by the other so to act
1. The one for whom action is to be taken is the principal
2. The one who is to act is the agent
b. Basically, agency is an agreement that the agent will act on the principals
behalf and under his control
II. FIDUCIARY DUTIES

a. The agent is the fiduciary to the principal.

b. Duty of Care antithesis of negligence
c. Duty of Loyalty
i. Undivided loyalty agent must act for the sole benefit of the
principal
ii. No Conflicts of Interest agent may not deal with the principal as
an adverse party
iii. No Profits An agent who profits while working for principal has
a duty to give the profit to the principal
1. This obligation forms the basis of the duty not to compete
and the duty not to appropriate opportunities belonging to
the principal
2. The no profits rule is the basis for laws against insider
trading (misappropriation of funds)
III. AGENCY AUTHORITY

a. For an agency relationship, the principal must manifest consent for the
agent to do something. Therefore, there is a zone of authority that the
agent is authorized to act.
i. An agent must have authority from the principal RSA 7
b. Actual Authority RSA 7
i. Authority is the power of the agent to affect the legal relations
of the principal by acts done in accordance with the principals
manifestations of consent to him

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Business Associations Spring 2007 Hauser

ii. Creation of Actual Authority RSA 26

1. Authority to do an act can be created
2. by written or spoken words
3. or other conduct of the principal which,
4. reasonably interpreted,
5. causes the agent to believe that the principal desires him
so to act on the principal's account
a. Ex: Two guys are at the hotel bar. One guy tells the
other to order him a drink and charge it to his room
iii. Actual authority may be express or implied
1. Implied Actual Authority RSA 35 Unless otherwise
agreed, authority to conduct a transaction includes authority
to do acts which are incidental to it, usually accompany it,
or are reasonably necessary to accomplish it
c. Apparent Authority RSA 8
i. Apparent authority is the power to affect the legal relations of
another person by transactions with third persons, professedly
as agent for the other, arising from and in accordance with the
others manifestations to such third persons.
ii. Creation of Apparent Authority RSA 27
1. apparent authority to do an act is created as to a third
person by written or spoken words or any other conduct of
the principal which, reasonably interpreted, causes the third
person to believe that the principal consents to have the act
done on his behalf by the person purporting to act for him.
a. Ex: An agent is authorized to bid on art, but only up
to $25K. The auctioneer knows he is authorized to
bid, but the agent bids $50K
iii. Occurs when a third-party believes that an agent is authorized
to act but the agent is not
1. Refers to the power to bind protects third parties who are
misled.
iv. Can co-exist with actual authority
v. Apparent authority creates an agency relationship that does
not otherwise exist
IV. AGENT LIABILITY

a. One consequence of an agency relationship is that the principal is

vicariously liable for the acts of the agent
b. RSA 219 A principal is not liable if the agent was acting outside the
scope of his agency
c. Agents Contract Liability to Third Persons
i. Disclosed PrincipalRSA 320a person acting in his capacity
as an agent of a disclosed principal does not become a party to the
contract unless otherwise agreed.
1. Agent not a party if principal is disclosed

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Business Associations Spring 2007 Hauser

ii. Partially Disclosed PrincipalRSA 321a person purporting

to make a contract for a partially disclosed principal is a party to
the contract, i.e., is liable on the contract, unless otherwise agreed.
A principal is partially disclosed when the third party knows that
the agent is acting on behalf of a principal, but does not know the
identity of the principal.
iii. Undisclosed PrincipalRSA 322an agent purporting to
make a contract on his own behalf, but who is contracting for an
undisclosed principal, is a party to the contract. If the agent is
acting within his authority, the principal is also liable on the
contract.
iv. Hauser An agent acting for an undisclosed principal is liable
on any contract he makes
v. Note: For an agent to avoid liability, the principal must be
disclosed at the time at which the contract is entered.
d. Agents Tort Liability to Third Persons
i. An agent who does an otherwise tortious act is not relieved of
liability because he acted on behalf of a principal RSA 343
e. Agents Liability to Principal in Contract
i. An agent is liable to the principal for breach of contract for failing
to perform a service in accordance with the parties agreement, i.e.,
liable to the principal if the agent acts outside the scope of the
agency relationship
V. PRINCIPAL LIABILITY

a. Principals Liability in Contract to Third Parties RSA 140

i. An agent has the power to bind the principal, to the extent that the
agent acts within the scope of his authority
ii. The principal is liable to a third party for a transaction the agent
conducts if the agent:
1. Was authorized, i.e., actual authority;
2. Was apparently authorized; OR
3. Had power from the agency relationship not dependent on
authority or apparent authority, i.e., express implied
authority (Incidental or reasonably necessary)
b. Apparent Authority Principals Liability RSA 8, 27, 140(b), 267
i. If a principal represents another as being his agent, causing a third
party to justifiably rely on the care or skill or such apparent
authority the principal is liable to third parties for harm caused
by someone who appears to be his agent
c. Respondeat Superior Principals Tort Liability to Third Parties
RSA 219, 220 & 229
i. Applies only to master/servant not independent
contractor/employer

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Business Associations Spring 2007 Hauser

ii. GR
1. Acts Within the Scope of Employment Principal is liable
for intentional torts of agent acting within the scope of his
employment, within his job description
a. Ex: Bar bouncer, security guards Principal is
liable
2. Acts Outside the Scope of Employment Principal is not
liable for torts outside of employment, unless
a. Principal intended the conduct OR
b. Principal was negligent or reckless OR
c. Conduct violated a non-delegable duty OR
d. Agent purported to act or speak on behalf of the
principal
d. Master / Servant Relationship RSA 2, 220
i. Master A principal who employs an agent to perform services
and controls or has the right to control the physical conduct of the
agent
ii. Servant An agent employed by a master to perform services or is
subject to the right to control by the master, i.e., the master can
control how the servant does his job
iii. Independent Contractor Contracts with another (principal) to
do something, but has autonomy. He may or may not be an agent,
e.g., an employer gives a contractor the authority to purchase
supplies
iv. Servant or Independent Contractor?
1. Look at the degree of control the employer has over the
hired person.
2. Consider:
a. Extent of control by principal
b. Distinct occupation?
c. Skill required
d. Does employer supply tools, etc?
e. Length of employment
f. Method of payment
v. Intentional Torts
1. Not generally within the scope of employment except for
certain instances, e.g., a bouncer punches a guy in the face
vi. Frolic v Detour
1. Frolic outside the scope of employment, principal is not
vicariously liable
2. Detour brief, minor deviation; within the scope of
employment principal is vicariously liable
vii. Independent Contractor
1. There are both agent and non-agent independent
contractors

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Business Associations Spring 2007 Hauser

2. Non-Agent I.C. Principal is not liable in tort or contract

for the acts of a non-agent independent contractor
3. Agent IC Principal is not liable in tort but is liable in
contract for acts of an agent independent contractor
VI. Franchisor/Franchisee Relationship
a. Franchisor Ex: McDonalds Corporation
b. Franchisee Ex: The local Hillsborough McDonalds
i. A parent corp can be held liable for the acts of a franchisee if
an agency relationship can be proved. Plaintiff must show:
representation, justifiable reliance and detrimental reliance
(see infra)
1. A franchisor may attempt to avoid a determination of
agency by including an agency disclaimer in the franchise
agreement but this doesnt guarantee that a court will
recognize the disclaimer.
c. Actual Agency Right to Control
i. Not to be confused with actual authority
ii. Right to Control Test If a franchise agreement goes beyond
merely setting standards and gives the franchisor the right to
exercise control over the daily operations an agency relationship
exists
1. A franchise agreement will not establish actual agency if
the franchisor does not control how the franchisee complies
with franchise requirements
2. If franchisor retains control over the details of a
franchisees performance, actual agency is established; e.g.,
manuals govern the manner in which daily operations are
conducted
3. If actual agency is found, the franchisor is liable to
third parties for the acts of the franchisee
d. Apparent Agency, aka Agency by Estoppel / Ostensible Agency
i. Not to be confused with apparent authority
ii. RSA 267 Apparent agency is when a party represents that
another is his servant or agent, causing a third party to justifiably
rely upon the skill of the apparent agency the apparent agenct is
subject to liability to third persons for harm caused by lack or care
iii. 3 Requirements
1. Representation, i.e., uniform appearance
a. Franchisor acts in a manner that would lead a
reasonable person to conclude that the
operator/employees of the franchise were
employees or agents of the franchisor
2. Justifiable Reliance, i.e., reliance on the brand
a. McDonalds P thought all McDs were owned by
the McDonalds corporation
3. Detrimental Reliance

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Business Associations Spring 2007 Hauser

a. Plaintiff relied to his detriment upon the care and

skill of the franchise
iv. Avoiding Apparent Agency
1. Ex: McDonalds can post a sign stating that it is
independently owned and operated
v. Apparent Agent v Apparent Authority
1. Apparent agency creates an agency relationship that does
not otherwise exist.
2. Apparent authority expands the authority of an actual agent

PARTNERSHIPS

Note: All but three NC statutes are the exact same as UPA. NC begins with 59, then add 30 to the UPA
I. UPA 6(1) NCGS 59-36(a)
a. A partnership is
i. An association no need for contract or written agreement just
an association
ii. Of two or more persons
iii. To carry on as co-owners this does not include other parties that
share in the profits
iv. A business
v. For profit
II. Formation of a Partnership Presumed when profits are shared
a. No formal requirements any association of two or more people carrying
on a business for profit forms a partnership whether they know it or not
i. Watch out for an inadvertent formation of a partnership
b. NCGS 59-37(4) Determining the existence of a Partnership
i. The receipt by a person of a share of the profits of a business is
prima facie evidence that he is a partner in the business.
ii. That inference will not be drawn if profits were received as
payment for:
1. Debt by installments or otherwise
2. Wages of an employee or Rent to a landlord
3. Annuity to a widow or representative of deceased partner
4. Interest on a loan though the amount varies with the
profits of the business
5. Consideration for the sale of a goodwill of a business
c. Debt Financing
i. 59-37(3) - The sharing of gross returns does not, itself, establish a
partnership that isnt the same as profit
d. Co-ownership is the essence of partnership; it distinguishes a partnership
from a loan
III. 59-39 Partner As Agent

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Business Associations Spring 2007 Hauser

a. (a) Every partner is an agent of the partnership, and their acts

carrying on in the usual way of business of the partnerships binds the
partnership UNLESS
i. the partner has no authority to act in the particular matter;
AND
ii. the person with whom he is dealing has knowledge of the fact
he has no authority
b. (b) An act not apparently for the carrying on of business as usual does
NOT bind the partnership unless authorized by other partners
IV. Fiduciary Obligations Between Partners
a. Meinhard v Salmon P and D were partners. D executed a lease for
property adjacent to the partnership property without informing his partner
of the opportunity A partner is owed the punctilio of an honor the most
sensitive
i. 59-51 Partner Accountable as Fiduciary
ii. (a) Each partner must account to the partnership of any benefit
derived by him without consent of the other partners AND he must
hold as trustee for it any profits derived by him without consent
1. Ex: So if one partner makes profit without the others
consent, he will be liable to pay his partner the fair share of
the profits
iii. (b) This also applies to the representatives of a deceased partner
V. Partners Authorities and Governance
a. NC 59-48(5), UPA 18(e) All partners have equal rights in the
management and conduct of the partnership
b. 59-48(8), UPA 18(h) Any difference as to ordinary matters may be
decided by majority of the partners
i. but no act in contravention of an agreement may be done
with unanimous consent
ii. Summers v Dooley Court held that an equal partner in a two-man
partnership did not have authority to hire an additional employee in
disregard to the objection of the other partner
c. Rights and Obligations in Absence of Partnership Agreement UPA
18
d. Absent a partnership agreement, all partners share equally in profits
and losses
i. Ex: A puts up 90% of capital, B is his partner and puts up 10%.
How are profits shared? Equally
e. No person can become a partner without the consent of all the partners
i. UPA 18
1. (a)repayment of contribution; equal sharing of profits
and losses, or losses are shared in the same manner which
profits are shared.
2. (b)indemnification for payments and personal liability
incurred by the partner in the ordinary course of partnership
business.

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Business Associations Spring 2007 Hauser

3. (c)interest on payments made to the partnership in excess

of the amount he agreed to contribute.
4. (d)interest on the capital contribution from the date the
contribution is supposed to be repaid.
5. (e)equal right in the management and conduct of the
partnership.
6. (f)no right to salary, except a surviving partner may
receive reasonable compensation for services rendered in
winding up the partnership.
7. (g)unanimous consent to bring in a new partner.
8. (h)disputes arising as to ordinary matters may be settled
by a majority vote. An act in contravention of the
partnership agreement requires unanimous consent.
f. How do you change any of these rights/duties? Partnership agreements
VI. Partnership Property UPA 8, NCGS 59-38
a. 59-38(a) All property originally brought into the partnership or
subsequently acquired by purchase or otherwise is partnership property
b. 59-38(b) Unless contrary intentions appear, property acquired with
partnership funds is partnership property
c. 59-38(c) Any estate in real property may be acquired in the
partnership name; title so acquired can be conveyed only in the
partnership name
d. UPA 24 - Partnership Property Rights are not readily transferable
i. A partnership interest confers
1. An interest in specific partnership property
2. An interest in the partnership; AND
3. The right to participate in the management of the
partnership
e. UPA 25 A partnership holds a tenancy in partnership with other
partners
i. Equal right to possess need consent of the other partners to use
partnership property for personal purposes
VII. NC 59-43 Partnership Bound by Partners Wrongful Act (Joint and
Several Liability
a. When a partner acts in the course of ordinary business and any wrongful
act or omission occur, the partnership is liable to the same extent as the
partner
b. 59-44 Partnership Bound by Partners Breach of Trust
i. Partnership is bound to make good the loss where one partner
misappropriates money while acting in the scope of his apparent
authority
c. 59-45 Nature of Liability

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Business Associations Spring 2007 Hauser

i. All partners are jointly and severally liable for the acts and
obligations of the partnership
d. Indemnification - 59-48(2)
i. The partnership must indemnify every partner is respect of
payments made and personal liabilities incurred in the ordinary and
proper conduct of business
ii. Note: This may be modified in a partnership agreement
iii. Ex: Maggie commits a tort. She and her partner, Jack, are sued.
Jack can seek indemnification from the partnership.
e. Contribution - 59-48(1)
i. Each partner is repaid his contributions and must contribute
towards the losses according to his share in the profits
ii. Note: Can also be modified in partnership agreement
iii. Ex: M puts in 70% capital, S 20% and H 10%. They split profits
three-ways (33%), absent a partnership agreement

Ending a Partnership
I. Under the UPA, there are 3 stages for ending a partnership (Note: end not =
dissolution)
a. Dissolution
b. Winding Up
c. Termination
II. 59-59 DISSOLUTION
a. The dissolution of a partnership is the change in the relation of the
partners caused by any partner ceasing to be associated with the carrying
on of the business
III. 59-60 Partnership NOT Terminated by Dissolution
a. On dissolution the partnership is not terminated, but continues until the
winding up of partnership affairs is complete
IV. 59-61 Causes of Dissolution
a. Without violation of Partnership Agreement
i. Termination of a definite term or undertaking specified in agreement.
A term is a specified time period
ii. Express will of any partner when no term is specified
iii. Express will of all partners, either before of after a term of undertaking
specified
iv. Expulsion of a partner, pursuant to partnership agreement
b. In breach of agreement by express will of any partner at any time
i. Breach is not automatic cause for dissolution. It makes dissolution
an option, but does not have to be pursued
ii. A partner can always leave it just may be in violation of an
agreement
iii. By any event making the business unlawful
1. Ex: Law partnership and a partner loses his license. He can no
longer lawfully carry on his business
iv. By the death of any partner

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Business Associations Spring 2007 Hauser

v. By the bankruptcy of any partner or the partnership

vi. By decree of court under UPA 32 (59-62)
c. Effects of Dissolution
i. 59-67, 68(a) Rightful Dissolution When there is a withdrawal
that is not wrongful, the withdrawing partner can request his share of
the partnership property he has the right to windup will trigger
winding up so he can get paid
1. NC Winding up is default position unless everyone
(including the dissolving partner) agrees, dissolution will occur
when a partner leaves
ii. 59-68(b)(2) Wrongful Withdrawal When there is a partnership
agreement and a partner wrongfully withdraws, the partners who have
not caused the dissolution may choose to continue the business The
remaining partners must unanimously agree to continue
partnership and pay dissolving partner his interest, less damages
V. 59-62 Dissolution by Decree of Court
a. Incompetence of a partner
b. Partner becomes incapable of performing his part of the partnership contract
c. Partner has been guilty of conduct that prejudicially affects the carrying on of
the partnership
d. Partner willfully or persistently breaches partnership agreement
e. The business can only be carried on at a loss
f. Other circumstances that render a dissolution equitable
VI. Winding Up
a. Winding up entails completing existing contracts, collecting existing
receivables and selling partnership assets. The liquidation of the business is
followed by paying all partnership debts
i. When winding up is complete, the business terminates
b. 59-70, UPA 40 Rules for Distribution
i. The liabilities of the partnership shall rank as follows:
1. Partnership creditors who are not partners (Outside creditors)
2. Creditors who are partners (Inside creditors) meant to be a
loan, to be repaid
3. Capital contributions amount of investment
4. Profits
c. Contribution for Liabilities
i. Partners shall contribute any amount necessary to satisfy the liabilities
of the partnership in the same proportions as the partners share profits
d. Partner Accounts UPA 18(a), RUPA 401(a)
i. A partners capital account is:
1. Credited, or increased by
a. Any money contributed
b. FMV of any property contributed
c. Partners share of profits
2. Charged, or decreased by
a. Any money distributed

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Business Associations Spring 2007 Hauser

b. FMV of property distributed

c. Partners share of losses
ii. Absent a contrary agreement, law presumes partners intended to
participate equally in profits and losses regardless of how much they
contributed to the capital

Limited Partnerships
I. Creation of a Limited Partnership
a. Unlike ordinary partnerships, limited partnerships cannot be formed
accidentally must be intentional
i. If you botch forming a limited partnership, you have a general
partnership, instead
b. 59-201(a); RULPA 201 Certificate of Limited Partnership
i. A certificate of limited partnership must be executed and filed to
form a limited partnership, including 5 pieces of information
1. Name of LP
2. Address of registered office
3. Term Date of dissolution. If no date is set, existence is
perpetual
4. Name and address of each general partner
5. Office at which records are kept
c. Limited Partnership Agreements
i. Not required in NC or under RULPA but every limited partnership
should have a carefully drawn up agreement
II. General Partners in a Limited Partnership
a. A limited partnership must have at least one general partner identified on the
certificate of limited partnership
b. A general partner does not have to be a natural person; they will often be a
corporation
i. This serves to limit liability to the true person behind the corporation
c. 59-403(b) Liability of General Partners
i. General partners liability is unlimited (as if he were a partner is a
regular partnership)
ii. This cannot be modified in a limited partnership agreement
d. 59-403(a) Management Authority
i. GR General partner manages the limited partnership
ii. A general partner of a limited partnership has the rights and powers of
a partner is a general partnership
1. This may be modified in a limited partnership agreement
III. Limited Partners
a. Seen and not heard Traditionally have no role in management
i. In exchange for limited power, limited liability for partnership debts
b. 59-302; RULPA 302
i. A partnership agreement may grant voting rights to limited partners
does this equate to management?
ii. UPA 303(b) Safe Harbor

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Business Associations Spring 2007 Hauser

1. There are responsibilities a limited partner can assume without

participating in management:
a. Consulting, advising with general partners
b. Participating in meetings
c. Acting as surety or guarantor
d. Involvement in extraordinary matters like amending
partnership agreement
2. Not managing? Not liable
iii. NC 59-303 Distinction from UPA
1. There is no limit on what a limited partner can do he does
not become liable by participating in management
2. So essentially a limited partner can assume control, manage
without opening himself up to liability (for the partnership)
IV. Distributions - 59-503
a. Income, gain, loss, deduction or credit of a limited partnership shall be
allocated among the partners in the manner provided by the partnership
agreement
b. What if no partnership agreement? (Default)
i. Not equal distribution
ii. To the extent a partnership agreement does not provide (is silent) for
allocation of items partners are liable based on the agreed value of
the contributions made by each partner (capital accounts)
iii. Ex: 2 partners, 1 contributes 60K, other contributes 40K. that could
be considered 60% and 40%
V. Withdrawal in a Limited Partnership
a. RULPA 602
i. A general partner can withdraw at any time by giving written notice to
other partners
ii. If withdrawal violates partnership agreement, the partnership may
recover damages for breach from withdrawing partner
1. Damages may be offset by any other share he is due
b. Withdrawal of Limited Partner
i. RULPA 603 and NC 59-603 are very different
ii. RULPA allows limited partner to withdraw if permitted by partnership
agreement; no agreement, there must be 6 months notice to general
partners
iii. 59-603 NC A limited partner may withdraw only as permitted
by partnership agreement. If silent, limited partner may not withdraw
prior to dissolution

Limited Liability Partnerships

I. Partners of an LLP are not liable for the debts or liabilities arising in either tort
or contract of the partnership solely by reason of their membership
II. However, a partner may be liable for:
a. Any negligent or wrongful act committed by that partner; OR
b. by any person under his supervision while rendering services for the LLP

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III. Partners can file a form with Secretary of State to change common law
partnership to an LLP but the limited liability only applies to future claims

Limited Liability Companies

I. Why form an LLC?
a. To create an entity that offers its investors limited liability (duh)
b. Flow-through tax status of partnerships
c. Ability to take part in management and still have limited liability
II. Forming an LLC
a. 57C-2-20 Formation
i. (a) One or more persons may form an LLC by delivering executed
articles of organization to the Secretary of State for filing
1. There can be an LLC with only one member
ii. (b) The organization becomes an LLC when the filing becomes
effective
iii. 57C-1-03(16) Operating Agreement (OA)
1. Any agreement, written or oral, of the members with respect
to the affairs of an LLC and the conduct of its business that is
binding on all members
b. 57C-2-21 Articles of Organization
i. Must set forth:
1. A proper name
2. Date of dissolution (if there is one)
3. Name and address of each executing party
4. Initial registered office and agent
5. LLCs principal address, if different; AND
6. Unless all members by virtue of their status as members are
managers, a statement that members are not automatically
managers
III. Entity Status
a. 57C-2-02 LLC is an entity for all purposes
i. Unless the articles of organization or operating agreement provide
otherwise, an LLC has the same powers as an individual to do all
things necessary to carry out business, including
1. Sue and be sued
2. Buy Property
3. Sell or mortgage its property
4. Make contracts borrow money
5. Lend money
IV. Management Structures
a. Member managed companies
i. The owners (members) manage the business themselves
b. Manager managed companies
i. The members employ managers to run the company, similar to a
corporation
c. How do you tell management structure?

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Business Associations Spring 2007 Hauser

i. 57C-3-20(a) Unless provided otherwise, all members by virtue of

their status as members shall be managers of the LLC
ii. Default: Member = manager, unless the organization agreement
says otherwise
iii. Every manager is an agent of the LLC - 57C-3-23
V. 57C-3-22(b) Fiduciary Duties of Managers
a. A manager shall discharge his duties in:
i. Good faith
ii. Care that an ordinary prudent person in similar position would exercise
iii. In a manner reasonably believed to be in the best interests of the LLC
b. Fiduciary duties apply to managers default = member has fiduciary duty
c. Alteration Cant waive fiduciary duties, theyre inherent
VI. 57C-3-30 Limited Liability
a. (a) Any person involved with an LLC is not liable for the obligations of an
LLC and does not become liable by participating in management or control
of the business.
i. A member/manager may become liable by his own acts, though
b. (b) A member of an LLC is not a proper party to proceedings by or against an
LLC the LLC should be the party
VII. Piercing the LLC entity veil
a. How do you sue an individual behind the LLC?
b. Ex: B, G and D form BGD, LLC. G orally employs client, C. G does not
make it clear that he is acting for the LLC he never mentions them. He
gives C a business card with his name, G, and BGDs addresses but the card
indicates nothing about an LLC.
i. If C does work and doesnt get paid who can he collect from???
ii. To answer, look first to the LLCs management style
1. Is the party youre trying to sue a manager? If so, he is an
agent and has power to bind the LLC
2. You could sue both the LLC and the individual member
iii. Is there an undisclosed principal?
1. If so, and the agent is acting within his authority, the principal
is also liable on the contract.
2. The agent is also individually liable
VIII. Capital Contributions
a. Members contribute capital in exchange for membership interest but,
b. No contribution is required for membership in an LLC
c. 57C-4-01 Contributions
i. A contribution may be in any form of property or benefit, e.g., cash,
services, etc.
ii. For non-cash contributions, the value is the FMV at time of
contribution
d. 57C-4-02 Liability for Contribution
i. (a) A promise by a member to contribute is only enforceable if set out
in writing and signed by the member (S/F)

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ii. (b) Even if member is unable to perform contribution (death, disability,

etc.), he (or his estate) is still liable to perform
1. Operating Agreement can specify otherwise, though
IX. Distributions
a. 57C-1-03(6) Distributions are not limited to cash they can be in benefits,
property, etc.
b. Interim Distributions - 57C-4-04
i. Made during the life of the business (whereas final distribution made
at liquidation)
c. 57C-4-03 Allocation of Distributions
i. Default Position: Absent an operating agreement, gains and losses are
allocated in proportion to the agreed value
ii. Ex: ACE, LLC. A puts up $200K, B and C each put up $50K. As
default allocation is 2/3, B and C each get 1/6
d. When do members have the right to distribution?
i. GR The operating agreement will provide when distributions are
made
ii. Single members cant force distributions
X. Membership Interest - Assigning
a. 57C-5-01 A membership interest is personal property no interest is
specific property of the LLC
b. Membership interest may be assigned, that is, the right to receive $ (personal
property)
c. Membership status may not be assigned
d. Assigning Membership Interest
i. Default Assignment does not dissolve the LLC
1. The assignee is not entitled to membership
ii. 57C-5-04 Right of Assignee to Become Member
1. An assignee must agree to become a member and there must
be unanimous consent by the members
e. Bottom Line: A member of an LLC can assign only the economic portion of
his interest not his status as member
XI. Restrictions on Transfers of Interests
a. A typical operating agreement (OA) will restrict voluntary transfers of
membership interests. Why?
i. Might not want to add someone the members dont know or approve
of
ii. Dont want to dilute ownership interest
b. Most Common Restrictions:
i. Right of First Offer
1. Requires the member who is trying to sell his interest to
a. First offer it to the other owners at the minimum desired
price
b. If they dont want to buy, then he can offer to third
parties
ii. Right of First Refusal

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Business Associations Spring 2007 Hauser

1. Requires a member with a third-party offer to:

a. Provide the other owner with an opportunity to match
the third-party offer
2. These are often criticized for chilling the ability of the owner to
sell a third-party may be reluctant to negotiate if the other
owners can reap the benefits of his efforts
XII. Withdrawal from LLC
a. 57C-5-06 A member can only at the time or upon the events specified in
the articles of organization or the OA
XIII. Dissolution of LLC
a. 57C-6-01 An LLC is dissolved when:
i. The specified term is complete
ii. The happening of an event specified in OA
iii. Written consent of all members
iv. There are no longer any members
v. Entry of a judicial dissolution OR by a filing by the Secretary of State
1. Non-compliance like not paying your state fees can get you
dissolved
b. 57C-6-02 Judicial Grounds
i. Member deadlock
ii. Liquidation is reasonably necessary for the protection of complaining
member OR the assets are being misapplied
1. Your only true safety valve but costly

CORPORATIONS
I. Controlled by NCGS, which are the same as MBCA except for a few instances
II. Attributes
a. Limited liability
b. Free transferability of ownership
c. Continuity of existence
d. Centralized management
e. Entity status
III. Forming the Corporation
a. Pre-Incorporation Promoters Liability
i. A promoter is a person instrumental in launching a corporation
ii. A promoter acting on behalf on the pre-incorporation business will be
held personally accountable for his acts. Why?
1. A promoter does not have power to bind the non-existent
principal this raises issues of enforceability of contracts
iii. Agency Principals
1. When it comes to a promoters pre-incorporation activity, there
is no agency problem because there is no principal so when
is a corporation liable for the promoters contracts?
b. Liability of the Corporation
i. GR A corporation is not bound by the promoters pre-incorporation
contracts unless

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Business Associations Spring 2007 Hauser

ii. Ratification Technically, only applies to post-incorporation activity

when the corporation accepts an act purportedly made on its behalf
by an agent (the promoter)
iii. Adoption Accepting the benefits of pre-incorporation agreements
means there has been implied adoption
iv. Acceptance of Continuing Offer The corporation accepts the
promoters continuing proposal/offer when it comes into existence
c. Watered Stock and Full Disclosure
i. Watered stock is an asset with an artificially-inflated value
ii. Sometimes, promoters exchange property the value of which is
overstated for stock resulting in the stated value of the stock not
equaling the value of the property
iii. Majority If more stock is to be issued (to other shareholders) then
there is fraud, and the promoter has breached his fiduciary duty
IV. Incorporation
a. 55-2-02(a) Required Provisions
i. The articles of incorporation must include:
1. A corporate name
2. The number of shares the corporation is authorized to issue
3. Address of the corporations initial registered office
4. If different, the address of the corporations principal office
5. Name and address of each incorporator
ii. Bylaws
1. Bylaws regulate the internal affairs of the corporation
(shareholder meetings, title and duties of officers, voting or
quorum requirements, etc.) and they must be adopted by the
directors or shareholders
2. Strict or Loose?
a. Large corps want the power in the hands of the board
for flexibility
b. Closed corps want restrictions to give power to the
shareholders
b. 55-2-02(b) Optional Provisions
i. The articles of incorporation dont have to, but may, include things
such as a provision limiting or eliminating personal liability of director
ii. This isnt a good idea, though (why not? )
iii. Default Status
1. Unless otherwise specified, all members have unlimited voting
rights
2. Members are also entitled to receive net assets upon dissolution
c. 55-2-03 Effect of Filing
i. Filing the articles of incorporation is conclusive proof of corporate
existence
ii. This operates as a shield of liability for shareholders once the articles
of incorporation are filed, theyre okay

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1. Ex: A creditor is owed money by a corporation. They will

look for some problem with the corporate formation in order to
be able to go after the individual shareholders.
d. Defective Incorporation
i. When a business entity has failed to properly incorporate it results in
something besides a corporation
ii. De facto corporation
1. There was a good faith attempt to incorporate, but something
hasnt been done right. So, the court will imply a corporation
in fact
2. NC No problem with de facto corporations in NC the
filing for incorporation is conclusive proof; dont worry about
the 3-part test
iii. Corporation by estoppel
1. Applies when someone deals with a business as if it were a
corporation, irrespective of whether the business tried to
incorporate only applies for contract matters (not tort)
2. If this occurs, the person dealing with the business is estopped
from arguing that the business was not a corporation
3. Likewise, a business that has carried itself as a corporation is
estopped from deny liability as a corporation if sued
V. Capital Formation
a. Bonds (Debt)
i. A bond is a debt, a liability They are used to raise capital, and are a
certificate that promises the corporation will pay the lender
1. Articles of incorporation may specify whether and how many
bonds can be issued this is to prevent too much debt
2. Creditors (bond holders) get paid out of company assets before
shareholders
b. Stocks (Equity)
i. A corporation may have more than one class of stocks; the classes can
be divided into series
1. 55-6-01(a) Articles of Incorporation must prescribe classes
of shares. If more than one class is authorized, the Articles
must prescribe a distinguishing designation
ii. Common Stock
1. A class of stock that does not have a preference not
necessarily a bad thing
2. Common stockholders are frequently referred to as owners of
the residual interest of the corporation
iii. Preferred Stock
1. A class of stock the is given preference over another the
nature of which must be included in the Articles of
Incorporation - 55-6-01(a)
2. The is usually a preference to some financial benefit, i.e.,
dividends or liquidation proceeds

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Business Associations Spring 2007 Hauser

iv. Cumulative v Non-Cumulative

1. With non-cumulative stock, if dividends are not declared, they
do not accrue
a. Ex: Preferred stock, $2 dividend preference. If no
dividend declared in 2006, tough. Stockholders dont
get one
2. If stock is cumulative, the dividends do accrue
3. Examples
a. Q-Cola, Inc. creates two classes of stock, 1 and 2.
Class 2 must receive a $2 dividend before any dividend
is paid to Class 1. 10,000 outstanding shares of Class 1,
2,000 outstanding of Class 2. Directors declare
dividend of $4,000. Who gets it?
i. Only the preferred (Class 2) shareholders.
Theres nothing left for Class 1
b. What if directors declare a $40,000 dividend?
i. Preferred shareholders still get $2 a share (total
of $4,000). $36,000 remains
ii. 10,000 common shares have a $3.60 dividend
each
iii. Preferred have no right to additional dividends
c. Similar facts, except Class 2 is cumulative preferred
stock. Board has not declared a dividend for previous 3
years.
i. The cumulate preferred dividend has accrued, so
each preferred dividend is $8/share (4 years at
$2 per year)
ii. $8 x 2,000 preferred shares = $16,000 payout
iii. Remaining $24,000 is distributed to common
shares 10,000 for a $2.40 dividend
c. Balance Sheet. Sets out the assets and liabilities of the corporation. Assets
on the left side must equal the liabilities, equity investments, and retained
earnings on the other side of the sheet.
i. Left side of balance sheet is divided into assets.
1. Short term asset. One that is readily convertible into cash.
2. Long term asset. One that will not be converted into cash
within a year. (real property, equipment).
3. Valuation of assets.
a. Usually the valuation of an asset will be its purchase
price (book value).
i. Inventory:
1. FIFO method. First in first out
valuation. Assumes first goods
purchased were the first ones sold.

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2. LIFO method. Last in first out

valuation. Assumes last goods in were
the first sold.
b. Mark-to-market method requires that assets be valued
at their current market value.
c. Collection of accounts receivable. Corporation will
need to reserve an amount on its balance sheet to reflect
its loss experience from bad accounts.
d. Intangible assets present difficult valuation issues.
ii. Right side of balance sheet is divided into liabilities and equity capital.
1. Short term liabilities. Must be repaid within a year.
2. Long term liabilities. Have a maturity of more than a year.
3. Senior debt. Priority for payment in bankruptcy over more
junior debt.
4. Equity capital. Below the liabilities on the right side of the
balance sheet. Equity capital may include preferred stock.
d. The Income Statement. This is the profit and loss statement. It is useful in
showing revenue, expenses and income. Helps managers with planning and
helps investors know if company is profitable.
i. Return on Equity ROE. May be computed by dividing the dollar
amount of the corporations earnings by the dollar amount of equity
capital from the balance sheet.
ii. PE Ratio. The market price of a stock divided by the corporations
earnings per share.
e. Leverage. Debt level. May be preferred because it avoids dilution of stock.
f. GAAP (Generally Accepted Accounting Principals) Account for things
on balance sheet at historical cost.

VI. Piercing the Corporate Veil (PCV)

a. Generally When a court disregards a corporations entity status and subject
the shareholders to unlimited liability, this is called piercing the corporate
veil
b. Exam: This is an equitable doctrine, allowing the courts to ignore the
entity business structure. However, there must be a convincing reason for
the court to do so
i. PCV is an equitable doctrine, used by creditors to impose liability on
the shareholders of a corporation
1. A publicly traded corporation has never had its veil pierced
this applies to closely held corporations
ii. 55-6-22(b) (Limited) Liability of Shareholders
1. Unless otherwise provided, a shareholder is not personally
liable for the acts of a corporation though they may subject
themselves to liability through their own acts or conduct
c. Three Variations of PCV In practice, virtually indistinguishable
i. (1) NC (Bar) Instrumentality Doctrine

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1. Exam: In Glenn v Wagner (313 NC 450) NC adopted the

instrumentality doctrine when PCV. This requires the
satisfaction of three elements
2. 3 Factors:
a. Complete domination of the corporation by the
defendant
b. Misuse by the defendant of his position of control to
commit a wrong
i. Ex: Under capitalization
c. Defendants control is the proximate cause of
plaintiffs injury
3. Dont get hung up on the last two factors look for dishonesty
or unjustness Look at the facts (fact centric)
4. 2 most common instances lack of corporate formalities and
under capitalization
ii. (2) Alter Ego Doctrine
1. Occurs when there is unity of interest between corporation and
controlling stockholders, such that the corporation has ceased
to exist as a separate entity and has been relegated to status of
alter ego of the controlling stockholder
iii. (3) Identity Doctrine
1. There is such unity of interest and ownership that the
independence of the corporation has ceased adhering to the
fiction of the corporation would defeat justice

d. Grounds for Piercing the Veil There are numerous grounds for piercing the
veil; normally one itself is not sufficient, i.e., the more the better
i. Involuntary Creditors
1. Tort Claims
a. As opposed to contract claims, where the creditor has
dealt with the corporation and should be aware that it
lacks substance a tort claimant is an involuntary
creditor not having any business dealings with the
corporation
2. Retail Customers
a. Again, unlike contract claims where creditors should
essentially know better, retail customers have no
business savvy
ii. Under (Inadequate) Capitalization
1. Forming a corporation without providing adequate capital to
meet business risks.
a. Insurance is okay to use as capital
2. This is gauged at formation not later in the life of a
corporation.
3. Ex: Contractors main client is Food Lion. Food Lion goes
through a rough spell and does not need any new buildings.

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Business Associations Spring 2007 Hauser

The contractor has operating losses, resulting in insufficient

capital. Shareholders are not liable for that (assuming there
was enough capital at formation)
iii. Failure to Observe Formalities of Corporate Formation
1. A corporation cannot be a mere conduit for an individual
a. There needs to be a board of directors who have proper
meetings to make decisions
b. Minutes should be kept, etc.
iv. Corporation is Alter Ego for Individual
1. When the stockholder is conducting business in his individual
capacity, he is liable
2. Walkoysky v Carlson The fact that a form of the company is a
sham is insufficient plaintiff must show there is something in
the operation of the company that is a sham
v. Other possible factors
1. Non-payment of dividends
2. Siphoning of corporate funds
3. Absence of corporate record
e. Parent / Subsidiary Relationship
i. A parent corporation owns stock of a subsidiary corporation
(corporations can be shareholders of other corporations)
ii. Not technically piercing the veil, but creditors will try to get past the
subsidiary to get at the parent company
iii. Situations in which Parent will be held liable for actions of the
Subsidiary:
1. Confusion of the parents business with the subsidiarys
2. Failure to observe formalities of separate corporate procedures,
i.e., the subsidiary is a mere appendage of the parent
3. Subsidiary inadequately capitalized
4. Parent and subsidiary represented as one
f. Enterprise Liability
i. A theory that allows a brother or sister corporation to be treated as a
single entity for liability purposes
ii. The idea is to break up businesses to isolate liability
iii. Ex: Shareholder has 10 corporations, each one consisting of 2 cabs
and $20,000 of insurance coverage.
iv.

Owner / Shareholder

Corp 3
Corp 1 Corp 2

1. Should this be treated as a single corporation?

VII. Corporate Responsibility & Ultra Vires (Common law doctrine)

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Business Associations Spring 2007 Hauser

a. 55-3-02 General Powers of a Corporation

i. (a) Unless the articles of incorporation provide otherwise, every
corporation has perpetual duration and has the same powers as an
individual to do all things necessary to carry out its business and
affairs, including:
1. (12) To pay pensions and other benefit or incentive plans for
any of its workers
2. (13) To make donations for the public welfare or for
charitable, religious, cultural, scientific or educational
purposes
3. (14) To transact any lawful business that will aid
government policy
4. (15) To make donations or any other act that furthers the
business and affairs of the corporation
5. (16) To provide insurance on its employees
b. Corporate Responsibility
i. What if a corporation wants to be charitable, can shareholders stop
this?
ii. Old Rule: Corporation could not disburse any corporate funds for
philanthropic or other public causes unless the expenditure benefited
the corporation
1. Ex: Cross v Midtown Club Corp. gave $1500 to Princeton.
Court held this wasnt ultra vires because the corp. could use
this as a contract to recruit Princeton graduates
iii. New Rule: A charitable donation is not ultra vires so long as it tends to
promote the good-will of the business
1. Modern view allows for charitable donations especially to
schools because they promote good-will in the public eye and
fulfill the corporations duty of citizenship
iv. Dodge v Ford Motor Co. Henry Ford wanted to restrict dividends
and reduce profits in order benefit the consumer. Court held that a
corporation is not a charity it conducts business to make money!
c. Ultra Vires
i. An ultra vires arises when a corporation undertakes transaction beyond
its express or implied powers.
ii. This isnt really a problem in NC, though, because of
iii. 55-3-01(a) Purposes
1. Every corporation incorporated under this Chapter has the
purpose of engaging in any lawful business unless a more
limited purpose is set forth in its articles of incorporation
iv. So a corporation is not limited in its action unless it limits itself, e.g.,
Our purpose is to
v. You have no reason to limit the scope of your corporation
VIII. Management of Corporations
a. Vocabulary

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Business Associations Spring 2007 Hauser

i. Voting Groups 55-1-40(26) All shares of one or more classes or

series that are entitled to vote and be counted together collectively at a
meeting of shareholders
ii. Proxy - 55-7-22 An appointment by a shareholder (directors cant
have proxies) of a third person to act as their agent in casting the
shareholders vote in a designated manner
b. Board of Directors
i. Generally Corporate statutes provide that affairs of corporations are
to managed by a board of directors - 55-8-01(b)
1. Directors are not agents but they are subject to certain
formalities and have fiduciary duties
ii. Appointment and Election
1. 55-8-03 A board of directors must consist of one or more
people This is set out in the articles or bylaws. May be
increased or decreased
2. Election Directors are elected at the first annual shareholders
meeting and at each meeting thereafter (unless their terms are
staggered)
iii. Shareholder Voting
1. Matters are submitted to shareholders and are approved by a
simple majority vote (unless otherwise specified in articles or
bylaws)
2. Straight Voting Most matters, each share of common stock
is entitled to one vote
3. Cumulative Voting This is used to protect minority
shareholders, to concentrate their votes Votes can be
divided. This applies only to election of directors
a. Ex: 3 director seats need to be filled. X owns 100
shares. With straight voting, X gets 100 votes for each
seat which must be cast separately. With cumulative
voting, X can allocate his votes, 300 for one candidate
or 150 each for two candidates.
iv. Director Removal
1. 55-8-08(c) If cumulative voting is authorized, a director
may not be removed if enough votes are cast to retain him as
would be necessary to elect him
2. If cumulative voting is not authorized, a simple majority vote is
required to remove a director
v. Classified Staggered Boards
1. Only a portion of directors are elected each year.
a. Ex: Board has 12 directors, 4 elected every year
2. NC Staggered boards authorized by 55-8-06
a. Allowed if the corp. has 9 or more directors
b. Must be authorized by articles or bylaw adopted by
shareholders

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Business Associations Spring 2007 Hauser

3. At the initial election, after staggered board is adopted, one

portion of directors is elected for 1 year, another for 2, another
for 3, etc.
a. As these directors are replaced, their replacements are
elected for uniform terms, e.g., 3 years
vi. Quorum and Voting Requirements - 55-8-24
1. Quorum The number of directors that must be present at the
board meeting for a board action to be valid
2. 55-8-24(a) By default, a quorum is a majority of the full
board not just those present
a. Full board number of directors authorized
b. Articles or bylaws may impose greater or lesser quorum
requirements
c. NC Quorum can be no smaller than 1/3 of
directors
3. 55-8-24(d) Voting
a. A director who is present is deemed to have assented to
an action unless:
i. They object (Vote no)
ii. The dissent or abstain (equal to voting no)
4. Ex: 9 directors authorized in articles. 2 vacancies on the board
(only 7 sitting). How many are necessary for a quorum?
a. 5 Five is a majority of nine (not the 7 sitting directors)
5. Ex: Same situation, 5 directors are present. How many must
vote yes for board action to be valid?
a. 3 must vote yes
6. Ex: Same situation, 5 present. 2 vote yes, 2 vote no, and 1
abstains. Does this action pass?
a. NO An abstaining is seen as a no
c. Housekeeping Requirements
i. Directors Meetings
1. Directors do not act singularly they are required to act at a
duly convened meeting
2. Directors cannot vote by proxy
3. Unless otherwise specified, a meeting can be held using
telecommunications (video conferencing, conference call) so
long as it can be heard by all
ii. Notice
1. All directors must know of meetings
2. Regular v Special Meetings
a. 55-8-22(a) If a meeting is a regular one, notice is not
required.
b. If a meeting is not regular (special), there must be 2
days notice to all board members
c. NC Requires 5 day notice - 55-8-22(b)

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Business Associations Spring 2007 Hauser

3. Waiver of notice attendance or participation waives a

directors required notice unless he objects to holding the
meeting
iii. Quorum and Voting Requirements
1. 55-8-24(a) Normally a quorum consists of a majority of the
total number of directors.
2. If a quorum is present, affirmative vote of majority of directors
present constitutes a board action
3. Voting Requirements
a. Directors cannot vote by proxy Shareholders can,
though
iv. Directors can act without meeting if there is unanimous consent in
writing
1. This can be retro-active, e.g., the board does something and
later unanimously agrees to consent to it
d. Officers
i. Generally Corps are managed by officers who implement policy
decisions made by the board of directors
1. Officers include: CEO or President, Vice Presidents (can have
numerous VPs), Treasurer, Comptroller/CFO, Secretary, etc.
ii. Removal of Officers
1. Officers may be removed at any time, with or without cause,
by:
a. The board
b. The officer who appointed said officer
c. Any other officer if authorized by bylaws or the board
2. Removal of officers is not a shareholder issue
iii. Officers are agents of the corporation they have the power to
bind the corporation
1. Conversely, shareholders and directors are not agents they
acts as groups
2. Basically, it is impossible to get a board resolution for every
corporate act this is why officers act with delegation actual,
apparent or implied authority
3. Is an officers authority actual or apparent?
a. Express authority is granted in the articles or bylaws
or by a resolution by the board
b. Implied Powers In addition to the power to take
action that is expressly authorized, officers have
implied power to undertake any act reasonably
incident to the accomplishment of an expressly
authorized act this is implied by the office they hold
4. Ex: X is president of ABC, Inc. Bylaws say that purchases
over $5K require approval. X goes out and buys a $10K piece
of equipment (without getting approval). Is the corp required
to pay the $10K? Yes the president is an agent, and inherent

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Business Associations Spring 2007 Hauser

in his authority is the ability to purchase equipment for the

company. When he represented himself as president to the
equipment company (3rd Party) he was binding the corp by
using apparent authority

Fiduciary Duties of Officers and Directors

I. Generally Directors and officers are deemed fiduciaries because they stand in a
position of trust
a. Being a fiduciary requires that directors and officers act: reasonably, in good
faith and for the benefit of the corp and shareholders
II. Business Judgment Rule (BJR)
b. GR The BJR is a presumption that directors are not liable for losses incurred
as a result of their good faith business judgment which was decided by
exercising reasonable care.
i. The BJR is used as a defense when breach of duty is claimed
ii. Basically, unless directors act in bad faith or unreasonably they are
going to be protected by the BJR
5. Ex: In the 60s Wrigley refused to put lights up at Wrigley
Stadium. Shareholders said this would allow night games and
would bring a lot of profits
6. Ex: In late 2004, Ford directors decided to invest heavily in
their SUVs and trucks because they were high profit vehicles.
Gas prices shot up and Ford is hurting. Directors not liable for
a bad decision, because it was reasonable at the time
III. Directors Duty of Care
a. A breach of the directors duty of care removes their decisions from
the protection of the BJR
b. Relates to the quality of the directors decision making and oversight
i. This is similar to a negligence standard of care in torts
c. 55-8-30 General Standards for Directors
i. A director shall discharge his duties:
7. In good faith
8. With the care an ordinary, prudent person in a like position
would exercise under similar circumstances; and
9. In a manner reasonably believed to be in the best interests of
the corporation
ii. Relying on 3rd Party Information - 55-8-30(b)
10. A director is entitled to rely on information presented by:
a. One or more officers or employees of the corp whom
the director reasonably believes to be reliable and
competent
b. Legal counsel, CPAs, etc
i. This is why opinion letters are used, e.g. the
director relied on an attorneys opinion as set
forth in the letter
c. A committee of the board which merits confidence

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Business Associations Spring 2007 Hauser

iii. A director is not entitled to the aforementioned benefits if he has

actual knowledge
11. Conversely, ignorance, i.e. not being informed, is also a reason
for liability
iv. Uninformed Decisions
12. Smith v Van Gorkom VG convinced the board to a leverage
buyout (LBO) getting $55 for stock that was trading at $38.
VG gave an oral presentation no document and this was all
decided in 2 hours time. Court held that this was a lack of
diligence on the board
13. BJR does not cover uninformed decisions
14. Directors have a duty to be informed may be liable for
gross negligence in failing to make an informed decision
IV. Directors Duty of Loyalty - 55-8-31
a. BJR not a defense to breach of duty of loyalty
i. BJR applies to board decisions not individual transactions
b. Potential problems involve:
i. Self-Dealing aka Interested Director transactions
ii. Conflicts of Interest
iii. Usurpation of Corporate Opportunity
iv. Competing with the Corporation
c. Self-Dealing / Interested Director
i. Occurs when a director/officer is transacting business with the
corporation
1. Ex: Director sells property to the corporation w/o disclosing
his connection to the property
d. 55-8-31(a) Conflict of Interest Transactions Sanitizing a
Transaction
i. At common law, a directors involvement in a self-dealing transaction
was presumed unfair. The burden was on the director to prove
fairness.
ii. 55-8-31 Allows the director to shift the burden of proof the
transaction can still be challenged, but the challenger has the burden of
proof
iii. A conflict of interest transaction is a transaction with the corporation
in which a director of the corporation has a direct or indirect interest
e. The mere fact that there is an interested director does not make a
contract voidable if (3 ways):
i. Disclosure and vote
1. (1) Material facts of the transaction and directors interest were
disclosed to the board or a committee of the board and they
approve or ratify the transaction
2. (2) Material facts were disclosed to shareholders entitled to
vote and they approved the transaction; OR
ii. (3) The transaction was fair and reasonable to the corporation

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3. If the transaction was not disclosed, the director has burden

to prove it was fair
iii. If one of three factors is satisfied, the transaction is sanitized and
not voidable
f. Usurping a Corp. Opportunity A species of Duty of Loyalty
i. A director breaches his fiduciary duty when he usurps a corporate
opportunity
ii. GR No liability if (1) Director disclosed opportunity to the corp.
and gave the corp. an opportunity to act; OR (2) The transaction is
entirely fair to the corp.
iii. Issues
1. Is this a corporate opportunity?
2. If so, is the director legally justified in taking it himself?
iv. When is an opportunity a corporate opportunity?
1. Guth v Loft
a. Set out that a director has a fiduciary duty to offer a
corporate opportunity to the corp. before he takes it
himself
b. Set out the Line of Business test:
i. Is the corp. financially able to undertake the
opportunity?
ii. Is the opportunity in the line of the corp.s
business?
iii. Does the corp. have an interest or expectancy?
iv. By taking the opportunity, will the fiduciary be
brought into conflict with the corp?
2. ALI (American Law Institute) Test
a. A corporate opportunity occurs if a director:
i. Learns about the opportunity in connection with
the performance of their corporate duties; OR
ii. Discover the opportunity through the use of
corporate info or property
3. NC (exam) Meiselman v Meiselman
a. To be a corporate opportunity a venture must
either:
i. Be functionally related to the corporations
business; OR
ii. The corporation must have an interest or
expectancy in the opportunity
b. 6 Recurring circumstances to look for:
i. The ability, financial or otherwise, of the corp to
take advantage of the opportunity
ii. Did corp engage in prior negotiations regarding
the opportunity
iii. Did officer/director learn of the opportunity
through his fiduciary position

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iv. Was opportunity disclosed to corp

v. Did corp reject the opportunity
vi. Were corporate facilities used to acquire the
opportunity
e. Duty of Care v. Duty of Loyalty
i. Duty of Care
1. Involve Board decisions
a. Informed
b. Rational
c. Good faith
2. Protected by BJR
ii. Duty of Loyalty
1. Involve Transactions
a. Conflict of Interest
i. May be sanitized by:
1. Disclosure to directors and vote to
approve;
2. Disclosure to shareholders and vote to
approve; OR
3. Director can prove the transaction was
fair
b. Self-Dealing
i. Director is an undisclosed third party to a
transaction
c. Corporate Opportunity
i. Meiselman Opportunity must be
1. Fundamentally related to the corps
business; AND
2. Corp must have an interest or
expectancy in the opportunity
IX. Shareholder Voting
a. 55-7-28(a)
i. Unless otherwise provided, directors are elected by a plurality of the
votes cast by shares entitled to vote at a meeting at which a quorum is
present
1. A majority note is not required
b. Cumulative Voting
i. 55-7-28(b) Unless the articles provide otherwise, shareholders do
not have the right to cumulate their votes for directors (see 55-7-25
for other matters)
1. 55-7-28(c) Def. Shareholders are entitled to multiply the
number of votes they are entitled to cast by the number of
directors for whom they are entitled to elect
ii. Notice/Affirmative Steps Required - 55-7-28(d) A meeting notice
or proxy statement must state conspicuously that cumulative voting is
authorized; OR

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1. Shareholder must announce in an open meeting his intent to

vote cumulatively
2. This entitles all shareholders to vote cumulatively
3. Chair announces number of votes represented at the meeting
and a recess must be called for 1-4 hours (so the shareholders
can do their math!) unless otherwise unanimously agreed
c. 55-7-28(e) Right to cumulative voting
i. Even if articles dont mention cumulative voting, shareholders may
have the right
1. 55-7-28(e)(1) Nonpublic corp formed before July 1, 1957,
shareholders have right to vote cumulatively if there is at least
1 shareholder who owns/controls more than of the votes
even if articles are silent
2. 55-7-28(e)(2) Nonpublic corp formed on or after July 1, 1957
and before July 1, 1990 shareholders have right to vote
cumulatively even if articles are silent
d. 55-7-25 Quorum and Voting Req. for Voting Groups
i. This is not the same as 55-7-28 that address shareholder voting for
directors
1. Shareholder votes on all other matters are governed by
55-7-25(c)
2. Voting Groups 55-1-40(26) A voting group is all the shares
or one or more classes that are entitled to vote together in a
given matter
a. Quorums are determined by voting groups
3. Required Formalities
a. Meeting Notice Quorum - Vote
ii. 55-7-25(a)
1. Shares entitle to vote as a separate voting group may take
action only if a quorum of that voting group exists
2. Unless otherwise specified, a majority of votes entitled to be
cast constitutes a quorum for that matter
iii. 55-7-25(b)
1. Once a share is represented for any purpose at a meeting it is
deemed present for quorum purposes for the remainder of the
meeting
2. A shareholder cannot break a quorum by leaving a
meeting
iv. 55-7-25(c)
1. If a quorum exists a simple majority of votes being in favor of
an action is required for approval
2. But articles or bylaws can require a greater number of
affirmative votes
e. 55-7-01 Annual Meetings
i. Corp must hold annual meetings can be outside the state of the corp

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ii. A failure to hold an annual meeting does not affect validity of a

corporate action
iii. Special Meetings 55-7-02
1. A corp shall hold a special meeting of shareholders
a. On call of the board; OR
b. For private corps within 30 days after holders of at
least 10% of all votes demand a meeting
2. Only business described within the notice may be conducted at
special shareholder meetings
iv. 55-7-05 Notice of Meeting
1. No fewer than 10 and no more than 60 days before the meeting
2. An annual meeting need not describe its purposes
3. Notice of a special meeting must include a description of the
purposes for which it is called

f. Shareholder Inspection Rights - 55-16-02

i. 55-16-01 Corporations are required to keep permanent records of
corporate documents
ii. 55-16-02 Shareholders have the right to inspect and copy corporate
records subject to certain limitations:
In NC, SH have a common law right to inspect corporate records,
and this right is supplemented by a statutory right
1. 55-16-02(e)(2) Expressly preserves SHs common law right
of inspection.
2. 55-16-02(i) SH of a public corp have no common law right
to inspect
iii. 55-16-02(b) Essay Analysis
1. A qualified shareholder is entitled to inspect and copy, during
regular business hours, records described in -16-01(e) if he
gives written notice of his demand at least 5 business days
before he wants to inspect
a. Qualified SH 55-16-02(g) Has been a SH at least 6
months preceding his demand or holds at least 5% of
the corps outstanding shares
iv. 55-16-02(c)
1. A qualified SH may inspect and copy records only if:
a. His demand is made in good faith and for a proper
purpose;
b. He describes with reasonable particularity his
purpose for inspecting; AND
c. The records are directly connected with his purpose
2. 55-16-02(b)(3) Trump Card
a. A shareholder of a public corp shall not be entitled to
inspect any accounting records any matter which the
corporation determines in good faith may adversely
affect the corporation

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b. I.e., If inspection of corp records would hurt the corp or

is made in bad faith you aint getting those records
X. Closely-Held Corporations
a. Closely held corps are basically incorporated partnerships
i. Stock is held by few people and the shareholders actively participate in
corporate management
b. Fiduciary Duties in Closely-Held Corp
i. Same duty requirements as partners Not honesty alone, but the
punctilio of an honor the most sensitive
1. Majority SHs owe a fiduciary duty to minority SHs
ii. Liquidity Problem There is no market for the shares of a closely-held
corp., i.e. shareholders are locked in and dont have the power to
dissolve the corporation
iii. Equal Opportunity Rule Donahue v Rodd Electrotype If a
controlling SH sells shares to the corp., the corp. must extend an
opportunity to the minority SHs to sell their shares at the same price
c. Minority SH Entitled to Relief?
i. Many close corps are companies based on personal relationships that
give rise to certain reasonable expectations on the part of those
acquiring an interest in the close corp
ii. MeiselmanWhat if personal relationships sour in a close corporation?
The majority SH is in a position of power he can terminate the
minority SH or exclude him from participating in management
decisions
1. A court should give relief, dissolution or other remedy to a
minority SH when controlling SHs act in a way that
disappoints the minority SHs reasonable expectations
2. (1) 55-14-30(2)(ii) Liquidation is reasonably necessary for
the protection of the rights and interests of the complaining
shareholder
a. If a minority SH is getting screwed, dissolution is
his way out but only if his reasonable expectation of
his rights and interests have been breached
3. (2) Reasonable expectations cannot be private They must
be known by the other SHs
a. E.g., Look at the SHs course-of-dealing with the corp
4. (3) 55-14-31(d) In any proceeding brought under
-14-30(2)(ii) in which the court determines that dissolution
would be appropriate, the court shall not order dissolution
if the corp elects to purchase the shares of the complaining
SH at their fair value
a. Avoid dissolution by buying the SH out
XI. Shareholder Voting Agreements
a. Voting Trusts - 55-7-30
i. SHs give a trustee legal power to vote they sign away their right
ii. Requirements

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1. One or more SH confer on a trustee the right to vote by

2. Signing an agreement setting out the provisions
3. Trustee shall prepare a list of all trust members along with
their number of shares and deliver to the corps office
iii. Duration
1. Effective when first shares subject to trust are registered to
trustee
2. Not valid for more than 10 years after its effective date
3. All or some of the parties may extend the trust for additional
terms for no more than 10 years by giving written consent
iv. Revocability
1. Nope (not normally)

b. Shareholder Agreements - 55-7-31

i. SHs vote themselves they enter into an agreement to vote their
shares as a unit in SH matters. Consideration is a mutual desire to
maintain voting control
ii. Requirements
1. Two or more SH in writing and signed by the parties
iii. Duration
1. No more than 10 years from date of execution
2. May be extended in same manner as a voting trust (written
consent)
iv. Revocability
1. SH Agreement may not limit director discretion, i.e., it may
not affect the conduct of the directors
2. Exception Close corp Where directors are the only SHs
there is no reason they cant limit their discretion through
unanimous decision
c. Proxies - 55-7-22
i. Assigning another the right to vote the stock owned by SH
ii. Establishes an agency relationship (along with fiduciary duties)
iii. Requirements
1. Appoint proxy by signing a form might be able to sign
electronically (?)
2. Public corp may permit SH to appoint by telephonic
transmission even without written communication
iv. Duration
1. Effective for 11 months unless otherwise specified
v. Revocability
1. Revocable at any time, except
2. 55-7-22(d) A proxy is irrevocable if conspicuously stated
and coupled with an interest

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