Complete subject outline

Business Associations outline for the bar exam

This outline follows a business from its formation to its ending: agency and authority, principal and agent liability, partnerships, corporate formation and capitalization, directors and officers, shareholder rights and fundamental changes. Each module lists the propositions to memorize, an attack sequence, the traps and exceptions, and a short worked application. The subject is tested on the MEE and in NextGen but not on the MBE, so the outline is written for essay answers that name the rule and apply it. Reread it as the continuous reference once a first pass through the rule bank by unit is done. Most essays turn on tracing liability from whoever acted back to whoever ultimately answers for it, agent, principal, partner or corporation. Practice writing out the duty of loyalty analysis in full sentences, because essays reward the whole chain of reasoning.

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Business Associations outline coverage by unit
Unit	Modules	Propositions
Agency	3	15
Agency and tort	1	5
Agency duties	1	5
Partnership	2	10
Formation	1	5
Corporate capital	1	6
Governance	1	5
Fiduciary duties	1	5
Owner litigation	1	6
LLCs and change	1	6
Corporate governance	3	41
Fundamental changes	1	12
Partnerships	1	10
Formation of corporations and limited liability companies	1	10
Formation and governance of corporations	1	10
Formation of corporations	1	10
Formation and governance of corporations and limited liability companies	1	14

01 · Agency

Creation and actual authority

Agency is a consensual fiduciary relationship in which an agent acts on a principal's behalf and subject to the principal's control; actual authority follows the agent's reasonable understanding of the principal's manifestations.

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Black-letter propositions

Agency can arise without contract, compensation, or formal label when assent, benefit, and control exist.
Express actual authority comes from explicit manifestations; implied authority includes acts reasonably necessary or customary to accomplish authorized objectives.
The agent's reasonable belief is judged from the principal's communications and circumstances.
Actual authority ends through agreement, accomplishment, lapse, revocation, renunciation, changed circumstances, or law, subject to powers given as security.
A principal can be bound even if undisclosed when actual authority exists.

Attack sequence

1Identify principal, agent, task, and control.

2Find every principal-to-agent manifestation.

3State express and implied authority.

4Track termination and agent notice.

5Then analyze third-party protection separately.

Traps and exceptions

!The parties' label independent contractor does not prevent agency for some purposes.

!An agent's own claim of authority does not create actual authority.

!Termination of actual authority does not automatically terminate apparent authority.

WORKED APPLICATION

A restaurant owner tells a manager to 'run daily operations.' The manager buys customary kitchen supplies.

The broad instruction and industry custom give implied actual authority to purchase ordinary supplies reasonably necessary for operations.

Essay-ready formulationAgency arises from assent, acting on behalf, and control; actual authority follows the agent's reasonable interpretation of the principal's manifestations.

02 · Agency

Apparent authority, estoppel, and ratification

A principal can be bound without actual authority through reasonable third-party reliance on the principal's manifestations or later affirmance of the act.

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Black-letter propositions

Apparent authority requires a principal manifestation reaching the third party and a reasonable belief that the agent is authorized.
A former agent may retain lingering apparent authority until third parties receive appropriate notice.
Agency by estoppel protects a third party who changes position because the principal carelessly or intentionally caused a belief in authority.
Ratification requires an identifiable principal with capacity, knowledge of material facts, and affirmance of the whole act before circumstances make ratification inequitable.
Ratification relates back subject to intervening-rights and timing limits.

Attack sequence

1Identify third party's exact information source.

2Separate principal manifestations from agent assertions.

3Assess reasonableness and detrimental change.

4For ratification, test principal existence, capacity, knowledge, and whole-act affirmance.

Traps and exceptions

!An agent cannot create apparent authority by self-description alone.

!An undisclosed principal ordinarily cannot create apparent authority.

!A principal cannot ratify only the favorable portion of one transaction.

WORKED APPLICATION

A company leaves a former purchasing officer listed on its vendor portal after termination, and a longtime vendor reasonably relies.

The company's continuing manifestation can create lingering apparent authority until adequate notice, binding the company despite terminated actual authority.

Essay-ready formulationApparent authority protects reasonable reliance on principal manifestations, while ratification binds through informed affirmance of the entire unauthorized act.

03 · Agency

Contract liability and agent warranties

Principal and agent liability on an authorized contract depends on authority and whether the principal was disclosed, unidentified, or undisclosed.

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Black-letter propositions

A disclosed principal is ordinarily liable and the authorized agent is not a party.
When the principal is unidentified or undisclosed, the agent is ordinarily liable, and the principal may also be liable if the act was authorized.
An agent purporting to act for a principal impliedly warrants authority and can be liable when authority is absent.
A third party can elect remedies subject to one-satisfaction and contract terms.
An unauthorized actor can become liable for misrepresentation or warranty even when the principal is not bound.

Attack sequence

1Identify authority route.

2Classify principal disclosure at contracting.

3Determine contractual parties.

4If no authority, analyze warranty of authority and tort theories.

Traps and exceptions

!Naming a trade name may not identify the principal's legal identity.

!A partially disclosed principal usually leaves agent and principal both liable.

!Ratification can eliminate the unauthorized premise but not all independent misrepresentation issues.

WORKED APPLICATION

An agent signs for 'my client' without naming the client.

The principal is unidentified, so the agent is ordinarily a party to the contract along with the authorized principal.

Essay-ready formulationContract liability follows authority and the third party's knowledge of principal identity; an unauthorized agent can separately breach a warranty of authority.

04 · Agency and tort

Employee status and vicarious liability

A principal is vicariously liable for an employee's tort within employment scope, while contractor torts ordinarily require an exception or direct principal fault.

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Black-letter propositions

Employee status emphasizes the principal's right to control manner and means, alongside skill, tools, duration, payment, business integration, and parties' understanding.
Scope includes assigned work and conduct intended at least partly to serve employer.
A commute or substantial personal frolic is usually outside; a minor detour can remain within scope.
Intentional torts can be within scope when force or friction is job related or conduct serves the employer.
Contractor exceptions include nondelegable duty, peculiar risk, apparent agency, and negligent selection or supervision.

Attack sequence

1Classify worker under control factors.

2Identify tort and time, place, purpose, and authorization.

3Distinguish detour from frolic.

4Test contractor exceptions and direct negligence.

Traps and exceptions

!A contractor label does not control actual status.

!Forbidden methods can still be within scope.

!Vicarious liability does not erase the tortfeasor's personal liability.

WORKED APPLICATION

A delivery employee makes a two-block personal stop and collides while returning to the route.

The small deviation is likely a detour within scope, making the employer vicariously liable.

Essay-ready formulationVicarious liability turns on employee status and scope, with separate contractor exceptions and direct principal negligence.

05 · Agency duties

Care, loyalty, obedience, information, and remedies

Agents owe fiduciary and performance duties to principals, and principals owe contractual, indemnity, and good-faith duties to agents.

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Black-letter propositions

Agents must act with reasonable care, competence, diligence, and within lawful instructions.
Loyalty bars undisclosed self-dealing, adverse interests, secret profits, usurpation, and misuse of property or confidential information.
Agents must provide material information relevant to entrusted matters and keep accounts.
Consent can authorize conflicts when informed and not otherwise improper.
Principal remedies include damages, disgorgement, constructive trust, rescission, and forfeiture; agent rights can include indemnification and compensation.

Attack sequence

1Identify relationship and scope.

2Name exact duty and challenged conduct.

3Test disclosure and informed consent.

4Trace loss or gain.

5Select compensatory and restitutionary remedies.

Traps and exceptions

!No-loss self-dealing can still require disgorgement.

!An agent may prepare to compete but cannot misuse confidential information or divert opportunities while serving.

!Good faith does not automatically cure lack of informed consent.

WORKED APPLICATION

A purchasing agent secretly owns the supplier and charges a market price without disclosure.

The undisclosed conflict violates loyalty even if the price was fair; the principal can seek disgorgement and other relief.

Essay-ready formulationAgency fiduciary duties protect the principal from undisclosed conflicts and can support gain-based remedies without proof of loss.

06 · Partnership

Formation, property, management, and authority

A general partnership forms when two or more persons carry on as co-owners a business for profit, whether or not they intend the legal label.

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Black-letter propositions

Profit sharing creates a presumption subject to wage, rent, debt, interest, and similar exceptions.
Partnership property belongs to the entity; a partner has economic and management rights but no transferable ownership of specific assets.
Default management gives equal rights, ordinary matters by majority, and acts outside ordinary course or amendments by unanimity.
Each partner is an agent for ordinary-course business unless the partner lacks authority and the third party knows.
A partnership agreement can alter many defaults but not eliminate core mandatory duties and rights.

Attack sequence

1Identify co-ownership, profit, control, and business.

2Classify asset as partnership property.

3Apply agreement then default vote.

4Analyze actual and apparent partner authority.

Traps and exceptions

!Joint ownership and shared gross returns alone do not establish partnership.

!Calling the relationship a joint venture may still invoke partnership rules.

!A transferee of a partner's economic interest does not automatically gain management rights.

WORKED APPLICATION

Two consultants share profits equally, jointly control clients, and operate continuously without filing papers.

Their conduct forms a general partnership despite absence of formal intent or filing.

Essay-ready formulationPartnership status follows co-owned profit-seeking conduct, after which entity property, default management, and partner agency rules apply.

07 · Partnership

Partner liability, duties, dissociation, and dissolution

Partners face entity and personal consequences for partnership obligations, fiduciary conduct, departure, winding up, and continuation.

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Black-letter propositions

The partnership is liable for partner acts in ordinary business or with authority and for partner torts within ordinary course.
General partners are jointly and severally liable for partnership obligations, usually after exhaustion requirements under governing law.
Partners owe duties of loyalty and care and an obligation of good faith; the agreement can define but not unreasonably eliminate core duties.
Dissociation changes a partner's status and can be rightful or wrongful; lingering authority and buyout rules protect relevant parties.
Dissolution triggers winding up in specified events; continuation can occur under agreement or statute.

Attack sequence

1Identify partnership obligation and authority.

2Determine entity and personal liability.

3Analyze duty and consent.

4Classify dissociation and any wrongfulness.

5State buyout, winding-up, and creditor effects.

Traps and exceptions

!Incoming partners are generally not personally liable for preexisting obligations beyond their investment.

!Dissociation is not always dissolution.

!A filed statement may alter third-party notice only after statutory timing.

WORKED APPLICATION

A partner leaves a term partnership early without authorization and a vendor still believes she is a partner.

Departure may be wrongful, creating damages, and lingering apparent authority may bind the partnership until notice or statutory protection takes effect.

Essay-ready formulationPartner departure requires separate analysis of wrongfulness, authority, buyout, dissolution, and continuing creditor protection.

08 · Formation

Corporations, promoters, and preincorporation contracts

A corporation forms through compliant public filing; promoter acts before formation and defective incorporation raise distinct liability and adoption issues.

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Black-letter propositions

Articles generally state name, authorized shares, registered agent, and incorporator information; corporate existence begins on filing unless delayed.
A promoter who contracts for a nonexistent corporation is personally liable absent contrary agreement or later novation.
The corporation can adopt a preincorporation contract expressly or through knowing acceptance of benefits but cannot technically ratify an act made before it existed.
A novation among promoter, corporation, and third party releases promoter liability.
De facto corporation and corporation by estoppel can protect against defective formation under limited good-faith and reliance circumstances.

Attack sequence

1Check filing and legal existence date.

2Identify promoter act and contract language.

3Analyze promoter liability, corporate adoption, and novation separately.

4Consider defective-formation doctrines.

Traps and exceptions

!Corporate adoption does not by itself release promoter.

!A corporation cannot ratify an act predating its existence.

!Limited-liability expectations do not excuse ignored filing requirements.

WORKED APPLICATION

A promoter signs a lease 'for NewCo, Inc.' before filing; after incorporation NewCo knowingly pays rent for months.

NewCo adopted the lease by conduct, but the promoter remains personally liable unless the landlord agreed otherwise or a novation releases the promoter.

Essay-ready formulationPreincorporation contracts can bind the promoter and later the adopting corporation, but only novation or original agreement ordinarily releases the promoter.

09 · Corporate capital

Shares, subscriptions, issuance, and veil piercing

Corporate capital rules govern valid issuance and ownership, while veil piercing exceptionally imposes entity obligations on owners who abuse limited liability.

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Black-letter propositions

The board ordinarily authorizes share issuance for permitted consideration; watered-stock liability can reach improper issuance.
Preincorporation subscriptions may be temporarily irrevocable under statute; postformation subscriptions are contracts.
Share classes, preferences, conversion, redemption, and preemptive rights depend on articles and governing statute.
A shareholder is not ordinarily personally liable beyond investment.
Veil piercing considers unity of interest, undercapitalization, commingling, ignored formalities, misuse, and whether respecting the entity would promote fraud or injustice; contract and tort contexts can differ.
Enterprise and reverse-piercing theories are exceptional and jurisdiction dependent.

Attack sequence

1Identify entity, shareholder, obligation, and capitalization.

2Review articles and board action.

3For veil piercing, prove domination plus misuse and causal injustice.

4State which owner and which obligation are affected.

Traps and exceptions

!Failure to follow one formality is rarely enough alone.

!Limited liability is the rule, not an equitable suggestion.

!An LLC can also face veil piercing despite fewer required formalities.

WORKED APPLICATION

A sole shareholder commingles all funds, leaves a hazardous business intentionally undercapitalized, and uses the company to evade known liabilities.

The combination of domination and misuse causing injustice strongly supports veil piercing, especially for an involuntary tort claimant.

Essay-ready formulationOwners ordinarily have limited liability, but domination plus misuse causing fraud or injustice can justify piercing for a particular obligation.

10 · Governance

Board, officers, shareholder voting, and distributions

Corporate power is allocated among the board, officers, and shareholders through statutes, articles, bylaws, and valid agreements.

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Black-letter propositions

The board manages business and acts through meetings with notice, quorum, and vote or unanimous written consent unless law permits otherwise.
Officers have authority from office, delegation, actual authority, and apparent authority.
Shareholders elect directors and vote on specified fundamental actions, with record dates, proxies, quorum, cumulative voting, and class rights as applicable.
Voting agreements are generally enforceable; voting trusts and shareholder-control agreements require statutory compliance.
Distributions require board authorization and cannot violate solvency tests; directors can face liability subject to reliance and defenses.

Attack sequence

1Identify decision and actor with authority.

2Check articles, bylaws, agreement, and statutory default.

3Verify notice, quorum, vote, proxy, and class requirements.

4For distribution, apply solvency and director protections.

Traps and exceptions

!Individual directors ordinarily lack authority to bind the corporation merely by office.

!Board action without a meeting usually requires unanimity.

!A shareholder cannot use a proxy beyond statutory or contractual limits without checking irrevocability.

WORKED APPLICATION

Two of five directors meet without notice to the others and approve a major contract.

Unless waived or emergency rules apply, lack of proper notice and likely quorum invalidates board action.

Essay-ready formulationCorporate decisions require the correct actor and compliance with governing documents, notice, quorum, voting, and any shareholder or class approval.

11 · Fiduciary duties

Care, loyalty, business judgment, and oversight

Directors and officers owe care and loyalty, while the business-judgment rule protects informed, disinterested, good-faith decisions within authority.

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Black-letter propositions

Care requires informed deliberation and reasonable attention; exculpation statutes may limit monetary liability but not all remedies or officers.
Loyalty addresses self-dealing, conflicts, corporate opportunities, bad faith, and improper entrenchment.
A conflict transaction can be cleansed through informed approval by disinterested directors or shareholders or fairness under governing law.
Corporate opportunity analysis considers line of business, expectancy, financial capacity, and use of corporate information; proper presentation can protect the fiduciary.
Oversight liability requires sustained failure or conscious disregard of monitoring or red flags, not ordinary business loss.

Attack sequence

1Identify fiduciary, beneficiary, and decision.

2Classify care, conflict, opportunity, oversight, or good-faith issue.

3Determine disinterest, information, process, and cleansing.

4Apply business judgment only after prerequisites.

5State equitable and monetary remedies.

Traps and exceptions

!A bad outcome is not itself a duty breach.

!Interested approval is not cleansing.

!Articles cannot eliminate loyalty or bad-faith accountability.

WORKED APPLICATION

A director buys an opportunity learned solely through board work without disclosing it, even though the corporation was considering expansion.

The opportunity likely belongs to the corporation; nondisclosure and appropriation violate loyalty unless the corporation validly rejected it after informed presentation.

Essay-ready formulationBusiness judgment protects informed disinterested good-faith decisions, not undisclosed conflicts, usurped opportunities, bad faith, or conscious oversight failures.

12 · Owner litigation

Direct, derivative, and closely held claims

Shareholder and member litigation depends on whose right was harmed, who receives recovery, standing, demand, and procedural control.

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Black-letter propositions

A direct claim redresses injury to the owner personally; a derivative claim enforces an entity right and recovery goes to the entity.
Derivative standing ordinarily requires ownership at the relevant time and throughout litigation plus adequate representation.
Demand on the board may be universally required or excused as futile under jurisdictional law.
A special litigation committee's independence, process, and conclusions receive the jurisdiction's specified review.
Settlement or dismissal requires court oversight in derivative cases.
Closely held owners may receive partnership-like duties or alternative oppression remedies depending on law.

Attack sequence

1Ask who suffered primary injury and who receives recovery.

2Classify direct or derivative.

3Test contemporaneous and continuous ownership.

4Apply demand and committee rules.

5Address fees, settlement, and closely held remedies.

Traps and exceptions

!Calling a claim direct does not make it so.

!Share-price decline from injury to the corporation is ordinarily derivative.

!Demand futility tests differ materially by jurisdiction and supplied law controls.

WORKED APPLICATION

A director diverts corporate cash, reducing every share's value equally.

The primary injury is to the corporation and recovery belongs to it, so the claim is derivative despite the shareholder's economic loss.

Essay-ready formulationOwner litigation classification turns on whose right was violated and who should receive recovery, followed by standing, demand, and judicial-control rules.

13 · LLCs and change

LLC governance and fundamental transactions

LLCs combine entity liability protection with operating-agreement flexibility, while corporations and LLCs require approvals for specified structural changes.

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Black-letter propositions

An LLC forms by public filing and is governed primarily by its operating agreement plus mandatory statutory limits.
Member-managed LLCs ordinarily give members authority; manager-managed LLCs allocate ordinary management to managers and provide notice of that structure.
Members and managers can owe care, loyalty, and good-faith duties as defined and limited by statute and agreement.
Members are ordinarily not personally liable solely by status, subject to personal torts, guarantees, and veil piercing.
Mergers, sales of substantially all assets outside ordinary course, conversions, and dissolution generally require board or manager action plus owner approval and filings.
Dissenters may receive appraisal rights for specified transactions subject to procedure.

Attack sequence

1Identify entity form and management structure.

2Read operating agreement and mandatory statute.

3Determine actor authority and duties.

4For structural change, list approvals, notice, filings, and appraisal.

5Address successor liability and dissolution.

Traps and exceptions

!An LLC is not merely a partnership with automatic partner authority.

!Operating agreements cannot always eliminate every fiduciary or good-faith obligation.

!A sale of ordinary inventory is not a sale of substantially all assets.

WORKED APPLICATION

A manager-managed LLC member signs an ordinary company contract, and the counterparty knows only managers have authority.

The member lacks status-based authority in the manager-managed structure, and known limitations defeat apparent authority absent another manifestation.

Essay-ready formulationLLC problems require management-structure and operating-agreement analysis; structural transactions add entity-specific approvals, filings, and owner remedies.

14 · Corporate governance

Director protections: exculpation, good-faith reliance, indemnification, advancement, and insurance (Delaware)

A corporation may indemnify directors and officers who acted in good faith, must indemnify a director or officer who wins, may advance defense costs on an undertaking to repay, and may buy insurance, with tighter limits when the suit is brought by or for the corporation.

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Black-letter propositions

A corporation has power to indemnify a person who is a party to a threatened, pending or completed action, other than an action by or in the right of the corporation, by reason of being a director, officer, employee or agent, against expenses, judgments, fines and settlement amounts actually and reasonably incurred, if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the corporation's best interests.
In a criminal proceeding the person must also have had no reasonable cause to believe the conduct was unlawful.
A termination of a proceeding by judgment, order, settlement, conviction or plea of nolo contendere does not of itself create a presumption that the person did not meet the standard of conduct.
In an action by or in the right of the corporation, such as a derivative suit, the corporation may indemnify only expenses, including attorneys' fees, actually and reasonably incurred in defense or settlement, if the person met the same good-faith standard, and it may not indemnify for any claim as to which the person was adjudged liable to the corporation unless the court decides the person is fairly and reasonably entitled to indemnity.
To the extent that a present or former director or officer has been successful on the merits or otherwise in defense of any proceeding, or of any claim, issue or matter in it, the corporation must indemnify the person against expenses, including attorneys' fees, actually and reasonably incurred.
The corporation may indemnify any other person who is not a director or officer to the extent that person has been successful on the merits or otherwise in defense of the proceeding.
Indemnification under the discretionary provisions, unless ordered by a court, may be made only as authorized in the specific case upon a determination that the person has met the applicable standard of conduct.
For a person who is a director or officer at the time of the determination, the determination is made by a majority of the directors who are not parties, even though less than a quorum, or a committee of such directors, or independent legal counsel in a written opinion if there are no such directors or they so direct, or the stockholders.
Expenses incurred by an officer or director in defending a proceeding may be paid by the corporation in advance of final disposition upon receipt of an undertaking by or on behalf of the officer or director to repay the amount if it is ultimately determined that the person is not entitled to indemnification.
The indemnification and advancement provided by the statute is not exclusive of other rights under a bylaw, agreement, vote of stockholders or disinterested directors, or otherwise.
A right to indemnification or advancement arising under the certificate of incorporation or a bylaw is not eliminated or impaired by a later amendment or repeal after the act or omission, unless the provision in effect at the time explicitly authorizes such elimination after the fact.
A corporation has power to purchase and maintain insurance on behalf of a person who is or was a director, officer, employee or agent against liability asserted against the person and incurred in that capacity, whether or not the corporation would have the power to indemnify the person against the liability.
A director, in performing the director's duties, is fully protected in relying in good faith on the corporation's records and on information, opinions, reports or statements presented by officers, employees, board committees, or other persons on matters the director reasonably believes are within that person's professional or expert competence and who was selected with reasonable care by or on behalf of the corporation.
The certificate of incorporation may eliminate or limit a director's or officer's personal liability to the corporation or its stockholders for monetary damages for breach of fiduciary duty, but not for a breach of the duty of loyalty, for acts or omissions not in good faith or involving intentional misconduct or a knowing violation of law, for an unlawful dividend or stock repurchase under section 174, or for any transaction from which the person derived an improper personal benefit.
An officer's exculpation does not extend to any action by or in the right of the corporation, and an exculpation provision does not eliminate liability for acts or omissions before the provision became effective.

Attack sequence

1Identify whether the proceeding is a third-party action or an action by or in the right of the corporation.

2Apply the good-faith standard, and for criminal proceedings the no-reasonable-cause standard.

3Ask whether the person was successful on the merits or otherwise, which makes indemnification mandatory for directors and officers.

4Identify who determines eligibility, and whether advancement requires an undertaking to repay.

Traps and exceptions

!Settlement payments and judgments can be indemnified in third-party suits, but in a derivative suit only expenses may be.

!Mandatory indemnification for a director or officer who is successful covers expenses only and turns on success on the merits or otherwise.

!Advancement requires an undertaking to repay, and the bylaws or an agreement can give rights beyond the statute.

WORKED APPLICATION

A director is sued by a stockholder, in a derivative action for the corporation, for breach of duty. The suit settles, and the director asks the corporation to pay the settlement amount and her attorneys' fees.

In a derivative suit the corporation may indemnify only expenses actually and reasonably incurred, if the director met the good-faith standard, and may not indemnify amounts paid in settlement to the corporation.

Essay-ready formulationSay whether the suit is a third-party or derivative action, apply the good-faith standard, address mandatory indemnification for success, then who decides, advancement, and insurance.

15 · Corporate governance

Stockholder meetings, voting, proxies, written consent, and removal or replacement of directors (Delaware)

Delaware sets default rules for quorum and voting at stockholder meetings, the life of a proxy, action by written consent, cumulative voting, and how directors are removed or vacancies filled, and the charter or bylaws can change many of them.

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Black-letter propositions

An annual meeting of stockholders must be held for the election of directors on a date designated by or under the bylaws, unless directors are elected by written consent in lieu of an annual meeting as the statute permits.
Notice of a stockholder meeting must be given not less than 10 nor more than 60 days before the meeting to each stockholder entitled to vote, and must state the place, date and hour and, for a special meeting, the purposes for which it is called.
Unless the certificate or bylaws specify otherwise, a majority of the shares entitled to vote, present in person or by proxy, is a quorum, and the certificate or bylaws may not set a quorum at less than one-third of the shares entitled to vote.
Unless the certificate or bylaws provide otherwise, on matters other than the election of directors the affirmative vote of a majority of the shares present in person or by proxy and entitled to vote on the matter is the act of the stockholders.
Unless the certificate or bylaws provide otherwise, directors are elected by a plurality of the votes of the shares present in person or by proxy and entitled to vote on the election of directors.
The certificate of incorporation may provide for cumulative voting, under which each stockholder has a number of votes equal to the shares held multiplied by the number of directors to be elected and may cast all votes for one director or distribute them among the candidates.
A stockholder may authorize another person to act as proxy, but no proxy may be voted after 3 years from its date unless the proxy provides for a longer period.
A duly executed proxy is irrevocable if it states that it is irrevocable and if, and only as long as, it is coupled with an interest sufficient in law to support an irrevocable power, whether the interest is in the stock itself or in the corporation generally.
Unless the certificate of incorporation provides otherwise, any action that may be taken at a stockholders' meeting may be taken without a meeting, without prior notice and without a vote, if written consents are signed by holders of outstanding stock having not less than the minimum number of votes needed to take the action at a meeting at which all shares entitled to vote were present and voted.
A written consent is not effective unless consents signed by enough holders are delivered to the corporation within 60 days of the first date on which a consent was delivered.
Unless the certificate or bylaws provide otherwise, vacancies and newly created directorships may be filled by a majority of the directors then in office, though less than a quorum, or by a sole remaining director.
Any director or the entire board may be removed, with or without cause, by holders of a majority of the shares then entitled to vote at an election of directors, except that stockholders may remove a director of a classified board only for cause unless the certificate provides otherwise, and with cumulative voting a director cannot be removed without cause if the votes against removal would be enough to elect the director.

Attack sequence

1Identify the default rule and check whether the certificate or bylaws change it.

2For a vote, determine whether the matter is an election of directors (plurality) or another matter (majority of shares present and entitled to vote).

3For a proxy, check its date and whether it is expressly irrevocable and coupled with an interest.

4For removal, check whether the board is classified or the corporation uses cumulative voting.

Traps and exceptions

!The default quorum is a majority of shares entitled to vote, but the charter or bylaws may lower it to no less than one-third.

!Directors are elected by a plurality, while other matters need a majority of the shares present and entitled to vote.

!A proxy is revocable unless it says it is irrevocable and is coupled with an interest.

WORKED APPLICATION

A corporation's bylaws are silent on quorum and voting. At the annual meeting, holders of 60 percent of the voting shares attend. On a proposed charter-related matter 35 percent of all shares vote for it and 25 percent vote against.

A majority of shares is present, so there is a quorum. On a matter other than the election of directors a majority of the shares present and entitled to vote must approve, and 35 of 60 is a majority, so it passes under the default rule.

Essay-ready formulationStart with the default quorum and voting rules, then adjust for charter or bylaw changes, then treat proxies, written consent, and director removal and vacancies.

16 · Fundamental changes

Mergers, sales of substantially all assets, dissolution, and appraisal rights (Delaware)

A Delaware corporation needs board approval and, for fundamental changes, a stockholder vote, and stockholders who dissent from a merger may have a right to a court appraisal of the fair value of their shares unless a market exception applies.

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Black-letter propositions

Two or more Delaware corporations may merge into a single surviving corporation, and the board of each corporation that wants to merge must adopt a resolution approving an agreement of merger and declaring its advisability.
The merger agreement must be submitted to the stockholders of each constituent corporation at a meeting on notice given at least 20 days before the meeting to each holder of stock, whether voting or nonvoting, with a copy or brief summary of the agreement.
A merger is adopted if a majority of the outstanding stock of the corporation entitled to vote is voted for adoption of the agreement.
A corporation may sell, lease or exchange all or substantially all of its property and assets on the terms its board deems expedient and in the corporation's best interests, when authorized by a resolution adopted by the holders of a majority of the outstanding stock entitled to vote, at a meeting on at least 20 days' notice stating that the resolution will be considered.
Notwithstanding stockholder authorization of a sale of substantially all assets, the board may abandon the sale without further stockholder action, subject to the rights of third parties under any contract.
For purposes of the asset-sale section, the property and assets of a corporation include the property and assets of its wholly-owned subsidiaries.
A corporation may be dissolved if the board adopts a resolution by a majority of the whole board and a majority of the outstanding stock entitled to vote votes for dissolution, or without board action if all the stockholders entitled to vote consent in writing.
A stockholder of a Delaware corporation who holds shares on the date of the demand, continuously holds them through the effective date of the merger, has complied with the demand procedure, and has neither voted in favor of the merger nor consented to it in writing is entitled to an appraisal by the Court of Chancery of the fair value of the shares in the circumstances the statute describes.
Appraisal rights are available in a merger under section 251 for the shares of a constituent corporation, but not for shares of a class listed on a national securities exchange or held of record by more than 2,000 holders as of the record date, and not for shares of the surviving corporation in a merger that did not need the vote of the surviving corporation's stockholders.
Even where the market exception would apply, appraisal rights are available if the holders are required by the merger agreement to accept anything other than shares of the surviving corporation, shares of another corporation that will be listed or held of record by more than 2,000 holders, cash in lieu of fractional shares, or a combination of those.
If not all the stock of a subsidiary is owned by the parent immediately before a parent-subsidiary short-form merger, appraisal rights are available for the shares of the subsidiary.
A corporation may provide in its certificate of incorporation that appraisal rights will be available for the shares of any class or series as a result of an amendment to its certificate, a merger or consolidation, or a sale of all or substantially all of its assets.

Attack sequence

1Identify the transaction (merger, asset sale, dissolution) and the board and stockholder approvals it needs.

2Check the notice period of 20 days for the vote on a merger or asset sale.

3For a dissenting stockholder, check that the stockholder did not vote for the deal and made the demand on time.

4Test the market exception and its exception for consideration other than stock or cash in lieu of fractions.

Traps and exceptions

!A stockholder who votes for the merger loses appraisal rights.

!The market exception for listed stock does not apply if holders must take consideration such as cash.

!The board may abandon an asset sale after stockholder approval without another vote.

WORKED APPLICATION

A Delaware corporation with stock listed on a national exchange agrees to be acquired in a merger in which each stockholder will receive $50 in cash per share. A stockholder who voted against the merger demands appraisal.

The market exception does not apply when holders must accept cash, so appraisal rights are available, and the stockholder who voted against the merger and complied with the demand rules may seek a court appraisal of fair value.

Essay-ready formulationState the approvals needed, then evaluate whether a dissenter has appraisal rights, working through the market exception and its cash exception.

17 · Partnerships

Purported partners, partner agency, and partner liability (Delaware Revised Uniform Partnership Act)

A person who holds herself out as a partner, or agrees to be held out as one, can be liable to someone who relied on it, even though no partnership exists between the parties, and actual partners are jointly and severally liable for partnership obligations.

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Black-letter propositions

Each partner is an agent of the partnership for its business, and an act of a partner apparently carrying on in the ordinary course the partnership's business, or business of the kind it carries on, binds the partnership unless the partner had no authority and the other party had notice of that.
An act of a partner that is not apparently for carrying on the partnership's ordinary business binds the partnership only if the other partners authorized it.
All partners are liable jointly and severally for all obligations of the partnership unless the claimant agrees otherwise or the law provides otherwise.
A person admitted as a partner into an existing partnership is not personally liable for any obligation of the partnership incurred before the admission.
A person who by words or conduct purports to be a partner, or consents to being represented by another as a partner, is liable to a person to whom the representation is made if that person relies on it and enters into a transaction with the actual or purported partnership.
If the representation is made in a public manner, the purported partner is liable to a person who relies on it even if the purported partner is not aware of being held out as a partner to that claimant.
If a partnership obligation results, the purported partner is liable as if a partner, and if no partnership obligation results the purported partner is liable jointly and severally with any other person consenting to the representation.
A person is not liable as a partner merely because another person names the person in a statement of partnership existence, and a person does not stay liable as a partner merely because no statement of dissociation was filed.
A partnership is liable for a loss or injury caused by a wrongful act or omission of a partner acting in the ordinary course of the partnership's business or with its authority.
A judgment against a partnership is not by itself a judgment against a partner, and a partner's personal assets cannot be reached to satisfy a partnership judgment unless there is also a judgment against that partner.

Attack sequence

1Decide first whether an actual partnership exists, then whether the person is only a purported partner.

2For a purported partner, find the words or conduct, the consent, and the third party's reliance.

3Ask whether the representation was made publicly, which removes the need to show the claimant was told directly.

4For a partnership contract, ask whether the act was apparently in the ordinary course of the partnership's business.

5Check whether the person joined after the obligation arose, and check the status of any limited liability partnership.

Traps and exceptions

!Reliance is required when the representation was made to the claimant directly, so a person who did not rely cannot recover from a purported partner.

!A new partner is not liable for obligations incurred before admission, though the partnership's assets remain exposed.

!Being named in a statement of partnership existence by someone else does not by itself make a person liable as a partner.

!A judgment against the partnership alone does not permit collection from a partner's personal assets.

WORKED APPLICATION

Dana tells a supplier that she is a partner in a landscaping business run by Eli and Fay, and Eli and Fay know she says so and do not object. Dana is only a lender to the business. The supplier ships $30,000 of materials on credit to the business, relying on Dana's statement, and the business does not pay.

Dana purported to be a partner and Eli and Fay consented to the representation. The supplier relied on it and entered into a transaction with the partnership, so Dana is liable to the supplier as if she were a partner, even though she is not one.

Essay-ready formulationIdentify whether a partnership exists, then apply the purported-partner section: words or conduct, consent, reliance, and the public-manner rule, and state the resulting liability.

18 · Formation of corporations and limited liability companies

Limited liability companies: formation, operating agreements, management, member liability, and fiduciary duties (Delaware)

A Delaware limited liability company is formed by filing a certificate of formation, is governed mainly by an operating agreement that may be written, oral, or implied, is managed by its members in proportion to profits unless the agreement provides for managers, shields members and managers from personal liability for its debts, and allows the agreement to expand, restrict, or eliminate fiduciary duties but not the implied covenant of good faith and fair dealing.

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Black-letter propositions

To form a Delaware limited liability company one or more authorized persons must execute and file with the Secretary of State a certificate of formation stating the company's name and the address of its registered office and name of its registered agent.
A limited liability company is formed at the time of filing of the initial certificate of formation, or at a later date specified in it, if there has been substantial compliance, and it is a separate legal entity whose existence continues until cancellation of the certificate.
A limited liability company agreement is any agreement, whether called an operating agreement or otherwise, written, oral, or implied, of the member or members as to the affairs of the company and the conduct of its business, and a member or manager is bound by it whether or not he executes it.
An operating agreement may be entered into before, after, or at the time the certificate of formation is filed, it is not subject to any statute of frauds, and an agreement of a company with only one member is not unenforceable because there is only one party to it.
A person is admitted as a member at the formation of the company or at the time provided in and upon compliance with the agreement, or if the agreement does not so provide when the person's admission is reflected in the company's records, and a later member is admitted by the consent of all members unless the agreement provides otherwise.
Unless the operating agreement provides otherwise, management is vested in the members in proportion to their current percentage interest in profits, and the decision of members owning more than 50 percent of that interest controls, and if the agreement provides for a manager, management is vested in the manager to the extent provided.
Unless the operating agreement provides otherwise, each member and manager has authority to bind the limited liability company.
The debts, obligations, and liabilities of a limited liability company are solely the company's and no member or manager is personally obligated for them solely by reason of being a member or acting as a manager, though a member or manager may agree to be personally obligated.
The policy of the Delaware act is to give maximum effect to freedom of contract, and the operating agreement may expand, restrict, or eliminate a member's or manager's duties, including fiduciary duties, provided that it may not eliminate the implied contractual covenant of good faith and fair dealing.
A member or manager is fully protected in relying in good faith on the company's records and on information, opinions, reports, or statements presented by another member, manager, officer, employee, or committee, or by any other person as to matters the person reasonably believes are within that person's professional or expert competence.

Attack sequence

1Confirm the certificate of formation was filed, and note the effective time.

2Look for an operating agreement, remembering that it may be oral or implied.

3Decide whether the company is member-managed or manager-managed under the agreement and the statutory default.

4Ask whether any member is personally liable, which requires a separate basis.

5For duties, check whether the agreement modified fiduciary duties and whether it respects the implied covenant of good faith.

Traps and exceptions

!A member is not personally liable for company debts merely because of being a member or manager.

!An oral operating agreement can be binding and is not subject to a statute of frauds.

!By default each member and manager may bind the company.

!The agreement may eliminate fiduciary duties but cannot eliminate the implied contractual covenant of good faith and fair dealing.

WORKED APPLICATION

Three friends form a Delaware limited liability company by filing a certificate of formation and agree orally that Ana holds 50 percent of the profits interest and each of the other two holds 25 percent. There is no manager provision. Ana and one friend vote to sign a lease that the third opposes.

Without a manager provision, management is vested in the members in proportion to their profits interests and the decision of members owning more than 50 percent controls, so Ana and the friend hold 75 percent and the lease decision is valid, and the oral agreement is binding because an operating agreement need not be written.

Essay-ready formulationState how the company was formed, identify the operating agreement and its terms or the statutory defaults, and apply the management, authority, liability, and duty rules.

19 · Formation and governance of corporations

Corporate charters, bylaws, board procedure, staggered boards, cumulative voting, and stockholder voting agreements (Delaware)

A Delaware corporation exists from the filing of its certificate of incorporation, the certificate and the bylaws govern internal affairs with the certificate controlling over inconsistent bylaws, directors act at meetings with a quorum or by unanimous consent, a board may be divided into up to three classes, and stockholders may enter voting agreements and cumulative voting only if the law and the certificate allow it.

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Black-letter propositions

The certificate of incorporation must set forth the corporation's name, the address of its registered office and the name of its registered agent, the nature of its business or purposes, and the authorized stock, including the number of shares and par value, and it may state that the purpose is to engage in any lawful act or activity.
Upon the filing of the certificate of incorporation with the Secretary of State, the incorporators become a body corporate by the name in the certificate from the date of the filing.
The original bylaws may be adopted, amended, or repealed by the incorporators, by the initial directors if named in the certificate, or by the board before the corporation has received payment for any stock, and after payment for stock is received that power is in the stockholders entitled to vote.
A corporation may confer the power to adopt, amend, or repeal bylaws on the directors in its certificate, but conferring that power does not divest the stockholders of it or limit their power to act.
The bylaws may contain any provision not inconsistent with law or with the certificate of incorporation relating to the business of the corporation, the conduct of its affairs, and the rights or powers of its stockholders, directors, officers, or employees.
A majority of the total number of directors is a quorum unless the certificate or bylaws require more, the bylaws may set a quorum below a majority but not below one third of the total number unless the certificate provides otherwise, and the act of the board is the vote of a majority of the directors present at a meeting with a quorum.
Unless the certificate or bylaws restrict it, any action required or permitted at a board or committee meeting may be taken without a meeting if all members consent in writing or by electronic transmission.
Unless the certificate or bylaws restrict it, directors may participate in a meeting by conference telephone or other communications equipment by which all participants can hear each other, and participation is presence in person.
A board may be divided into one, two, or three classes with staggered terms by the certificate, an initial bylaw, or a bylaw adopted by the stockholders, and a certificate may give holders of a class or series of stock the right to elect one or more directors.
The certificate of incorporation may provide for cumulative voting, under which each stockholder has a number of votes equal to the shares multiplied by the number of directors to be elected and may cast them all for one director or distribute them, and stockholders may, by a signed written agreement, agree how their shares will be voted.

Attack sequence

1Identify the source of the rule: the statute, the certificate of incorporation, the bylaws, or a stockholder agreement.

2If the certificate and a bylaw conflict, the bylaw must yield.

3For a board action, check quorum and vote, or whether a unanimous written consent was used.

4For a staggered board, check that the classes and terms were created by the certificate or a proper bylaw.

5For voting arrangements, check that a written agreement exists and that cumulative voting appears in the certificate.

Traps and exceptions

!A bylaw inconsistent with the certificate of incorporation is invalid.

!Unanimous written consent in lieu of a board meeting requires all directors to consent.

!Cumulative voting is not a default rule in Delaware and must be in the certificate.

!Giving the directors the power to amend bylaws does not take that power away from the stockholders.

WORKED APPLICATION

A Delaware corporation has five directors, and its bylaws set the quorum at one third of the directors. The certificate of incorporation is silent on quorum. Two directors attend by telephone, and one director attends in person, and the three vote to approve a contract.

The bylaws may set a quorum as low as one third of the total number of directors, participation by conference telephone counts as presence, and three of five directors exceeds that quorum, so the vote of a majority of those present approves the contract.

Essay-ready formulationIdentify the governing source, apply the quorum and vote rules, and address any conflict between the certificate and the bylaws or any special voting arrangement.

20 · Formation of corporations

Promoters, preincorporation contracts, de facto corporations, and corporation by estoppel

A promoter is personally liable on a contract made for a corporation not yet formed unless the other party knowingly agrees to look only to the corporation, courts in some states protect people who dealt with a defectively formed corporation through the de facto and estoppel doctrines while statutes based on the Model Act make the filing of the articles the cut-off, and shareholders are not personally liable for corporate debts merely as shareholders.

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Black-letter propositions

As a general rule, promoters are personally liable for the contracts they make, even though made on behalf of a corporation to be formed.
A promoter is not personally liable if the contracting party knows the corporation is not in existence but agrees to look solely to the corporation and not to the promoter for payment, and the agreement to release the promoter may be shown by circumstances making it reasonably certain that the parties intended it.
A person who funds a corporation only nominally and who deals for it before it exists cannot deny being a promoter.
A corporation is de facto where there was a bona fide attempt to organize it in the manner the statute prescribes and there was an actual exercise of corporate powers, as by negotiating and signing a contract in the corporate name.
When a party knowingly dealt with the entity as a corporation, the party may be estopped from attacking its legal existence collaterally in order to impose personal liability on the individual, so a person who acted for a de facto corporation is not personally liable as a promoter.
A corporation is not de jure if the certificate of incorporation was filed after the contract was signed, even if the filing was mailed before, so the de facto and estoppel doctrines may apply in the absence of a statute displacing them.
Under a statute providing that a corporation comes into existence only when the certificate issues, there is no corporation de jure, de facto, or by estoppel before the certificate issues, and the persons who assume to act as a corporation without authority are jointly and severally liable for the debts incurred.
The doctrine known as corporation by estoppel has been criticized as a misnomer because there is no corporation and often no holding out followed by reliance.
Under the North Carolina Business Corporation Act, corporate existence begins when the articles of incorporation become effective, and the Secretary of State's filing of the articles is conclusive proof that the incorporators satisfied the conditions precedent to incorporation, except in a proceeding by the State to cancel or revoke the incorporation.
Unless the articles provide otherwise, a shareholder is not personally liable for the acts or debts of the corporation, except that the shareholder may become personally liable by reason of his own acts or conduct, and a purchaser of shares is liable only to pay the consideration for the shares.

Attack sequence

1Identify when the corporation was formed and whether the contract was signed before that time.

2Ask who dealt with the other party and whether the other party agreed to look only to the corporation.

3If the corporation did not exist, check whether the jurisdiction recognizes de facto or estoppel doctrines or has a statute displacing them.

4For de facto status, look for a bona fide attempt to organize and an actual exercise of corporate powers.

5Separately ask whether any shareholder became personally liable by his own acts.

Traps and exceptions

!A promoter who signs for a corporation to be formed is liable unless the other party agrees to look only to the corporation.

!A late-filed certificate can defeat de jure status but may still leave a de facto corporation in jurisdictions that recognize it.

!Under a statute that makes filing the cut-off, there is no de facto corporation or corporation by estoppel before filing.

!A shareholder's limited liability does not shield the shareholder from liability for the shareholder's own acts.

WORKED APPLICATION

A person signs a lease for the business in the name of a corporation that has not been formed, and the landlord knew the corporation was not yet formed but insisted on a personal guarantee. The corporation is later formed, and the business fails.

A promoter is generally personally liable on a preincorporation contract, and here the landlord did not agree to look only to the corporation but demanded a personal guarantee, so the promoter is personally liable.

Essay-ready formulationState the general rule of promoter liability and its exception, decide whether the corporation existed de jure, de facto, or by estoppel under the governing law, and address any shareholder liability.

21 · Corporate governance

Director and officer duties, conflict-of-interest transactions, and unlawful distributions under the North Carolina Business Corporation Act

The North Carolina Business Corporation Act, which follows the Model Business Corporation Act, requires a director or officer with discretionary authority to act in good faith, with the care of an ordinarily prudent person in a like position, and in a manner reasonably believed to be in the corporation's best interests, allows reasonable reliance on others, saves a conflict-of-interest transaction from being voidable if it was approved after disclosure or was fair, bars distributions that would leave the corporation unable to pay its debts or with assets below liabilities, and makes directors who assent to an unlawful distribution liable with rights of contribution.

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Black-letter propositions

A director must discharge the duties of the office in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner the director reasonably believes to be in the best interests of the corporation.
A director may rely on information, opinions, reports, or statements prepared or presented by officers or employees the director reasonably believes reliable and competent, by legal counsel, public accountants, or other experts on matters within their competence, or by a committee of which the director is not a member that merits confidence.
A director cannot rely on such information if the director has actual knowledge about the matter that makes the reliance unwarranted.
A director is not liable for any action or failure to act if the director performed the duties of the office in compliance with the statutory standard, and the duties of a director weighing a change of control are not different and the standard of care is not higher.
A director's personal liability for monetary damages for breach of a duty may be limited or eliminated only to the extent the articles of incorporation permit under the statute, and a director may be entitled to indemnification.
A conflict-of-interest transaction is a transaction with the corporation in which a director has a direct or indirect interest, and it is not voidable by the corporation solely because of the interest if the material facts and the interest were disclosed and the board or a committee approved it, or the disinterested shareholders approved it after disclosure, or the transaction was fair to the corporation.
A director has an indirect interest when another entity in which the director has a material financial interest or is a general partner, or of which the director is a director, officer, or trustee, is a party to the transaction.
Board approval of a conflict-of-interest transaction requires the affirmative vote of a majority of the directors who have no direct or indirect interest, and a quorum for that purpose exists if a majority of the disinterested directors vote.
Shares owned or voted by an interested director may not be counted in the shareholder vote that cleanses a conflict-of-interest transaction.
An officer with discretionary authority must act in good faith, with the care of an ordinarily prudent person in a like position, and in a manner the officer reasonably believes to be in the corporation's best interests, and may rely on officers, employees, counsel, and accountants but not on a committee.
No distribution may be made if, after giving it effect, the corporation would not be able to pay its debts as they become due in the usual course of business, or its total assets would be less than its total liabilities plus any preferential rights on dissolution of superior shareholders.
A director who votes for or assents to a distribution made in violation of the statute or the articles is personally liable to the corporation for the excess if it is established that the director did not perform the duties in compliance with the general standard, and is entitled to contribution from other liable directors and to reimbursement from shareholders who accepted the distribution knowing it was unlawful.
A proceeding for an unlawful distribution is barred unless commenced within three years after the date the effect of the distribution was measured.
A shareholder may not commence a derivative proceeding until a written demand has been delivered to the corporation and 90 days have passed, unless the demand was rejected earlier or irreparable injury would result from waiting, and the shareholder must have been a shareholder when the act occurred and must fairly and adequately represent the corporation's interests.

Attack sequence

1Identify whether the person is a director or an officer with discretionary authority and state the three-part standard.

2Ask whether the person relied on a source the statute allows and whether the person actually knew something that made reliance unwarranted.

3If a director has a personal interest in a transaction, test each of the three ways to save it: disinterested board approval, disinterested shareholder approval, and fairness.

4For a dividend or repurchase, apply both the inability-to-pay-debts test and the assets-less-than-liabilities test as of the date the effect is measured.

5Identify who is liable for an unlawful distribution, the contribution and reimbursement rights, and the three-year limit.

6For a suit on behalf of the corporation, check demand, the 90-day wait, and standing.

Traps and exceptions

!A director's good-faith reliance on counsel or accountants is protected only if the matter is within their competence and the director has no actual knowledge that makes reliance unwarranted.

!A conflict-of-interest transaction survives if it was fair to the corporation even without disinterested approval, so fairness is an independent path.

!The votes of an interested director's shares are not counted to cleanse a transaction by shareholder approval.

!A director is liable for an unlawful distribution only if the director did not comply with the standard of conduct, so an ordinarily prudent reliance defeats liability.

!The three-year period runs from the date the effect of the distribution was measured, not from discovery.

WORKED APPLICATION

The board of a North Carolina corporation approves a purchase of land from a company owned by one of its directors after that director discloses the ownership, and the disinterested directors vote for it. Separately, the board pays a dividend that leaves the corporation unable to pay its debts as they come due, after relying on a financial statement that the chief financial officer had told two directors was false.

The land purchase is not voidable solely because of the director's interest, because the material facts and the interest were disclosed and a majority of the disinterested directors approved it, and the transaction would also be safe if it was fair. The dividend is unlawful because it leaves the corporation unable to pay its debts, and the two directors who knew the statement was false cannot rely on it, so they did not comply with the standard of conduct and are liable for the excess, with contribution from the other directors who could be held liable.

Essay-ready formulationState the director's standard and the reliance rule, test the conflict-of-interest transaction under the three safe harbors, and apply the distribution limits and the liability, contribution, and reimbursement rules.

22 · Formation and governance of corporations and limited liability companies

North Carolina limited liability company management, standards of conduct, distributions, derivative actions, and dissolution

Under the North Carolina Limited Liability Company Act, members are managers by default unless the operating agreement designates managers, decisions approved by a majority of the managers control, each manager owes duties of good faith, ordinary prudent care, and reasonable belief in the company's best interests, a person is not liable for the company's obligations solely by reason of being an owner or manager, distributions are barred when the company could not pay debts or its liabilities would exceed its assets, and a member may sue derivatively after demand and 90 days.

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Black-letter propositions

The management of an LLC and its business is vested in the managers, each manager has equal rights to participate, and management decisions approved by a majority of the managers are controlling.
Managers may make management decisions without a meeting and without notice.
Subject to the direction and control of a majority of the managers, each manager may act on behalf of the LLC in the ordinary course of its business.
All members are managers by virtue of their status as members, together with any persons designated as managers in the operating agreement, unless the operating agreement provides or contemplates that members are not necessarily managers, in which case those designated are the managers.
The operating agreement may provide that the LLC is managed by company officials who are not designated as managers, and all members are managers for any period during which the LLC would otherwise have no managers or company officials.
Each manager must manage in accordance with the operating agreement and discharge duties in good faith, with the care an ordinary prudent person in a like position would exercise under similar circumstances, and, subject to the operating agreement, in a manner the manager believes to be in the best interests of the LLC.
A manager may rely on information, opinions, reports, or statements from persons the manager believes to be reliable and competent, unless the manager has actual knowledge that makes reliance unwarranted, and a manager who acts in compliance with the standard is not liable to the LLC.
A person who is an interest owner, manager, or other company official is not liable for the obligations of the LLC solely by reason of that status.
No distribution may be made if, after giving it effect, the LLC would not be able to pay its debts as they become due in the ordinary course of business or its total liabilities would exceed the value of its assets, measured as of the authorization date if paid within 120 days.
A manager or company official who had authority and approved a wrongful distribution is personally liable to the LLC, but not to any other person, for the excess only if the official did not act in compliance with the statutory standard, without regard to any modification of the standard by the operating agreement, and a proceeding is barred unless commenced within two years after the distribution.
An official held liable for a wrongful distribution is entitled to contribution from each other official who could be held liable and to reimbursement from each interest owner who received it knowing it was wrongful.
A member may bring a derivative action if the member was a member when the act occurred, or the interest devolved from one who was, and made written demand on the LLC to take suitable action and either the demand was rejected, 90 days passed, or irreparable injury would result from waiting.
The superior court may dissolve an LLC on the application of a member if it is not practicable to conduct the business in conformance with the operating agreement and the Act, or liquidation is necessary to protect the member's rights and interests, and on the application of the Attorney General for fraud in obtaining the articles or continued abuse of authority.
After dissolution the LLC must wind up, the managers collect assets, discharge or provide for liabilities, and distribute what remains, and dissolution does not change the standards of conduct of the managers or prevent proceedings by or against the LLC.

Attack sequence

1Read the operating agreement first, because the statute supplies default rules that the agreement may change.

2Decide who the managers are: all members by default, or those designated in the agreement.

3Apply the majority-of-managers rule and the rule that each manager may act in the ordinary course.

4State the manager's standard of conduct and check reliance, and separately check any modification in the operating agreement.

5Ask whether any member or manager is personally liable to third parties, which is not so by status alone.

6For a distribution, apply both the inability-to-pay test and the liabilities-exceed-assets test.

7For a derivative claim check membership at the time of the act, written demand, and the 90 days.

8For dissolution, ask whether it is not practicable to conduct the business under the agreement or whether liquidation protects the member.

Traps and exceptions

!Members are managers by default even if the operating agreement is silent, so every member can act in the ordinary course unless the agreement designates managers.

!A person is not liable for the LLC's debts merely by being a member or manager, though the person may be liable for the person's own acts or a guarantee.

!A wrongful-distribution claim belongs to the LLC and only a breach of the statutory standard, unmodified by the agreement, creates liability.

!The two-year period for wrongful distributions is shorter than the three-year period for a corporation.

!A member derivative plaintiff need not prove the demand was futile if 90 days have passed.

WORKED APPLICATION

Three friends form a North Carolina LLC with no provision about managers. Two of them vote to sign a lease over the third's objection, and later two of them approve a distribution that leaves the LLC unable to pay its debts. A creditor also sues all three members personally for the LLC's rent.

Because the operating agreement does not designate managers, all members are managers, and a majority of the managers controls, so the two members' vote on the lease controls and the third may not stop it. The creditor's claim against the members personally fails because a member is not liable for the LLC's obligations solely by reason of being a member. The two who approved a distribution leaving the LLC unable to pay its debts are liable to the LLC, but not to the creditor directly, if they did not comply with the statutory standard of conduct, and they have contribution rights against other liable officials.

Essay-ready formulationIdentify who manages the LLC and which decisions the majority controls, state the standard of conduct and its limits, decide whether members are liable to third parties, apply the distribution limits and the liability of the approving managers, and address derivative suits and dissolution as raised.

QUICK ANSWERS

What NCBE lists for Business Associations

What corporation topics are in the MEE outline?+

Pre-organization transactions, piercing the veil, financing, management and control, fiduciary duties, close corporations, organizational structure, and shareholder and member litigation.

What does the financing the organization category include?+

Sources of finance, securities issuance and characteristics, dividends and distributions, and redemptions and repurchases, listed as category IV of the corporations outline.

What does management and control include?+

Shareholders' meetings and voting, directors' meetings and actions, officers' authority and liability, and members' and managers' authority, liability and powers.

What are close corporations and special control devices?+

Share transfer restrictions, special agreements allocating authority, resolution of disputes and deadlocks, and option or buy-sell agreements.

Which fiduciary duties does the agency outline list?+

The duty of care, the duty of loyalty and the duty of obedience, listed under fiduciary duties between principal and agent in the MEE outline.

What organizational structure topics does NCBE list?+

Amendments, mergers and consolidations, sales of substantially all assets, recapitalizations, exchanges of securities and dissolution, including parent and subsidiary relationships.

What is shareholder litigation in the outline?+

Direct, derivative and class litigation by shareholders and members. NCBE lists it as category IX, the last category of the corporations outline.

What are pre-organization transactions?+

Promoters' contracts and fiduciary duties, and subscriptions for shares, according to the MEE outline, where they are category II of the corporations section.

SOURCE DESK

Official NCBE sources

NCBE: MEE subject matter outline↗NCBE: preparing for the MEE↗NCBE: NextGen UBE content scope↗

Governing text

Corporate-law questions are usually answered under the Delaware General Corporation Law, whose current text is published by the State of Delaware. Delaware General Corporation Law (Delaware Code) ↗