FINAL EXAMINATION
BUSINESS ORGANIZATIONS
FALL, 1992
PROFESSOR KLEINBERGER
MODEL ANSWERS AND COMMENTS
Part One
A. SE, Inc. is a publicly traded corporation, subject to the Rule 14a-8 of the Securities Exchange
Commission. Martha is a director of SE, Inc. and owns 1000 of the 5 million shares of common
stock outstanding. Martha's shares have a market value of $10,000.
Martha has tried to convince the SE board of directors to have SE purchase its office supplies
from George, Inc., a office supply wholesaler owned by Martha. Although Martha has offered to
beat any price available to SE from other vendors, the board of directors has declined. Martha's
fellow directors have been concerned about "the appearance of impropriety."
Martha has now notified the board that she intends to present a proposal at the next shareholders'
meeting, asking the shareholders to make the decision to have SE, Inc. buy its office supplies from
George, Inc.
Assume that Martha's proposal complies with Rules 14a-8(a), 14a-8(b) and 14a-9. May SE, Inc.
properly omit Martha's proposal from the proxy statement and form of proxy?
Model Answer: Rule 14a-8(c) provides a number of independent grounds for omitting a
shareholder's proposal. Four of those grounds apply here.
Under Rule 14a-8(c)(1), a registrant may exclude proposals that, under state law, are not proper
matters for shareholder action. Buying office supplies is a management question -- the province
of the board and those it supervises. (Martha could have avoided this problem by phrasing the
proposal as a recommendation to the board.)
Under Rule 14a-8(c)(4), a registrant may exclude a proposal that seeks to provide a special
benefit to a particular shareholder. Because Martha's proposal seek to gain business for a
company Martha owns, item (4) applies.
Under Rule 14a-8(c)(5), a registrant may exclude a proposal that does not relate to a significant
amount of the registrant's business. This item considers significance in terms of 5% of total assets
and 5% of net earnings. SE, Inc. does not sell office supplies, and it seems unlikely that office
supplies will account for 5% of the company's assets. Moreover, there are no social concerns or
other issues that could trigger the "otherwise significant" language.
Under Rule 14a-8(c)(7), a registrant may exclude a proposal that relates to ordinary business
matters. . There are no social issues or other concerns to take office supplies out of the category
of the mundane.
Common Mistakes: citing only one, two or three of the four applicable rules; citing 14-8(c)(2)
and asserting that a decision challengeable as self-dealing would be unlawful [the transaction, if
approved by the shareholders, would shelter in the "safe harbor" of full disclosure plus approval
by disinterested shareholders; the question instructs you to assume that Martha's proposal
complies with rule 14a-9; therefore Martha's interest in the transaction must have been disclosed
in the supporting statement]; omitting rule 14a-8(c) completely and trying to use state law to
answer the problem
B. The William Mitchell Exam Conflict and Make-Up Policy (1992-3 Handbook, p.19) states in
part:
Students will take exams at the time and place announced in the exam schedule unless:
(1) A student is prevented from taking the exams because of his or her illness or illness or death in the student's immediate family;
(2) A student has two exams scheduled on the same day;
(3) A student has three exams scheduled within a period of three calendar days. ....
(4) A student has two exams scheduled to begin within 23 hours of each other;
(5) A student has exceptional circumstances that, in the discretion of the Dean of Students, justifies [sic] a rescheduling. Exceptional circumstances must relate to personal situations not to a burdensome examination schedule.
....
No make-up exam will be given more than one week after the end of the regular exam period,
except when such a delay is necessitated by illness or other exceptional circumstances.
No student shall take any exam before the regularly scheduled time for the exam.
On account of a serious illness in the immediate family, a student requests permission to
reschedule an exam. Due to long-standing and significant employment responsibilities, the only
practical time for the make-up exam is three days before the regularly scheduled time. The Dean
of Students grants the request, and the student buys two nonrefundable airline tickets.
Subsequently, the professor whose exam is involved learns that an unidentified student will take a
make-up in advance of the rest of the class. The professor objects and asserts that an advance
make-up violates the Policy quote above. Has the action of the Dean of Students bound the
College to allow the advance make-up?
Model Answer: The Dean is an agent of the College. To bind the College, the Dean must have
some form of agency power: actual authority, apparent authority or inherent agency power. In
this matter the Dean has no power to bind the College.
For actual authority to exist, some manifestation of the principal must cause the agent to
reasonably believe the agent has the right to bind the principal. The most salient manifestation
given by the facts is the Student Handbook. That Handbook expressly precludes the scheduling
of advance make-ups. The Dean's discretion, mentioned in item (5), relates to adequate cause for
a makeup and does not override the subsequent, express prohibition on advance makeups. The
Dean could not reasonably believe that she or he has the right to schedule advance makeups.
For similar reasons, apparent authority will not help the student. For apparent authority to exist,
some manifestation of the principal must cause the third party (here, the student) to reasonably
believe the agent has the right to bind the principal. Arguably, at least, the Dean's position
constitutes a manifestation, as does the Handbook's reference to the Dean as the person who
authorizes makeups. However, those who rely on the appearance of authority have a duty of
reasonable diligence. For a law student, that duty encompasses knowing the contents of the
Student Handbook. Therefore, the student could not reasonably believe that the Dean has the
authority to violate the Policy.(1)
Inherent authority also will not help the student, even though the Dean is a general agent (i.e.
authorized "to conduct a series of transactions involving a continuity of service"). In some
circumstances a general agent has the inherent power to bind its principal even through an
unauthorized act. However, the power does not exist when the third party has reason to know
that the act is unauthorized.
Common Mistakes: ignoring the Handbook provision that prohibits advance makeups; not
carefully reading that provision and concluding that the Policy makes that provision subject to the
Dean's discretion; assuming that the student had read the Handbook; considering only apparent
authority and not actual authority
C. This problem requires you to analyze and apply a statute that we did not study this
semester. DON'T PANIC. We have spent time developing skills in statute reading. Apply
those skills.
The Background: This question concerns a Minnesota limited liability company (LLC) -- a new
form of entity that is a mix between a partnership and a corporation. In answering this question
you may find the following background helpful:
In a corporation, the owners' interests are called "shares" or "stock." In a partnership, the
owners' interests are usually called "partnership interests." In an LLC, the owners' interests are
called "membership interests."
The Minnesota Limited Liability Act bifurcates "membership interests" into two parts:
-- financial rights, consisting essentially of the right to share in profits; and
-- governance rights, consisting essentially of the right to vote and otherwise influence the management of the entity.
Minn.Stat. § 322B.31, subd. 1 states in part:
Assignment of financial rights permitted. ... a member's financial rights are transferable in
whole or in part.
Minn.Stat. § 322B.313, subds. 1 and 2 state in part:
Subdivision 1. Transfer of membership interests restricted. A member may assign the
member's full membership interest only by assigning all of the member's governance rights coupled
with a simultaneous assignment to the same assignee of all the member's financial rights. A
member's governance rights are assignable, in whole or in part, only as provided in this section.
Subd. 2. When unanimous consent required. ... a member may, without the consent of any
other member, assign governance rights, in whole or in party, to another person already a member
at the time of the assignment. Any other assignment of any governance rights is effective only if
all the members, other than the member seeking to make the assignment, approve the assignment
by unanimous written consent.
The Problem: Narnia, LLC is a Minnesota limited liability company, with four members: Peter,
Susan, Edmond and Lucy. The four members are all siblings. Based on the statutes quoted
above, answer the following questions.
1. Peter wishes to sell his entire membership interest to Lucy. To make the sale effective, what
consent, if any, does he need?
2. Susan wishes to assign half of her right to share profits to her adult son, Caspian. To make the
assignment effective, what consent, if any, does she need?
3. Lucy is going away on vacation for six months and wants to authorize her adult daughter,
Belle, to vote for her at meetings of the members of the LLC. To make the authorization
effective, what consent, if any, does Lucy need?
Model Answer to Question #1: Peter needs no consent. Transfer of the entire membership
interest involves the transfer of all Peter's financial rights and all his governance rights. Minn.Stat.
§ 322B.313, subd. 1. Financial rights are freely transferable to any transferee. Minn.Stat. §
322B.31, subd. 1. That is, no consent is required is required for that aspect of the sale that
involves Peter's financial rights. Governance rights are freely transferable to any transferee who
is already a member of the LLC. Minn.Stat. § 322B.313, subd. 2. Since Lucy is already a
member, no consent is required for that aspect of the sale that involves Peter's governance rights.
Model Answer to Question #2: Susan needs no consent. A right to profits is a financial right,
and financial rights are freely transferable to any transferee -- regardless of whether the transferee
is a member of the LLC. Minn.Stat. § 322B.31, subd. 1.
Model Answer to Question #3: Lucy needs the consent of all of the other members. The right to
vote is a governance right, and Belle is not a member of the LLC. Transferring any governance
right to a nonmember requires unanimous consent. Minn.Stat. § 322B.313, subd. 2.
Common Mistakes: failing to note in Question #1 that a complete membership interest consists of
financial and governance rights, and failing to invoke the separate statutory sections that cover
transfers of each; asserting that transfer of financial rights requires no consent because Minn.Stat.
§322B.313 is silent on the matter [this would be an excellent argument but for the fact that
another section of the statute, Minn.Stat. § 322B.31, subd. 1, expressly address the issue];
answering a question by giving only a citation, but not explaining the cited statute's meaning;
stating a conclusion without stating either the applicable legal rule or the relevant facts; stating the
applicable legal rule but omitting either the citation or the relevant facts, or both
D. Sanders, Inc. is a Delaware corporation with four shareholders: Pooh, Piglet, Rabbit, Kanga
and Roo. Pooh, Piglet and Rabbit are all children of the founder of the business, and each owns
30% of the corporation's stock. Kanga and Roo are key employees of the corporation, and each
owns 5% of the corporation's stock.
Sanders, Inc. has a three person board of directors. From 1955 (when the founder died, leaving
her stock to her three children) through 1990, the board consisted of Pooh, Piglet and Rabbit. In
1991, the three siblings decided that, when they died, they would each probably bequeath their
stock to a charitable institution, Eeyore Hospital. The three siblings also decided that it would be
a good idea for employees of the Hospital to learn how to run the business. Since that time the
three siblings have arranged to elect the president, the vice president and the treasurer of Hospital
as the board of Sanders, Inc. None of those three Hospital employees own any stock in Sanders,
Inc.
Kanga has just learned that in 1990 the board of Sanders, Inc. approved the sale of one of the
corporation's major assets to a partnership owned by Pooh, Piglet and Rabbit (who were at the
time still the directors of Sander's Inc.). She wishes to bring a derivative suit on behalf of the
corporation and have the asset sale rescinded. Must she make demand on the board, or is demand
excused? (Do not consider the issue of possible direct claims. Confine your analysis to the
question asked.)
Model Answer: Since Sanders is a Delaware corporation and this issue involves an internal
dispute, Delaware law applies. To show demand futility, a derivative plaintiff must: (a) allege
with particularly facts, which if true, (b) would raise a reasonable doubt that, (c) as to the
underlying transaction, (d) either (i) the directors were interested or (ii) for some other reason the
business judgment rule will not shelter the directors' conduct.
In the stated problem, the underlying transaction is the sale of one of the corporation's major
assets to a partnership owned by the three individuals who at the time of the sale were directors of
the corporation. The sale therefore constituted self-dealing. If those individuals were still the
directors, Kanga could certainly allege particular facts to raise a reasonable doubt as to the
directors' disinterestedness in the underlying transaction (d-i, above). Demand would be excused.
However, those individuals are no longer the directors, and the current directors had no interest in
the underlying transaction.
Demand should nonetheless be excused, for at least two reason. First, the old directors' self-dealing raises a reasonable doubt that the business judgment rule will shelter the underlying
transaction. That reasonable doubt should satisfy the second prong of the demand-excused
requirement (d-ii, above).
Second, the former directors effectively control the current directors. Those former directors,
after all, still own 90% of the stock. Moreover, the current directors will probably wish to protect
the Hospital's expectations of charitable bequests. For those reasons, the new directors will wish
not to offend the former directors.
The "interestedness" of the former directors will thus greatly influence the current directors. That
"interestedness" should therefore be imputed to current directors, satisfying the first prong of the
demand-excused requirement (d-i, above). Cf. Sinven (parent corporation that controlled
individual directors of subsidiary treated as if it were itself a director).
Common Mistakes: failing to explain that Delaware law applies; failing to note that the current
directors were not interested in the underlying transactions, while the individuals who were
interested in that transaction are no longer directors [this point was quite subtle; I did not deduct
points for missing it, but rather gave bonus points to the few students who found it and dealt with
it effectively] ; going into a detailed analysis of self-dealing under the Delaware statute but failing
to "connect it up" [the connection: the facts raise a reasonable doubt that the business judgment
rule will protect the underlying transaction, because the facts, if true, show self-dealing]; asserting
without adequate analysis that demand is not required because the new board is not itself the
subject of the claim
Part Two
For the past five years a partnership has periodically sold widgets to a corporation No ongoing
agreement has existed. Instead, each transaction has reflected a separate, written contract.
Various partners have negotiated and signed for the partnership. The Vice President of
Purchasing (VP-P) has negotiated and signed each of the contracts for the corporation.
Two months ago, both businesses independently decided to abandon the relationship. The
partnership has five partners, and the partnership agreement expressly allows a vote of the
majority of partners to select the partnership's customers. The partners voted 4-1 to stop selling
to the corporation. They did not, however, inform the corporation of the decision.
At about the same time, the corporation's board of directors resolved to make no further
purchases from the partnership. The board communicated its decision to the corporation's CEO.
Rather than passing the word immediately to the VP-P, however, the CEO telephoned Koestler,
one of the partners. When the CEO explained the board's decision, Koestler said, "We just
decided the same thing. It's stupid. The business is too good for both our firms to give it up."
When the CEO said that she shared that sentiment, Koestler made the following proposal to the
CEO, who agreed:
The CEO would not inform the VP-P or anyone else at the corporation of the board's decision
or of the partnership's decision.
Koestler would not inform the other partners of the board's decision.
Koestler would approach the VP-P and negotiate and sign another contract between the
partnership and the corporation.
If the VP-P signed the contract, Koestler would give the CEO $5000 as a "signing bonus."
All went as agreed. The VP-P, ignorant of both the board's decision and the partnership's
decision, signed another contract on behalf of the corporation.
1. Is the corporation bound to the contract?
2. Is the partnership bound to the contract?
3. Assuming that the corporation and the partnership are both bound to the contract and that each
has been damaged by the contract:
a. Does the partnership have any claims against Koestler?
b. Does the corporation have any claims against Koestler? If so, can the corporation collect on
that claim(s) from the partnership?
c. Does the corporation have any claims against the CEO?
Model Answer to Question #1: The corporation is bound because the VP-P had actual authority
to bind the corporation.(2) All the elements of actual authority are present. For some time it had
been the corporation's practice to allow the VP-P to enter into widget contracts with the
partnership. The practice constituted a manifestation of the principal (i.e. the corporation) to the
agent (i.e. the VP-P) that the VP-P was authorized to so act. The VP-P actually made another
widget contract, which indicates that the VP-P believed him or herself authorized. In the
circumstances that belief was reasonable.
The board's decision does not undercut the actual authority, because the corporation never
communicated that decision to the VP-P. That decision was therefore not part of the principal's
manifestation to this particular agent.
The corporation may also be bound under apparent authority. The corporation's purchasing
practices constituted a manifestation from which the partnership might reasonably infer that the
VP-P had authority to bind the corporation to the contract at issue. Koestler's knowledge of the
board's decision would preclude that inference (or at least make it unreasonable), but under UPA
§ 12 Koestler's knowledge is perhaps not attributable to the partnership. (Under §12, a partner's
knowledge is not attributable if the partner is committing a fraud on the partnership.)(3)
Common Mistakes in Question #1: analyzing the authority or power of the CEO to bind the
corporation by entering into the contract [it was the VP-P who executed the contract]; in
discussing the absence of apparent authority, dealing only with Koestler's knowledge of the
corporation's change of policy and not attributing that knowledge to the partnership [the
partnership, not Koestler, is the party to the supposed contract]; concluding baldly that the
board's decision means that actual authority cannot exist (failing to consider that information
about the decision did not reach VP-P); considering only actual authority and not apparent
authority, and vice versa
Model Answer to Question #2: The partnership is probably not bound to the contract. The 4-1
vote of the partners concerned an "ordinary matter." See UPA §18(h) and the partnership
agreement (as described in the facts). That vote therefore removed each partner's actual authority
to make widget contracts with the corporation. If Koestler nonetheless succeeded in binding the
partnership, his power must have come from UPA § 9.
At first glance, § 9(1) appears to supply that power. Koestler's act in negotiating and signing the
contract was certainly "the act of [a] partner." Moreover, based on past experience, from the
perspective of VP-P the act reasonably appeared to be for carrying on the business of the
partnership in the usual way.
However, the crucial question is not what reasonably appeared to VP-P, but rather what
reasonably appeared to the corporation. Of course, the knowledge of VP-P, acting within the
scope of his or her actual authority (see analysis to Question #1), is attributed the corporation as
principal. But so too is the knowledge of the CEO. The CEO knew that the partnership was no
longer willing to make widget contracts with the corporation. With that knowledge attributed to
the corporation, it could not reasonably appear to the corporation that Koestler's act was
apparently/usual.(4) So, § 9(1) did not empower Koestler to bind the partnership.
Both § 9(4) and the last portion of § 9(1) also support this conclusion. Both those provisions
prevent a partner from binding the partnership when the partner lacks actual authority and the
third party knows of that lack. The stated facts satisfy both criteria. The 4-1 vote deprived
Koestler of authority, and the CEO's knowledge of that vote (and the consequent lack of
authority) is attributable to the corporation.
Common Mistakes in Question #2: using UPA § 13 to bind the partnership to a contract [if every
unauthorized act by a partner in the name of the partnership sufficed to bind the partnership under
§13, then §13 would swallow up §9]; asserting that Koestler lacked actual authority without
explaining why; applying §9(1)'s "apparently/usual" rule as if the key question were the
partnership's usual course of business rather than the appearance (to the third party) of usualness;
applying §9(1)'s "apparently/usual" rule as if the key question were the appearance to VP-P, not
the appearance to the corporation; failing to attribute the CEO's knowledge to the corporation
Model Answer to Question #3a: Like an agent, a partner has a duty not to take unauthorized
action. Koestler breached that duty by disregarding the 4-1 vote and binding the partnership to a
contract with the corporation. That breach apparently caused damage to the partnership, and
Koestler is liable.
It is possible also to argue that Koestler's scheme, conducted in secret and in contravention of the
4-1 vote, violated Koestler's duty of loyalty to the co-partners. However, since there is no
indication that Koestler personally profited from the scheme, the loyalty theory will not support a
claim for disgorgement. The loyalty theory would at best be another way to claim damages.
Common Mistakes in Question #3a: failing to state what remedy is available against Koestler
[damages]; asserting that Koestler must disgorge profits [there is no indication in the facts that
Koestler expected or received any personal profit from the contract; the contract was between the
partnership and the corporation]
Model Answer to Question #3b: Koestler fraudulently represented that he was authorized to bind
the partnership and wrongfully induced the CEO to violate the CEO's duty of loyalty to the
corporation. The corporation has a tort claim against Koestler.(5)
The corporation probably cannot collect from the partnership. The corporation's best theory
would be UPA §13. Under § 13 the partnership is liable for a wrongful act of a partner if that act
is either authorized by the co-partners or "in the ordinary course of the business of the
partnership." As explained in the answer to Question #3a, Koestler's act was not authorized. It
might, however, have been "in the ordinary course."
The partnership will argue that making unauthorized contracts and bribing the employees of other
companies is not "ordinary course." The corporation will counter that the proper inquiry is
whether rightful activity in the same sphere is "ordinary course." Making contracts for widgets is
certainly "ordinary course" for the partnership.
Although perhaps a close question, I think that Koestler's conduct is not ordinary course.
Consider, for example, a grain broker whose ordinary activities include making representations
about grain quality and who on one occasion happens to make a misrepresentation. Consider also
a driver whose ordinary sphere includes the making of deliveries and on occasion happens to drive
carelessly. For each of those two situations, the wrongful conduct has a rightful counterpart.
For Koestler's wrongful acts, in contrast, the facts reveal no rightful counterpart. There is no
indication that the partnership had previously used tactics similar to Koestler's. For this
partnership, at least, conspiracy and bribery are more than ordinary behavior gone wrong. They
are therefore not "ordinary course."
Common Mistakes in Question #3b: not finding the § 13 analysis; not noting that Koestler's
wrongful conduct did not qualify under the "authorized" leg of § 13; merely asserting that
Koestler's wrongful conduct satisfied the "ordinary course" requirement of § 13 and not
considering whether forbidden conduct can be "ordinary course"and whether conduct that
involves fraud and bribery can be "ordinary course"; not seeing Koestler's conduct as wrongful
toward the corporation; asserting that Koestler is liable to the corporation merely under §15 [the
problem with this assertion is that it leaves you unable to answer the rest of Question #3b];
asserting the Koestler is liable to the corporation for breach of the warranty of authority [the facts
state that the partnership was bound]
Model Answer to Question #3c: By concealing the change in policy from the VP-P and by
conspiring with Koestler, the CEO breached his or her duty of loyalty to the corporation. Since
that breach has caused damage, the CEO is liable for the damages. Moreover, if the CEO has
received the $5000 signing bonus, the CEO must disgorge that amount. An agent may not profit
from a breach of loyalty. (Moreover, an agent may not receive and retain remuneration for
matters connected with the agency, unless the principal consents after full disclosure.)
Common Mistakes in Question #3c: using director duties to analyze CEO's conduct [the facts do not indicate that the CEO is a director; they imply to the contrary]; making a self-dealing analysis without considering that the CEO is not necessarily a director, without explaining how the CEO had a material financial interest in the transaction and without recognizing that the typical remedy for self-dealing (rescission) would not be a claim against the CEO; considering what duties the CEO breached but not considering what remedies might exist (i.e. both damages and disgorgement); asserting that the CEO had breached a duty of care rather than an agent's duty to obey instructions
1. A few people argued that the Dean's position is a manifestation that the Dean, as chief "fixer," is authorized to violate school policies. In light of the "due diligence" aspect of apparent authority, I think the argument unpersuasive. However, I gave it credit when it was well made.
2. This answer assumes that the partnership is also somehow bound. As a matter of contract law, the corporation will not be bound unless the other party to the contract is also bound.
3. It is perhaps possible to argue that the partnership will be equitably estopped from invoking the contract, since the contract resulted from a pattern of wrongful conduct by one of the partners. An interesting theory -- but not one whose key elements were covered in this course.
4. It makes no difference whether the CEO actually communicated the information to the board, the VP-P or any other part of the corporation. The function of an attribution rule is to impute information to the principal, regardless of whether the principal actually possesses that information.
5. At minimum, the corporation has a claim against Koestler for tortious interference with the contract between the corporation and the CEO. An action for fraud probably exists as well. However, since this was not a torts course, it was not necessary to be precise here. It was necessary to have in mind UPA § 13 and so understand that Koestler's conduct had somehow to be characterized as "wrongful" viz a viz the corporation.