FINAL EXAMINATION

BUSINESS ORGANIZATIONS

SPRING, 1996

PROFESSOR KLEINBERGER

General Instructions

This is an open book examination. You may use the photocopied agency and partnership book, the assigned photocopied materials, any additional photocopied materials distributed by the professor during the semester and any notes you have made or developed in studying for the course or the exam. You may use outlines or other notes developed by a group of students enrolled in this course this semester if you played a substantial role in the development of the group outline or notes. Except as stated in the second and third sentences of this paragraph, you may not use treatises, hornbooks, commercial outlines, other commercial works or any other materials prepared by others.

This examination lasts three hours and has two parts. Part One consists of five separate questions, each based on a separate fact pattern and each requiring a relatively short answer. Part Two consists of a single fact pattern, requiring a more intricate answer. Each Part of the examination is equal in weight to the other Part. That is, the five questions in Part One, taken together, have the same weight as Part Two.

Please keep in mind that "spotting issues" is only the first step in doing a legal analysis. You must also take the issues you identify and organize them into a coherent structure. Then, within that structure, you must examine those issues (by applying the law you see as relevant to the facts you see as relevant) and argue for some conclusion. For the questions in Part One, your analysis will be less complicated than in your answer for Part Two. But for both Parts, your answers must reflect a coherent analysis.

Please do not write about subjects that are not germane to your analysis. Writing a "treatise" on some area of law that the question does not put in issue wastes your time and conveys the unfortunate impression that you do not understand which issues are relevant.

To the extent that your analysis involves a particular statutory provision, you MUST cite that provision. If your analysis involves the construction (as distinguished from mere application) of a particular word, phrase or provision, it may make sense to quote that word, phrase or provision. Otherwise, do not waste your time quoting the statute at length. (On the other hand, if you can quote a piece of a statute faster than you can paraphrase it, feel free to do so.) There is no need to cite case names. If citing case names helps you, feel free to do so. Do not, however, use case names as a substitute for stating the law.

The grading rewards coherence. It will probably be worth your while to take some time to think about the organization of your answer before you begin writing. Ask yourself:

whether you have identified all the necessary parts to your analysis;

whether all the issues you have identified are actually necessary; and

whether you have organized your issues in a way that is likely to make sense to your reader.

Please write legibly. Please write on only one side of each page. If legibility is not your strong point, please skip every other line as you write.

Budget your time.

BUDGET YOUR TIME.

Applicable Law and Related Matters

Unless a problem specifically indicates to the contrary:

1. Any reference to a partnership means an ordinary general partnership.

2. General partnerships are governed by the Uniform Partnership Act as included in the materials.

3. Limited partnerships are governed by the Revised Uniform Limited Partnership Act, with 1985 amendments.

4. Corporations are organized under the law of a state that has adopted the Revised Model Business Corporation Act, except as to the duties of directors, derivative lawsuits and rules applicable to closely held corporations.

a. As to the duties of directors, Minn.Stat. § 302A.255 applies; otherwise the state slavishly follows Delaware court opinions.

b. As to derivative lawsuits, the state slavishly follows Delaware court opinions.

c. As to closely held corporations, the state follows the case law covered in this course.

Part One

A. For many years, George and Gracie operated as a two-person partnership. Although Gracie had contributed $100,000 in capital and George only $50,000, the partners shared profits equally. Last year Gracie died, and George spent the following sixth weeks winding up the partnership business. During that time he spent $15,000 of his own money in winding up expenses.

To wind up the partnership, George sold all the partnerships assets, realizing a total of $500,000. Outstanding bills to outside creditors totaled $250,000. In the final partnership accounting, how much should Gracie's estate and George each receive?

B. Minn. Stat. section 268.161, subd. 9 (relating to reemployment [formerly called unemployment] insurance) states in part:

Any officer, director, or employee of a corporation or any manager, governor, member, employee of a limited liability company which is an employer under [the re-employment insurance statute], who

(1) either individually or jointly with others, have or should have had control of, supervision over, or responsibility for the filing of the [reemployment] tax report or the making of payments under [the reemployment insurance statute] and

(2) willfully fails to file reports or to make payments as required,

shall be personally liable for [the amounts due from the employer] including interest, penalties, and costs in the event the employer does not pay the department those amounts for which the employer is liable.

. . . .

Any partner of a limited liability partnership, or professional limited liability partnership, shall be jointly and separately liable for [the amounts due from the employer], including interest, penalties, and costs in the event the employer does not pay those amounts for which the employer is liable."

Gily is the sole manager of a limited liability company with 150 employees. Ilan is one of 50 partners in a law firm organized as a professional limited liability partnership. The partnership is managed by a 5-person management committee (consisting solely of partners), and Ilan is not now nor has he ever been a member of that management committee. The partnership has approximately 50 employees. Assuming each organization fails to pay its reemployment insurance taxes, who is more at risk of personal liability, Gily or Ilan?

C. Sylvester, Inc. has made a bid to take over Tweety, Inc., and the overwhelming majority of Tweety's shareholders appear to favor the proposed deal. However, for the deal to go forward, Tweety must amend its articles of incorporation, which currently include a very toxic poison pill. If the proposed takeover occurs, all the current directors and chief officers of Tweety will doubtlessly lose their positions. Those individuals are therefore reluctant to submit to the shareholders for approval the necessary amendment to the articles of incorporation. RMBCA Section 10.03(c) states that: "the board of directors may condition its submission of a proposed amendment on any basis." In light of that provision, and the directors' prospects of future unemployment, may the directors condition submitting the necessary change to the shareholders upon the shareholders voting to adopt a resolution ratifying a $200,000 per director honorarium?

D. Minn. Stat. § 302A.255, subd. 3, provides in part that:

During any tender offer, or request or invitation for tenders of any class or series of shares of a publicly held corporation . . ., the publicly held corporation shall not enter into or amend, directly or indirectly, agreements containing provisions, whether or not dependent on the occurrence of any event or contingency, that increase, directly or indirectly, the current or future compensation of any officer or director of the publicly held corporation.

How does this provision compare with the Delaware approach applicable to the same issue?

E. Last year, the city of Lake Woebegone ("the City") undertook a major sewer separation project ("the Project"). It hired a general contractor ("the Contractor") to do the Project and hired a civil engineering firm ("the Firm") to supervise and review the Contractor's work on the City's behalf. The City's contract with the Contractor released the Contractor from any claim for damages resulting from any condition existing in the Project "if at the time the City formally accepts the Project the City knows of the condition."

At the completion of the Project, the Firm, acting on behalf of City, inspected the Project. The Firm's Project manager, who was in charge of all the Firm's work on the Project, inspected the Contractor's work and noticed a significant flaw. The manager made note of this flaw in her report to the Firm, but the secretary who transcribed the dictation notes omitted the crucial passage. The Project manager then left on vacation. The Firm's chief operating officer, who was responsible for reviewing all major reports before the Firm submitted them to any client, reviewed the Project manager's report. Unaware of the crucial missing passage, the CEO advised the City to accept the Project. The City did so. Several months later, the City suffered serious damage caused by the defect. It sued the Contractor, asserting that "neither the City nor any of its employees had any knowledge of the defect at the time the City accepted the Project." The Contractor asserted that the City waived its claim when it accepted the Project. Who was right?

Part Two

Residential Plumbing Services Company ("Residential Plumbing") began its existence ten years ago as a sole proprietorship (i.e. an unincorporated business) owned solely by Kathy. For various reasons irrelevant here, Kathy did not wish to be publicly known as the owner. She therefore installed Garrett as her manager, authorizing and directing him to appear as if he owned the business. The company's business consisted exclusively of residential plumbing, and Kathy (always a prudent person) instructed Garrett in writing to confine operations to residential work because "the risk of damages in commercial settings is far too large." Kathy also determined the business's operating hours and its price schedule. Otherwise, however, she rarely interfered with Garrett's management of the business. She did have him periodically report to her, because, as she was fond of saying to him, "in the final analysis it is my business and what I say, goes."

Kathy's company operated its business in leased premises, and two years ago Kathy fell behind significantly in the rent. She promptly met with the landlord, who was aware that Kathy was the true owner of the business. Kathy persuaded the landlord that the business had a bright future and was merely going through some rough times. Kathy and the landlord agreed to the following financial arrangement:

The landlord would purchase from Kathy all the business's equipment and would lease it back to Kathy. The rent on the equipment would be set at zero for the first twelve months, with the parties to renegotiate subsequently.

2. The fixed amount of the rent on the premises would be cut in half, with the landlord receiving in compensation 25% of the business's profits.

3. The landlord would have the right to inspect the business's books at any time.

4. One of the landlord's employees would take over management of the accounts receivable⁽¹⁾ and the accounts payable.⁽²⁾

The lease expressly disclaimed any partnership or agency relationship between the two parties.

Kathy did not inform Garrett of this arrangement, considering it none of his business. She merely told him that she had arranged to have the landlord "manage the accounts receivable and the accounts payable in order to free you for the plumbing side of the business."

Sometime after Kathy and the landlord had entered into and had begun operating under the new arrangement, Garrett purposely disobeyed Kathy's instructions about commercial projects. Eric, a friend of Garrett's, called Garrett one afternoon in dire need of assistance on a large commercial job. Mindful of Kathy's admonition to avoid commercial work, Garrett initially refused, saying "You know we don't do commercial work. We're strictly residential."

Eric chided Garrett, saying "What good is it being your own boss and owning your own company, if you are a slave to your own dumb rules? Besides, this isn't really commercial work. We're just putting bathrooms and kitchens into a bunch of suites at a new hotel." In addition, Eric offered Garrett a considerable bonus. Garrett eventually gave in, rationalizing the decision to himself by saying the bonus would go not to him but to the business and its owner, i.e. Kathy.

Eric arranged with the customer to divide the project into two separate halves, with Garrett taking one half under a separate contract directly with the customer. Garrett signed the contract "Residential Plumbing Services Company/Garrett."

The job seemed to go well, but unbeknownst to either Garrett or Eric, Garrett's work contained a serious, latent defect. The defect materialized several months later, causing $50,000 worth of consequential damages.

A. If the customer sues Garrett for breach of contract on the $50,000 worth of consequential damages, can Garrett successfully defend by revealing that Kathy is the true owner of the business?

B. Assuming the customer has a valid breach of contract claim and that the customer can establish the consequential damages, can the customer hold Kathy personally liable?

C. Assuming the customer has a valid breach of contract claim against Garrett and can establish the consequential damages, can the customer hold the landlord personally liable?

D. Assume that (i) instead of arranging for separate contracts, Eric took the entire project himself, under contract with the customer, and then subcontracted half the work to Garrett; (ii) Eric gave Garrett the project specifications (i.e. details of what work was to be done, as agreed in the contract between Eric and the customer) but otherwise let Garrett work on his own, without any supervision.

1. If the customer sues Eric for the $50,000 in consequential damages, alleging breach of contract, can Eric successfully defend by establishing that it was Garrett who did the faulty work?

2. Assume further that the defect causes bodily injury to a third party and that the third party can establish that Garrett's negligence proximately caused the injury. Can the third party recover from Eric?

1. Accounts receivable are amounts owed to a business by its customers.

2. Accounts payable are amounts owed by a business to its suppliers, vendors, service providers, etc.