CLOSELY HELD BUSINESSES

SPRING, 1995

PROFESSOR KLEINBERGER

General Instructions

This exam is a limited open book exam. You may use only the following materials ("Permitted Materials"):

the assigned photocopied materials (including the Supplemental Materials) and any additional photocopied materials distributed by the professor during the semester,

any notes you have personally made or developed in studying for the course or the exam (including notes you have made while studying the Supplemental Materials), and

outlines or other notes developed by a group of students enrolled in this course this semester if: (a) you played a substantial role in the development of the group outline or notes, (b) neither the group outline nor other notes discuss or make reference to the Supplemental Materials or their subject matter, and (c) the group discussions that led to the group outline or notes strictly excluded any consideration of the Supplemental Materials and their subject matter.

Except for Permitted Materials, 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. Each part is of equal weight in the grading. How you allocate your time between the two parts is your decision. Remember, however, that the two parts count equally.

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.

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.)

You are not required 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.

Part One

Fabricators, Inc. ("Fabricators") is a Minnesota corporation in the business of manufacturing machine tools. Fabricators has seven shareholders, 800 shares of issued and outstanding common stock and a three-person board of directors. The board is elected annually.

Fabricators was incorporated and its business begun in 1985. Originally the corporation had only four shareholders. Their holdings and role in the business were as follows:

name	# of shares	role in business	corporate positions
Shirley	200	chief decision maker (fulltime)	CEO, chair of the board of directors, employee
Harry	200	in charge of mfg. and admin. (fulltime)	CFO, member of board of directors, employee
Jim	200	in charge of sales and marketing (fulltime)	Sr. V.P., member of board of directors, employee
Judith	200	passive investor	none

These roles have remained unchanged to date, except that four years ago Shirley and Harry each transferred one-half of their respective holdings to their respective spouses and Jim transferred one-half of his holdings to his adult child. None of these new shareholders have ever taken any part in the business.

Judith recently filed suit against Shirley, Harry and Jim ("the defendants"). Her complaint contains the following four Counts:

Count I -- alleging that the defendants had failed to properly implement a non-compete agreement for key employees, that a key employee had left the company to join a competitor and had taken a substantial number of customers, causing Fabricators to lose profits of $150,000.⁽¹⁾

Count II -- alleging that the defendants caused Fabricators to enter into a long-term lease for a manufacturing facility owned by a limited liability company owned by the defendants, that although the leased facility was suitable the lease payments were far higher than market value, resulting in harm to Fabricators over the 7-year life of the lease of $250,000 and a profit to the limited liability company of $320,000.⁽²⁾

Count III -- alleging that for the past four years, the defendants in their capacities as directors had frozen dividends at $200 per share, while paying themselves excessive bonuses that were, in fact, disguised dividends available only to them, and that the excess payments amounted to $240,000

Count IV -- that the misconduct alleged in Counts I-III had combined to prevent Fabricators from providing Judith the return on her investment that she reasonably expected to receive.

A. The defendants have moved to dismiss the suit, asserting that the claims must be brought in a derivative action. Judith insists on her right to bring a direct claim. As to each Count, who is correct? Why?

B. Select one of the Counts, assume that it can be brought as a direct action,⁽³⁾ assume that Judith will prove her allegations under that Count and indicate the amount Judith should recover under that Count. Explain.

Part Two

Discord, Inc. ("Discord") is a Minnesota corporation, founded 15 years ago with five shareholders, each of whom worked fulltime in the business: CEO, CFO, Exec. V.P., Comptroller, and Mfg.-Director. From the beginning, the corporation had in place a buy-back agreement, requiring a shareholder whose employment was terminated to offer his or her shares to the corporation at a formula price.

Five years ago, the CEO announced he was considering retirement. A power struggle over succession resulted, pitting the CFO against the Exec. V.P. Eventually the CFO won, when the CEO threw his support to her. In return, the CFO (now head of the company) arranged for the company to buy out the CEO at 30% above the formula price and to provide the CEO a lucrative consulting agreement.

As you may imagine, the Exec.V.P. was incensed at this result. She became angrier still when the CFO cut her travel and entertainment budget. Exec.V.P.'s major function was sales, and her productivity depended on that budget.

Exec. V.P. decided that "something has to be done." She decided to bring a lawsuit, seeking rescission of the buy-back of the CEO's shares, cancellation of the consulting agreement and demotion of the CFO. Exec. V.P. enlisted Mfg.-Director as a co-plaintiff in the suit. (Mfg.-Director had previously stayed off the battlefield, but Exec. V.P. convinced him that CFO was imperiling the company.)

Shortly after the suit was filed, CFO ordered "an investigation into productivity and worker satisfaction in the manufacturing division." At the CFO's behest, the corporation retained its regular accounting firm to make the investigation. The investigation reported "severe failure to properly manage," although the report cited no specifics.

With that report in hand, CFO fired Mfg.-Director, citing "poor management as well as the disloyalty reflected in and the disruption caused by the bringing of a lawsuit against the company and its top management." The CFO also invoked the buy-back agreement and tendered Mfg.-Director the amount based on the formula. Mfg.-Director decided to contest both the firing and the buy-back and refused to tender his shares. Discord promptly cancelled his shares and placed the formula amount in an interest-bearing bank account.

Mfg.-Director promptly brought suit, raising every colorable claim within the scope of this course.

Three months later, Discord received an unsolicited purchase offer from a large corporation. The offer, which had not been anticipated or even suspected prior to the firing of Mfg.-Director, was promptly accepted and will bring each of the remaining shareholders in Discord three times the formula price stated in the buy-back agreement.

What, if anything, should Mfg.-Director recover, from whom, under what theories?

1. Most actual complaints do not state figures so precisely. I do so here and with regard to the other Counts for the sake of convenience and simplicity.

2. These figures imply that a market rate lease would have provided the limited liability company a profit of only $70,000.

3. Neither this assumption nor Question B are meant to imply that a direct claim is available for any of the Counts.