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Illustrates a common fact pattern for partnership formation issues - one of the people argues that the relationship constituted a partnership so that (s)he can claim a violation of partnership statute
1) FACTS:
a) Patricia Holmes made an oral partnership agreement with Sandra Kruger Lerner to start a cosmetics company, "Urban Decay"
i. They got together and came up with some color concepts, etc.
ii. Lerner asked Holmes if she thought they should start a company, Holmes responded in the affirmative
iii. Lerner contacted David Soward to start the process, and Holmes determined she was serious because of her tone of voice
iv. However, there was no express agreement to divide profits
b) Holmes was very involved with the company launch, but over time was getting squeezed out by Lerner
c) Soward finally offered Holmes a 1% ownership interest in the company
2) PROCEDURE:
a) Holmes sued Lerner and Soward for, among 10 counts:
i. Breach of oral contract
ii. Intentional interference with contractual relations
iii. Fraud
iv. Breach of fiduciary duty
v. Constructive fraud
b) During trial, Lerner denied Holmes ever had any stake in the company
c) Jury found for Holmes
3) LAW: An express agreement to share profits can be evidence of a partnership, rather than a required element of the definition of partnership; the Lerner-Holmes agreement was sufficiently definite
4) MORAL: The test for whether a relationship constitutes a partnership is objective intent.
a) Court relied on UPA, which omitted the language regarding division of profits and defines partnership simply as "an association of two or more persons to carry on as co-owners a business for profit." § 15006
b) UPA provides for situations in which partners have not expressly stated a profit-sharing agreement in § 15018
f. Another common fact pattern is where a creditor of a sole proprietorship argues that the business was actually an inadvertent partnership in an effort to reach additional pockets
a. Default statutory rule under RUPA is: "Each partner has equal rights in the management and conduct of the partnership business. § 401(f)
1) Does not mean that every partnership decision is put to a vote
2) A matter is normally put to a vote only if there is disagreement among the partners as to how to proceed, the matter is outside the ordinary course of partnership's business, or a third-party is requiring formal partner approval as a condition of entering into a transaction with the partnership.
b. Default for ordinary course of business matter: put to a partnership vote is approved if a majority of partners votes in favor of it. RUPA § 401(j)
c. Default for matter outside the partnership's ordinary course of business: requires unanimous partner approval. RUPA § 401(j)
d. Common variation of RUPA default rules:
1) Allocating votes proportionally based on the amount of capital each partner has contributed.
2) Delegating decision making authority with respect to partnership business to one partner (called the managing partner) or a committee of partners (management committee)
3) Requiring super-majority for specified decisions
a) E.g. Any expenditure in excess of $X requires the approval of at least 75% of the partners or voting power
4) Changing the approval requirement for matters outside the partnership's ordinary course of business to something less than unanimous partner approval
e. Default rule for adding new partners: RUPA § 401(i) - new partner requires consent of all partners
Decision extended the duties of partnership far beyond the duties under contract
1) FACTS
a) 1902 Salmon bought a 20-year lease for the Hotel Bristol, owned by Gerry.
b) Salmon intended to convert the hotel to shops and offices - entered into a joint venture with Meinhard
i. Meinhard provided capital while Salmon managed the business
ii. Partners were to share equally in the profits and losses
iii. Meinhard was given the sole power to assign the lease during the term of the venture, which was set to terminate at the end of the lease (20 years)
c) After 20 years the lease was expiring and venture coming to an end
i. Gerry (owner of the reversion of the lease) negotiated a new lease with Salmon which contemplated substantial redevelopment of the property
• Destruction and reconstruction of buildings after 7 years
ii. Salmon signed the lease in his individual capacity without telling Meinhard
2) PROCEDURE
a) Meinhard sued, arguing that the new opportunity belonged to the joint venture and the lease should be transferred to a constructive trust
b) Salmon argued the new lease could not belong to the venture because it was understood that the venture would terminate when 20-year lease expired.
c) A referee agreed that the opportunity belonged to the joint venture and awarded Meinhard a 25% interest (based upon his half interest in the property). Salmon appealed.
d) The appellate division sided with the referee, and ratched Meinhard's interest up to 50%. Salmon appealed.
3) LAW
a) Lowering the award to 49%, it held that Salmon, as the managing partner, owed Meinhard, as the investing partner, a fiduciary duty.
i. Included a duty to inform Meinhard of the new opportunity.
b) Joint venturers owe each other the highest duty of loyalty and Salmon, as managing partner had assumed responsibility by which Meinhard must rely on him to manage the partnership.
i. "A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior... the level of conduct for fiduciaries [has] been kept at a level higher than that trodden by the crowd."
c) Salmon was also obligated by the duty of loyalty to share profits with the venture.
i. Undivided and unselfish, a breach can come from innocent conduct, not just fraud or intentional bad-faith.
d. Partnership agreement cannot eliminate the duty of loyalty or care. RUPA § 103(b)(3)-(b)(4)
1) Partners can consent to conflicting interest transaction or other breach of duty, provided there is full disclosure.
e. Partnership agreements frequently contain provisions releasing a partner from liability for actions taken in good faith and in the honest belief that the actions are in the best interests of the partnership and indemnifying the partner against any liability incurred in connection with the business of the partnership if the partner acts in a good faith belief that (s)he has the authority to act.
a. As used in RUPA, dissolution is the point at which the partnership begins the winding up phase of its existence.
1) The partnership continues for the limited purpose of winding up the business
a) Selling its assets
b) Paying its debts
c) Distributing the net balance, if any, to the partners in cash according to their interests (RUPA calls this the "surplus")
i. Divvied up among the partners based on each partner's capital account balance and, if any money remains, each partner's profit sharing percentage.
ii. A partner's capital account consists of:
• contributions made to the partnership by the partner (e.g. cash or other property transferred by a partner to the partnership in exchange for his or her partnership interest) and the partner's share of partnership profits, minus
• amounts distributed by the partnership to the partner and the partner's share of partnership losses.
d) If the surplus is less than the aggregate of the partners' capital accounts, the shortfall is allocated to the partners' capital accounts based on their loss sharing percentage.
2) When winding up is completed, the partnership entity terminates.
b. Unless the partnership agreement provides otherwise, per RUPA § 801, dissolution is triggered at will whenever a partner notifies the partnership of his or her express will to withdraw as a partner.
c. In a partnership for a definite term or particular undertaking, the RUPA default rule is that dissolution is triggered by "the expiration of the term or completion of the undertaking" [RUPA § 801(2)(iii)] or "the express will of all the partners to wind up the business" before the expiration or completion. [RUPA § 801(2)(ii)]
d. Regardless of the type of partnership, dissolution is triggered by "an event that makes it unlawful for all or substantially all of the business of the partnership to be continued, but a cure of illegality within 90 days after notice to the partnership of the event is effective retroactively to the date of the event for purposes of this section." RUPA § 801(4)
e. Dissolution may be ordered by a court on application of a partner if the court determines that
1) "the economic purpose of the partnership is likely to be unreasonably frustrated;
2) another partner has engaged in conduct relating to the partnership business which makes it not reasonably practicable to carry on the business in partnership with that partner; or
3) it is not otherwise reasonably practicable to carry on the partnership business in conformity with the partnership agreement..." RUPA § 801(5)
f. Dissolution may also be ordered by a court on application by a transferee of a partner's transferable interest if the court determines that
1) "after the expiration of the term or completion of the undertaking, if the partnership was for a definite term or particular undertaking at the time of the transfer or entry of the charging order that gave rise to the transfer; or
2) at any time, if the partnership was a partnership at will at the time of the transfer or entry of the charging order that gave rise to the transfer." RUPA § 801(6)
g. The court-ordered dissolution rules are mandatory rules and cannot be altered by a partnership. (They appear on the RUPA § 103(b) list.)
1) FACTS
a) Louis Ederer (plaintiff), an attorney, joined the law firm of Steven Gursky (defendant). The firm began as Gursky and Ederer, P.C. (the PC) and eventually became a limited liability partnership called Gursky and Ederer, LLP (the LLP).
b) The LLP consisted of Gursky, Ederer, and three other attorneys. They did not create a written partnership agreement.
c) During his time with the law firm, Ederer entered into various financial agreements with the PC and LLP. Among other arrangements, the LLP agreed to repay a personal loan Ederer made to the PC.
d) When Ederer decided to leave the firm in June 2003, he entered into a withdrawal agreement, which promised him a set level of compensation for the rest of the year.
2) PROCEDURE
a) In December 2003, Ederer sued the PC, the LLP, Gursky, and the three other partners for breach of contract relating to the withdrawal agreement and personal loan debt.
b) The individual defendants moved to dismiss the complaint as to them, arguing that the limited liability partnership entity shielded partners from personal liability.
c) The trial court denied the motion to dismiss, and the Appellate Division affirmed.
3) LAW: LLP provisions do not shield a general partner in a registered limited liability partnership from personal liability for breaches of the partnership's or partners' obligations to each other.
a) Where a partnership agreement does not contain language about right to an accounting, the default rule applies that a right to an accounting exists.
Discusses the LLC fiduciary duties
a. FACTS
1) The parties were members of a limited liability company called Del Bay Associates, LLC. Del Bay built the Beacon Motel in Lewes, Delaware in 1987, with 66 guest units.
2) Later, some of the members (the Lingos) wanted to end their business relationship with the other members.
3) The Lingos concocted a story about their need to dissolve the limited liability company and sell the motel to fulfill obligations under a section 1031 tax-deferred exchange. "On June 10, 2003, the Lingos convinced Hoyt to sign the contract immediately so they could present it to the JGT board. The Lingos told Hoyt that if he did not sign the contract, JGT might back off."
4) The court found that the representations were not true. Instead, the Lingos controlled both sides of the transaction - seller and buyer.
a) "The Lingos manipulated the sales process through misrepresentations and repeated material omissions such as (1) imposing an artificial deadline justified by 'tax purposes;' (2) failing to inform Saliba and Ksebe that they were matching their offer by assuming the existing mortgage; [and] (3) failing to inform Saliba and Ksebe that they had already committed to selling the property to JGT, an entity the Lingos controlled."
b. LAW
1) "By standing on both sides of the transaction - as the seller, through their interest in and status as managers of Del Bay, and the buyer, through their interest in JGT- they bear the burden of demonstrating the entire fairness of the transaction."
a) Entire fairness test
i. Fair price
• Focus on substance (how much paid for hotel)
ii. Fair dealing
• Focus on process (timing, forthrightness)
c. MORAL: The default rule appears to be that managers of a Delaware LLC owe the duty of care and loyalty.
4. Fiduciary duties of care and loyalty owed under the DLLCA can be modified or even eliminated in an LLC's operating agreement, but "the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing." DLLCA § 18-1101(c)
Addresses the scope of the LLC liability shield.
a. FACTS
1) Handy contracts to purchase the Property with intent of forming an LLC with Ginsburg and McKinley for the purpose of building a residential community on the Property.
2) Handy learned that the Property contained wetlands, which depreciate the value of the Property. Handy abandons development plans, and opt to sell it.
3) Pepsi and Handy negotiate an option to purchase the Property. Pepsi discloses its intent to build a bottling facility on the Property and Handy has not disclosed the existence of wetlands.
4) Defendants Handy, Ginsburg, and McKinley form Willow Creek Estates, LLC.
5) Pepsi hires Hynes to do Phase I, during which time Hynes specifically asks Handy about the existence of wetlands, to which Handy responds in the negative.
6) The defendants, through Willow Creek, settle and take title to the Property.
7) The defendants, through Willow Creek, sell the unimproved Property to Pepsi for over twice the amount of their purchase price, and do not disclose the existence of wetlands.
b. PROCEDURE
1) Pepsi sued, claiming that defendants sold it property, fraudulently failing to disclose that it contained wetlands.
c. LAW
1) Because the misconduct occurred before the LLC was formed, the defendants could not have been acting solely as members of the LLC when they committed those acts.
a) Because all five counts of the complaint are based on conduct that occurred before the LLC was formed, those claims are not barred by § 18-303. Under the Limited Liability Company Act, no protection against liability is afforded to LLC members who (as here) are sued in capacities other than as members of the LLC.
1) FACTS
a) Haley and Talcott each owned 50% of a restaurant. They were organized as an LLC. They got into an argument and Haley wanted out.
b) The terms of the LLC allowed Talcott to buy out Haley. However, Haley personally co-signed for the mortgage on the property, which meant that even if he was no longer a co-owner, he'd still be on the hook to pay back the mortgage if the LLC went bankrupt.
2) PROCEDURE
a) Haley sued for dissolution of the LLC.
i. The court would order the company to sell off all its assets, distribute the cash to the shareholders, and then stop doing business.
ii. A court is allowed to dissolve an LLC "whenever it is not reasonably practicable to carry on the business in conformity with the limited liability company agreement." DLLCA §18-802
b) Talcott argued that the terms of the LLC already allowed a mechanism for Haley to leave, and that should be his sole option for leaving.
3) LAW
a) Since the LLC agreement didn't have a clause for how to effectively deal with the problem of Haley being responsible for the mortgage, it was no longer "reasonably practical" for the LLC to carry on in conformity with the LLC agreement.
i. The LLC agreement was improper because it left Haley holding the bag for the mortgage.
4) MORALS
a) In general, an LLC is more like a partnership than a corporation, and so the members can negotiate any deal they want to negotiate, including limiting the ways a member could leave the LLC.
b) Talcott was not out of options if he wanted to keep the restaurant running. All he had to do was buy the restaurant when it was offered for sale by the LLC. Then he'd own 100% of what the LLC used to own, and he'd be on the hook for the mortgage, and Haley would be free and clear
Direct and unambiguous communication not required for Implied Authority: P's constructing hotel, concerned about rusting of metal fixtures, were given written five-year warranty by territory manager on letterhead.
PROCEDURE: D moved for directed verdict - insufficient evidence for jury to find territory manager had authority to act for principal in providing warranty. Trial court said could find apparent authority, so directed verdict denied.
RULE: Apparent authority arises when actions of a principal cause a 3rd party to reasonably believe that an agent has authority to act on behalf of principal in a particular matter. Apparent authority arises when principal allows an agent to do those things reasonably necessary for carrying out express authority. Also when agent takes actions completely outside of actual authority if principal allows agent to appear to have the authority to bind the principal.
Must be an affirmative step by the principal. Either expressly authorize or cloak with authority.
Sufficient to cause 3rd party to reasonably believe principal has vested authority in agent.
3rd party must rely on that belief in dealing with the agent.
Focus of inquiry is principal's actions, but 3rd party is not required to have information directly from principal, just information that can be traced back to the principal.
ANALYSIS: Here, agent is territory manager. He is isolated from company, and regarded by all who do business with him to be the face for the company; He was given letterhead. Reliance requirement from Court is NOT present in R3d. Organizations are treated as possessing the collective knowledge of their employees and other agents.
P offered to buy 30 acres of land from D, President of D, a closely-held Corp, accepted offer in doc where he asserted authority to bind Corp, board of directors of Corp refused to complete sale.
PROCEDURE: P sues for specific performance of K, D asserts not bound as President had no authority to enter into K or bind Corp. Court rejects D's argument, and says that as president, agent had inherent authority to bind Corp.
LAW: Inherent agency power term used to indicate the status based authority customarily possessed by a person in the particular type of agency relationship. "Customary implication would seem to have been that authority was without limitation of the kind imposed here." Judge Learned Hand. P dealt with President here - a person whom the law recognizes as one of the officers who are the means, the hands, and the head by which corps normally act.
R2d: Agent's inherent authority subjects his principal to liability for acts done which (1) usually accompany or are incidental to transactions the agent is authorized to conduct; (2) 3rd party reasonably believes agent is authorized to do them; and (3) 3rd party has no notice otherwise.
Scope of general authority given to agent v. scope of usual business dealings: R2d looks at agent's office or status and the Court looked at scope of the business in which general agent was employed. The Ct., finds here that R2d approach more appropriate involving corporate officers.
Positional authority: "Because the principal puts the agent in a position of trust, the principal should bear the loss."
ANALYSIS: Because Menard was negotiating and contracting with the President of the Corp, inherent agency power existed and bound the corporation to the K even though there was no actual, apparent, or estoppel authority to act on behalf of the corporation. They could have sued him in his individual capacity based on RESTATEMENT § 6.10
both are pass-through.
d.
e. Sub-S criteria - Domestic entity; 100 or fewer owners; one class of ownership interest (disregarding differences in voting rights); all of its owners are individuals, estates, certain types of trusts, or tax exempt organizations; no non-resident alien owners, etc. - LP cannot meet b/c has two classes of interest - general partnership interest and limited partnership interest.
f. A multi-owner unincorporated business gets to decide whether it wants to be taxed as a partnership under Subchapter K or as a corporation under Subchapter C or Subchapter S.
1) Multi-owner entity is taxed as a partnership unless it chooses otherwise.
g. A corporation is taxed under Subchapter C unless it files an S-election.
h. Single member LLC is taxed as a disregarded entity (essentially the same as a sole proprietorship) unless it elects to be taxed as a C-corp or S-corp.
1) Cannot be taxed under Sub-K because it is only available to unincorporated entities with two or more owners.
i. A publicly traded unincorporated entity is taxed under Sub-C unless at least 90% of its gross income consists of qualifying income, in which case it can be taxed under sub-K.
j. If under Sub-K, owners of a business subject to self-employment tax if they participate actively in its business affairs or have management rights.
k. If under Sub-S, there is not self-employment tax on the business's income, but they are subject to FICA and Medicare taxes on wages paid by the business to its owners at a combined rate equal to the self-employment tax. However, income retained by a sub-S business or distributed to its owners as dividends is not subject to FICA or Medicare tax.
l. Sub S v. Sub K; winner is Sub S because no SE tax
m. Disregarded entity is subject to same self-employment tax as Sub-K
n. Disregarded entity v. Sub S; winner is Sub S because no SE tax
o. Why go with an LLC under Sub S instead of a corporation?
1) Fewer formalities
2) Anticipation of becoming ineligible for sub S; sub S LLC defaults to sub K when it loses sub S; Corporation defaults to Sub C
3) However, Many state do not recognize S elections by LLCs for state tax purposes