Business Law Comprehensive Examination

Statement of the Question

The PCV, or piercing the corporate veil, legal situation may arise when the court decides to treat a corporation and its participants as a single legal entity for the purposes of incurring debts and damages brought about by either direct or indirect exposure of contract and tort creditors thereto (Steinberg, 2012, p.112). Two key cases of the PCV may be routinely observed: the former occurs when the creditors seek to hold “the active shareholders of a closely held corporation…whose stock is publicly traded” (Steinberg, 2012, p.112) personally liable for the damages incurred by the corporation’s action or inaction. The latter may result from the situation where the “parent company” and “a number of its other subsidiaries” may be sought to be held liable for the other subsidiary’s transgressions (Steinberg, 2012, p.113). However, as Steinberg (2012) observes, “no case has been reported where individual shareholders of a publicly-held corporation…has been held personally accountable” (p.113). Thus, the PCV cases are effectively limited to either parent-subsidiary or close corporation-individual shareholder legal settings.

Proceeding from the aforementioned, one may claim that a successful plaintiff’s argument in the PCV situation may make use of both basic agency law principle and alter ego judicial theories with the similar efficacy. As a matter of fact, the analysis to be conducted here will seek to support this claim.

Analysis of the Question

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The alter ego liability doctrine centers on the notion of the lack of proper corporate procedures as the grounds for implementing the PCV investigation. Among key factors underlying the application of the alter ego theory in jurisprudence are the failure to adhere to corporate formalities (“not holding board of director and shareholder meetings, not electing officers, and failing to document properly corporate actions” (Steinberg, 2012, p.114)), failure to open accounts and hold transactions under its legal name, and most importantly, the instances of commingling, e.g. “directing company employees on a company payroll to perform personal tasks for a shareholder without additional compensation” (Steinberg, 2012, p.114). The same situation would occur if parent company employs the individuals that are simultaneously on the paycheck of the other corporation being its subsidiary. Thus, alter ego legal doctrine offers ample grounds for suing both closely held companies’ shareholders and subsidiary corporations for the damages incurred from their parent company.

However, the agency law principle would be equally applicable here. Proceeding from the single business enterprise doctrine, “when corporations are not operated as separate entities, but integrate their resources to achieve a common business purpose, each constituent corporation may be held liable in the pursuit of that business purpose” (Gardemal v. Westin Hotel Co., 186F. 3d 588, 594 (5th Circ. 1999). Consequently, a company or similar organization entering into the principal-agent relationship with the company the actions whereof have led to respective damages inflicted upon a plaintiff would be logically liable to share the responsibilities of its agent. According to Steinberg (2012), in particular, the actual authority clause, which refers to the agent’s entitlement to “act on behalf of a principal”, given the “manifestations which may be in the form of “written or spoken words or other conduct” from the principal to agent” (p.6).

Therefore, even if the formal agreement between the parent company and its subsidiary does not include the definite close on its agency character, such ‘manifestations’ as, e.g., the subsidiary’s obligations to act “in compliance with the [principal’s] prescribed standards, policies, practices, and procedures…specifications and blueprints for the equipment” that are utilized in the parent company’s manuals and instructions, furthermore, may lead the court to conclude that an actual authority agency relationship has arisen between the parent company and its subsidiary. For this reason, the parent company would be obliged to pay all damages incurred by its subsidiary’s action or inaction.

Such situation may be discerned from the case of Miller v. McDonald’s Corp. (945 P.2d 1107 (Or. Ap. 1997), which involved the plaintiff’s claim that McDonald’s Corp., as a franchisor of the 3K fast food company’s restaurant, would be liable for the damages caused by the discovery of a foreign object in the patron’s food. While the trial court ruled that McDonald’s Corporation was not liable to damages, as it “did not own or operate the restaurant”, the Oregon Court of Appeals, upon considering the case, deemed it plausible that a “defendant [i.e. McDonald’s Corp.] retained sufficient control over 3K’s daily operations that an actual agency relationship existed” (Miller v. McDonald’s Corp., 945 P.2d 1107 (Or. Ap. 1997), p.1111). Thus, the jury may have decided that McDonald’s Corp. and 3K were in the actual agency relationship, making McDonald’s liable to the plaintiff’s suit for damages.

Hence, a plaintiff’s lawyer, using the same line of reasoning, may argue that a defendant in a similar situation has entered into an actual agency relationship with its subsidiary (e.g. master-servant relationship in the case of an individual shareholder using the services of the company’s employees, or the actual agency relationship in the case of the franchise agreement between a parent and a subsidiary company), and thus may be held liable for his/her action or inaction. Additionally, this means that the basic agency law may be referred to when dealing with the PCV cases on an equal par with alter ego liability clauses.

Question #2

Statement of the Question

Several forms of business organizations have been discussed in Steinberg (2012). These include sole proprietorship, general partnership companies, and limited liability companies (LLCs). However, the majority of these business forms are scarcely regulated by the legislation in force, effectively making the LLC form the only necessary one from a blank state legislative perspective.

Analysis of the Question

Among the core forms of entrepreneurial activity, those of sole proprietorship and general partnership company are scarcely regulated by the legislative provisions. For instance, “there are no steps or formalities that are required to form a proprietorship” (Steinberg, 2012, p.35). An individual wishing to form and run his/her own business entity is not required to present “written documents or filings with the applicable state authorities” (Steinberg, 2012, p.35). Furthermore, he/she is not subject to any specific corporate or similar tax; “the proprietorship is not a taxable entity” (Steinberg, 2012, p.36). The net income of a sole proprietor is added to his/her other personal income for the reasons of calculating his/her contributions to the respective taxation authority.

Further, the sole proprietor’s profits and losses are “attributed to the owner personally” (Steinberg, 2012, p.35). This means that the sole proprietor has “personal and unlimited liability”, so that the contract and tort creditors would be able to demand the payment of their debts due not only from the proprietorship’s capital, but from the proprietor’s personal assets as well (Steinberg, 2012, p.35). Therefore, for the purposes of legal distinctions, the sole proprietor is treated as if he/she were an ordinary taxpayer/debtor. The only case where the sole proprietor may be treated as a separate legal entity is that of his/her performing the function of an independent contractor (Restatement of the Law (Second) Agency, 1958). In this case, some elements of principal-agent relations may be applied, even though an independent contractor “is not a fiduciary, has no power to make the one employing him a party to a transaction, and is subject to no control over his conduct” (Restatement of the Law (Second) Agency, 1958).

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A general partnership company may be operationally defined as “the association of two or more persons to carry on as co-owners a business for profit” (Revised Uniform Partnership Act, 1994, §202(a)). Just as in the sole proprietor’s case, “the general partners have personal and unlimited liability” (Steinberg, 2012, p.37). Furthermore, “a general partner can vote on matters affecting the partnership…even when that partner does not in fact have an actual authority to engage in a particular transaction” (2012, p.37). Thus, the creditors may be led to believe that an individual partner’s action is authorized by the business’s co-owners. Finally, and most importantly, the general partners are not obliged to file for the registration of their company as a corporation with the respective State’s authorities.

As it may be evident from the discussion of the sole proprietorship and the general partnership’s legal situation, these forms of business entities lack either a distinct registration procedure or the specific provisions for determination of their liability limits. In fact, the law treats their participants as regular natural persons, without additional entitlements or limitations inherent in the corporate law. Consequently, from the legislator’s point of view, the only specifically distinct business form may be a limited liability company.

Question #3

Statement of the Question

The major contracts inherent in the activity of a closely-held corporation are partnership, operating, and shareholder agreement. These forms serve as instruments of allocating and maintaining the shareholders’ control over an enterprise. Nevertheless, one may claim that the closely-held corporation would need only such documents as the corporation statute, the articles of incorporation also, the corporate bylaws and the share certificates, to operate properly under control of its shareholders. Thus, it is necessary to further consider this issue.

Analysis of the Question

A closely-held corporation may be defined as the one based on the flexible corporation agreement that would enable the respective shareholders to customize their level of involvement in the company’s life. Unlike regular corporation, a closely-held, or a “statutory close corporation” (Steinberg, 2012, p.52), may directly provide for the role of shareholders as the direct decisionmakers, dispensing with the board of directors or any other similar formalities. Thus, a closely-held corporation presents a worthwhile flexibility option to its prospective shareholders.

In general, the certified corporations need several legal documents to function as the State-recognized entities. Of them, the articles of incorporation, or the certificate of incorporation, represent the defining legal guarantee of a corporation’s life, for it denotes that “contracts entered into and debts incurred” (Steinberg, 2012, p.48), as well as all other business transactions, are conducted in the name of a corporation, not its constituent shareholders. In this way, a limited liability condition may be fulfilled.

The corporation statute and the corporate bylaws represent another important element of the corporation’s activities. They denote the exact procedure of decision making and provide for respective executive officers to implement the shareholders’ decisions. In particular, the corporate bylaws may contain provisions for shareholders’ meetings’ date and quorum requirements, the corporate officers’ duties and powers, or the rules regulating shareholders’ voting. Through these instruments, it is possible to regulate the corporation’s internal life.

Similarly, the share certificates determine the respective measure of control held by each shareholder over the corporation. The issuance and distribution of the new shares have a direct impact upon the shareholders’ capacity to control the situation in the company.

On the other hand, such documents as partnership agreement or a written shareholder agreement are generally optional, given recent legislative innovations in many of the States. The partnership agreement may be deemed necessary only if the corporation is based on the limited partnership principle, with one of the partners assuming the role of a general partner, being subject to unlimited liability. Understandably, such situations rarely arise within the modern circumstances. Moreover, the operating agreement is effectively substituted by the corporate bylaws, for the purposes of defining the internal regime of the corporation in question. Finally, the shareholder agreement may be likewise replaced by the corporation statute or the corporate bylaws. In case of the closely-held corporation, these latter may include the provisions stipulating the personal participation of the shareholders as the corporation’s decision makers.

Therefore, the partnership agreement, operating agreement, and shareholder agreement may be viewed as superfluous to the proper functioning of the closely-held corporation, with their functions being played by the more flexible variants of the corporate statute and bylaws.

Question #4

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Statement of the Question

According to Steinberg (2012), corporate “directors and officers owe two general fiduciary duties: the duty of care and duty of loyalty” (2012, p.185). The duty of care is defined as “an amount of care exercised by like persons in similar circumstances” (Steinberg, 2012, p.187). Additionally, the duty of loyalty situation may be referred to when a director or the other corporate officer “benefits at the expense of a corporation, or otherwise fails to act in the best interests of a corporation” (Steinberg, 2012, p.190). Similar duties are expected from “general partners in a partnership” or “managers in a limited liability company (LLC)” (Steinberg, 2012, p.185). Thus, the agency as such may be defined as a “fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control” (Restatement of the Law (Second) Agency, 1958, 1‘1(1)).

Nonetheless, it may be asserted that the fiduciary duties in question are dependent upon the legal construct of equity, as the majority of shareholders are now equity investors that do not enter into principal-agent relations with their fiduciaries. Therefore, it may be inferred that the fiduciary duties’ regulation should be relegated to the field of contracts and statutes, rather than to a direct court jurisdiction.

Analysis of the Question

The main instruments used to shield the fiduciaries from the suits based on the fiduciary duties’ invocation are the business judgment rule (“the presumption that in making a decision, the [fiduciaries] of a corporation acted on an informed basis and in a good faith”; Steinberg, 2012, p.188), which may be utilized in case where one may claim that a fiduciary acted on the rational basis and was not engaged in financial self-dealing, and the director protection statutes (i.e. the State-adopted legal instruments providing for a option of eliminating or limiting the liability of a fiduciary to the corporation and its shareholders, while retaining his/her liability under antitrust or similar laws). Given the wide proliferation of the director protection statutes and the possible application of the business judgment rule, the plaintiffs may resort to invoking duty of candor (referring to the directors’ obligation to supply their shareholders with the accurate and verified information) or the duty of good faith (in cases when a director “acts with conscious indifference or recklessly disregards the corporation’s best interests; Steinberg, 2012, p.193).

However, the considerations of all such fiduciary duties are limited by the fact that the relations between corporate officers and shareholders are frequently constructed on the basis of residual claims that do not have the legal powers of the full contractual or statutory agreement. In the case of modern dynamic capital flows, it is scarcely possible to enforce the fiduciaries’ obligations before the equity investors without the exact contractual/statutory framework. Lastly, it is necessary to radically reconstruct the fiduciary duties’ concept. 

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