5.2 Case Study Corporations

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1 5.2 Case Study Corporations Business Administration, ECPI University LAW225: Legal Environment of Business Stuart Innes

2 5.2 Case Study Corporations Robert K. Powers and Lee M. Solomon were among the limited partners of the Cosmopolitan Chinook Hotel (Cosmopolitan), a limited partnership. Cosmopolitan entered into a contract to lease and purchase neon signs from Dwinell’s Central Neon (Dwinell’s). The contract identified Cosmopolitan as a “partnership” and was signed on behalf of the partnership, “R. Powers, President.” At the time the contract was entered into, Cosmopolitan had taken no steps to file its certificate of limited partnership with the state, as required by limited partnership law. The certificate was not filed with the state until several months after the contract was signed. When Cosmopolitan defaulted on payments due under the contract, Dwinell’s sued Cosmopolitan and its general and limited partners to recover damages. Powers and Solomon denied liability, arguing that they were limited partners. Dwinell’s Central Neon v. Cosmopolitan Chinook Hotel , 587 P.2d 191, 1978 Wash. App. Lexis 2735 (Court of Appeals of Washington) 1. What is a defective formation of a limited partnership? A defective formation of a limited partnership typically refers to a situation in which a limited partnership has not been properly formed or registered in accordance with the requirements of state law governing limited partnerships. Limited partnerships are typically required to file a certificate of limited partnership with the state's relevant authority to establish their legal existence. Failure to comply with these formalities can result in a partnership being considered "defective" in the eyes of the law. 2. Did Powers and Solomon act ethically in denying liability for the contract? Why or why not? Whether Powers and Solomon acted ethically in denying liability for the contract depends on the specific circumstances and the basis for their denial. If they were aware that the limited partnership had not been properly formed or registered at the time the contract was entered into, their denial of liability might be seen as ethically questionable. Generally, partners in a limited partnership have limited liability, which means they are shielded from personal liability for the partnership's debts and obligations. However, this limited liability is contingent on the partnership's compliance with legal formalities, such as filing the required certificates with the state. 3. Are the limited partners liable? Why or why not? The liability of limited partners in a limited partnership is generally limited to the extent of their capital contributions to the partnership, provided that the partnership has been properly formed and registered in accordance with applicable state laws. However, if the limited partnership is considered defective due to non-compliance with legal formalities, limited partners may potentially be held personally liable for partnership obligations. In this case, it appears that Cosmopolitan Chinook Hotel had not filed its certificate of limited partnership with the state until several months after entering into the contract with Dwinell's Central Neon.

3 4. Do you agree with the outcome of the case? Why or why not? he outcome of the case would depend on the specific legal arguments and evidence presented, as well as the application of relevant state laws and regulations regarding limited partnerships. Without access to the full details of the case, it is difficult to assess the appropriateness of the outcome. However, if the court determined that the limited partnership was indeed defective at the time the contract was entered into due to non-compliance with state law, it would be consistent with legal principles to hold the limited partners, including Powers and Solomon, personally liable for the partnership's obligations. Lawrence Gaffney was the president and general manager of Ideal Tape Company (Ideal). Ideal, which was a subsidiary of Chelsea Industries, Inc. (Chelsea), was engaged in the business of manufacturing pressure-sensitive tape. Gaffney recruited three other Ideal executives to join him in starting a tape manufacturing business. The four men remained at Ideal for the two years it took them to plan the new enterprise. During this time, they used their positions at Ideal to travel around the country to gather business ideas, recruit potential customers, and purchase equipment for their business. At no time did they reveal to Chelsea their intention to open a competing business. The new business was incorporated as Action Manufacturing Company (Action). When executives at Chelsea discovered the existence of the new venture, Gaffney and the others resigned from Chelsea. Chelsea sued Gaffney and the others to recover damages. Chelsea Industries, Inc. v. Gaffney , 449 N.E.2d 320, 1983 Mass. Lexis 1413 (Supreme Judicial Court of Massachusetts) 1. What is the fiduciary duty of loyalty? The fiduciary duty of loyalty is a legal and ethical obligation that requires individuals in positions of trust or authority, such as corporate officers, directors, and employees, to act in the best interests of the organization or entity to which they owe the duty. 2. Did Gaffney act ethically in this case? Why or why not? Gaffney's actions in this case could be considered ethically questionable. While he had the right to leave his position at Ideal and start a new business, it appears that he and his partners used their positions at Ideal to plan and establish a competing business without Chelsea's knowledge or consent. They traveled around the country, gathered business ideas, recruited potential customers, and purchased equipment for their new venture, all while still employed by Ideal. 3. Did Gaffney and his partners breach their fiduciary duty of loyalty? Why or why not? Based on the information provided, it appears that Gaffney and his partners may have breached their fiduciary duty of loyalty to Chelsea and Ideal. They used their positions and resources at Ideal to plan and establish a competing business without disclosing their intentions to Chelsea. This non-disclosure and the use of company resources for personal gain could be seen as a conflict of interest and a breach of their duty to act in the best interests of Chelsea and Ideal. 4. Do you agree with the outcome of the case? Why or why not? The agreement on whether one agrees with the outcome of the case may vary depending on individual perspectives and legal interpretations. However, based on the information

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4 provided, the court's decision appears to align with the principles of fiduciary duty and corporate ethics. If Gaffney and his partners used their positions at Ideal to plan and establish a competing business without proper disclosure or resignation, it is reasonable for Chelsea, the parent company, to seek damages for breach of fiduciary duty.

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