Instructor Notes CHAPTER 11
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CHAPTER 11: THE LAW OF BUSINESS ORGANIZATIONS
AND BANKRUPTCY
PURPOSE AND SUBSTANTIVE CONTENT
This chapter covers the basic forms of business organizations, sole proprietorships,
partnerships, and corporations as well as limited liability partnerships and companies. The law
of bankruptcy is also introduced.
CHAPTER OUTLINE
Case file
11–1 Introduction
11–2 The Law of Agency
Agents vs. Independent Contractors Respondeat Superior
Agents Acting with Actual or Ostensible Authority
11-3
Sole Proprietorships
11-4
General Partnerships
11-5
Limited Partnerships
11-6
Corporations
Business Corporations
Professional Corporations
Close Corporations vs. Public Corporations
Nonprofit Corporations
Piercing the Corporate Veil
Security Regulations
Federal Regulation
State Rules
Sarbanes-Oxley Act of 2002
Corporate Practice
11-7
Limited Liability Partnership
11-8
Limited Liability Companies
11-9
Bankruptcy Law
Chapter Cases
Kaplan v. Coldwell Banker Residential Affiliates, Inc., 59 Cal.App.4th 741, 69
Cal.Rptr.2d 640 (1997)
Oakland Raiders v. National Football League, 93 Cal.App.4th 572, 113 Cal.Rptr.2d
255 (2001)
In re Tia Carrere, Debtor, 64 Bankr. 156
Case Summary
In re Walt Disney Co. Derivative Litigation, 906 A.2d 27 (Del.Supr.,2006)
Technology Corner
Chapter Summary
Terms to Remember
Questions for Review
Application and Analysis Problems
Assignments and Projects
Skills Assessment
SKILL BUILDING
The examples, assignments, case questions, and projects provide the opportunity for
students to build the following skills:
Legal Research
Statutory Analysis
Investigative
Case Analysis
CASE SUMMARIES, CASE QUESTIONS, AND SUGGESTED ANSWERS
Kaplan v. Coldwell Banker Residential Affiliates, Inc., 59 Cal.App.4th 741, 69 Cal.Rptr.2d
640 (1997)
Plaintiff (a superior court judge) utilized the services of a real estate business advertising itself as
“Coldwell Banker.” In fact the business was a franchise and had a written agreement with
Coldwell Banker indicated that it was to hold itself out as an independent contractor. The real
estate business posted a large sign on its premises, using the name Coldwell Banker and
containing the disclaimer language in very small print. Plaintiff eventually sued the real estate
business on several theories related to the purchase of property. Coldwell Banker was named as
a defendant on the theory of respondeat superior. Coldwell Banker made a motion for summary
judgment which was granted. The appellate court reversed, holding that there were sufficient
facts to hold Coldwell Banker as an ostensible agent. The court restated the general rule that an
ostensible agency must be created by acts of the “principal.” Here the court reasoned that by
allowing businesses to use its name and call themselves “members” of the organization, an
ostensible agency could be found.
1. Why did the appellate court refuse to apply the doctrine of respondeat superior?
Suggested Answer
:
The court found there were no facts to support an agency relationship. This franchise
was clearly an independent contractor relationship.
2. Why did the court say that the theory of ostensible agency might apply?
Suggested Answer:
The court restated the general rule that an ostensible agency must be created by acts of
the “principal.” Here the court reasoned that by allowing businesses to use its name and
call themselves “members” of the organization, an ostensible agency could be found.
Oakland Raiders v. National Football League, 93 Cal.App.4th 572, 113 Cal.Rptr.2d
255 (2001)
This factually complex case involved a lawsuit brought by the Oakland Raiders football
team against the NFL and the Commission of the league. The NFL conducts its business through
a variety of profit and non-profit organizations. The first issue in the case was whether the
dispute was properly before the court or whether the matter should be resolved by the court or
whether the court should decline to exercise jurisdiction and allow the companies to self-regulate
according to their by-laws (the Abstention Doctrine.) The second issue involved a derivative
action and whether the plaintiff needed to make a demand that the board of directors take some
action prior to the football team filing a lawsuit. The Raiders claimed that making a demand
would be futile because the directors were not disinterested parties. The court found that the
Abstention Doctrine did apply and that the requirement of making a demand was not a futile
effort.
1. Why did the abstention doctrine apply in this case?
Suggested Answer:
The following language from the case explains. “In many disputes in which [the rights
and duties of the membership in relation to the association] are at issue ... the courts may
decline to exercise jurisdiction. Their determination not to intervene reflects their
judgment that the resulting burdens on the judiciary outweigh the interests of the parties
at stake. One concern in such cases is that judicial attempts to construe ritual or obscure
rules and laws of private organizations may lead the courts into what Professor Chafee
called the ‘dismal swamp.”
2. Did the Oakland Raiders win or lose their case?
Suggested Answer
:
They lost.
In re Tia CARRERE, Debtor
, 64 Bankr. 156; Bankr. L. Rep. (CCH) P71,279, 15 Collier
Bankr. Cas. 2d (MB) 407, 14 Bankr. Ct. Dec. (CRR) 977 (July 16, 1986)
The issue in this bankruptcy proceeding is whether a debtor who was under a personal
service contract is entitled to reject the contract after filing bankruptcy. In this case, the debtor, a
movie and television actress, was under a contract to appear in a soap opera. She also entered
into a separate agreement to appear in a different television program, “The A Team,” for more
money. The second agreement was in the nature of an option. The actress subsequently filed
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bankruptcy and requested release from the first, binding contract. Under bankruptcy law, the
trustee may assume contracts that are advantageous to the estate and reject contracts that are not.
The bankruptcy court found that under bankruptcy law, personal service contracts are not part of
the bankrupt estate. Furthermore, in this case, the court was concerned with the good faith issue.
1.
Why did Carrere file bankruptcy?
Suggested Answer:
She claimed that her liabilities were $76,575 and her assets were $13,191.
2.
What is a personal services contract?
Suggested Answer:
While the court does not specifically define the term, it certainly suggests enough to tell
that a personal service contract is one in which the personal and unique services of one
party are to be supplied to the other party.
3.
Under bankruptcy law, what is meant by the term “estate”?
Suggested Answer:
Again, the court does not expressly define the term, but from a reading of the case, it is
clear that estate means all of the property and debts turned over to the bankruptcy trustee.
APPLICATION AND ANALYSIS PROBLEMS
1. A Partnership failed to pay employment taxes for its employees and within the proper time
limitations, the I.R.S. assessed the taxes against the Partnership, but not against individual
partners. Later, the IRS tried to collect the taxes from the individual partners. The partners
claimed that they were not liable because the I.R.S. did not assess them individually as
taxpayers and the time limits in which to do so had expired. Why did partners claim they
should have been individually assessed? Why did I.R.S. claim it was not necessary? How did
court resolve this?
See
U.S. v. Galletti
541 U.S. 114, 124 S.Ct.1548 (2004).
Suggested Answer:
The partners claimed that if the government wanted to tax them individually they should
have been notified within the statute of limitations. They claimed that under partnership
law they are primarily liable for any partnership debts. The government argued that
naming the partnership was sufficient to extend the normal statute of limitations. The
Court found in favor of the government, holding that the partnership law had nothing to
do with deciding this case. The case turned on the fact that the law extended the statute
of limitations is a tax was properly “assessed.” The Court found this was done.
2. Wells filed a lawsuit against her employer Clackamas Gastorenterology Associates, P.C.
alleging that the medical clinic violated the Americans with Disabilities Act of 1990 (ADA
or Act) when it terminated her employment. The medical clinic asserted that it was not
subject to the provisions of the ADA because the ADA applies only to businesses with 15 or
more employees. That assertion's accuracy depended on whether the four physician-
shareholders who own the professional corporation and constitute its board of directors were
counted as employees. The District Court concluded that the physicians were more analogous
to partners in a partnership than to shareholders in a corporation and therefore were not
employees under the ADA. The Ninth Circuit reversed, finding no reason to permit a
professional corporation to reap the tax and civil liability advantages of its corporate status
and then argue that it is like a partnership so as to avoid employment discrimination liability.
Which argument do you think is correct? Why? How do you think the Supreme Court
resolved this?
See
Clackamas Gastroenterology Associates, P. C. v. Wells,
538 U.S. 440, 123 S.Ct. 1673
(2003).
Suggested Answer
:
In deciding if the doctors were to be considered employees the Court looked to the
common law guidepost of control, rather than accept the argument that the doctors were
more like partners because of the unique nature of the professional corporation. Here the
Court asked questions such as whether the employer can hire and fire employees, can
assign tasks to employees and supervise their performance, and can decide how the
profits and losses of the business are to be distributed. In this case, the record was not
clear on these questions and the case was remanded. 3. While they were married to one another, John and Jane were both employed as real estate
sales agents. In 1999, a year before John and Jane separated, John’s accountant
recommended that he create a business for tax purposes. John created Manhattan Associates
and filed a d.b.a. claiming it was a general partnership, with Jane named as his partner. Jane
had no knowledge that this was done. After they separated, John never changed the status of
the business to a sole proprietorship, although he was the only one actually working in the
business. In fact, in 2004 he renewed the d.b.a. without change. John also filed partnership
federal income tax returns for Manhattan Associates in which he apparently indicated the
entity was instead a limited partnership, with the other partner holding only a .01 percent
interest. After the parties separated, John generated substantial commissions from this
business. Under the community property laws, a spouse’s income after separation is usually
that spouse’s separate property. Jane claimed that rule did not apply because Manhattan
Associates was a partnership in which she was a general partner and was therefore entitled to
share in the profits of the business. How would you resolve this?
See
In re Marriage of Geraci,
144 Cal. App. 4th 1278, 51 Cal. Rptr. 3d 234 (2006).
Suggested Answer:
In Geraci
, the court found that wife was not a general partner. In spite of the d.b.a. and
tax returns, wife never demonstrated any intent to become a partner and in fact did not
know of the existence of the partnership until after the divorce was filed. As a result, the
business profits were the separate property of the husband.
4. Charlotte Lee was named as a defendant partner in a lawsuit against a partnership. Her
interest was as follows: Lee’s husband had been a named partner in the business and when
he died, his interest passed to his estate. The remaining partners continued the business and
treated the estate as a partner. The estate was represented by Charlotte Lee who appeared on
partnership records as the personal representative of the estate of Robert H. Lee. In her
capacity as the personal representative of the estate, she acted on behalf of the estate in
partnership matters. At some point as the personal representative of the estate she assigned
to herself individually the estate’s interest in the partnership. Plaintiffs claim that she was a
partner. Lee claims that the estate and not she personally was the partner. What are the
arguments for each party? How would you resolve this?
See
Axtell v. Canyon Center Ltd. Partnership, 138 F.R.D. 556, W.D.Wis. (1988).
Suggested Answer:
Plaintiffs would argue that Lee became a partner by her involvement in the business and
receipt of the estate’s interest. The court found that she was not an individual partner.
Her involvement was always as the personal representative. To have become a partner,
she would have needed the consent of all the other partners, since a partnership is a
consentual relationship. Also, the assignment of the interest in the estate is not a transfer
of the partnership. It is only a transfer of the profit (an assignment of rights).
5. BCBSD, Inc. was a non-profit health insurance company and Crosse was a plan participant.
Crosse sued the insurance company for not distributing claiming that health insurer breached
its fiduciary duties by accumulating a surplus of over $50 million. Crosse claimed the
surplus should have been passed on to plan participants. Crosse also claimed that the
directors of the company should be held individually liable. The lawsuit raised two issues.
First, did the insurance company have a fiduciary duty to the insured. Second, was it proper
to “pierce the corporate veil” based on the fact that the company failed to act as a non-profit
company in accumulating its profits. How did the court resolve these issues?
See Crosse v. BCBSD, Inc
. 836 A.2d 492 (Del.Supr. 2003).
Suggested Answer:
The court found that the relationship between the insurance company and the insureds
were purely a contractual one, even though the insurance company was not-for-profit. As
such the relationship was governed by general contract law and nothing in the facts
supported a finding of a fiduciary duty. Also, nothing in the facts supported a finding
that piercing the corporate veil was appropriate here.
6. Reread the facts of Kaplan
. In this case, the appellate court did not find that Coldwell Banker
was an ostensible agent, only that there were sufficient facts to withstand a summary
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judgment (a declaration by the court that there were no
facts to support a jury’s finding that
an ostensible agency existed.) The case was remanded for trial on the issue of whether an
ostensible agency did in fact exist. Summarize the argument of Kaplan that an ostensible
agency existed. How would Coldwell Banker argue to support its contention that no
ostensible agency existed? Suggested Answer:
Student answers may vary on this question
. Kaplan’s argument was as follows: Although
Coldwell Banker made no specific representations to appellant personally, it did make
representations to the public in general, upon which appellant relied. The venerable name,
Coldwell Banker, the advertising campaign, the logo, and the use of the word “member”
were and are designed to bring customers into Coldwell Banker franchises. Coldwell
Banker will probably base its argument on the fact that it did nothing to create this
ostensible agency. Further, the disclaimer on the sign should have made any consumer
aware of the relationship between Coldwell Banker and the independent agent.