Associations Class Notes
More on conflicts of interest
Let us finish up the material on conflicts of interest, then we’ll look at partnerships, which we’ll look at today, tomorrow, and the day after. We’ll do limited partnerships and LLCs on Thursday.
Perlman v. Feldmann
is a highly egalitarian decision that came as a big shock to the corporate
community. There were earlier cases
dealing with the sale of a control bloc to a looter. The big case was Gerdes v. Reynolds from the Supreme
Court of New York in the 1930’s. What
were the facts back in that case? There
was a liquid pool of money in the corporation.
The corporation was managed, under contract, by an investment
company. The investment advisor had two
classes of stock: (1) the voting stock, and (2) non-voting stock. A purchaser appeared for the voting stock,
offering much more than liquidation value for the stock. The officers, directors, and controlling
person making the sale did some
checking of the proposed purchaser, but not enough—they were negligent. The stock was sold. The purchaser took out the old board and put
in his guys, as you would expect. The
new guys looted the investment company! The
trustee in bankruptcy brought suit in state court against the controlling shareholder
and the officers and directors of the seller.
It was held that the trustee in bankruptcy could get a double recovery. He could recover jointly and severally the control premium that the purchase paid
for the voting stock. Next, in ordinary negligence,
the trustee in bankruptcy could recover from
the same group. All jurisdictions
follow the looting cases. Within the past twenty years, a
Perlman itself is a diversity case
in the Second Circuit under
The same thing was true with Perlman in the Korean War. There were huge federal contracts left for big companies like GM. All of these contracts involved using a lot of steel. There was not enough steel to go around. The end users could not raise the price that they paid for steel, but the price of stocks and bonds of corporations was not subject to the wage and price controls. Therefore, if you were an end user like GM and you were having trouble getting steel, you would get together with another end user and try to buy mid-sized steel companies by buying the controlling bloc of stock. The end users who bought stock from the controlling family did not loot or financially abuse the company. They paid a fair price by the steel. We know it was fair because it was set by central planners (ha ha). The case was brought originally as a shareholders’ derivative action, which would indicate that the plaintiff thought the recovery ought to go into the corporate treasury.
the course of the Second Circuit opinion, we see a strange “mid-course
correction”: the opinion starts out by saying that “control is a corporate
asset” and that the controlling person has misused or misappropriated it for
himself. Then, towards the end of the
opinion, the court oozes into the
remedy: they decide to share the control premium with the minority shareholders,
indicating that this right can be asserted either derivatively, as a duty owed
to the corporation (under FRCP Rule 23.1) or directly, as a class action (Rule 23) on the basis of duties owed
to the minority shareholders themselves.
The court could have cited a
case that we started the course with, Speed
v. Transamerica, for that exact proposition (and Shipman says they should
this case, the
A suit was brought and it reached the California Supreme Court. They discuss Perlman and Brown v. Halbert. The cause of action could be asserted either directly, derivatively, or both. Was it a breach of the fiduciary duty to form the holding company and not let the minority shareholders in on equal, per share terms? It was held that this was probably so, but the case was tried below under an erroneous legal standard. The case shall be sent back to the trial court, which will be told that the controlling shareholder will win if he can show both of two things: (1) there was a valid, bona fide business purpose for excluding the minority shareholders, and (2) the purpose could not have been served by less drastic means. Of course, he couldn’t prove that. He died, and his estate settled the suit. Here is where it gets interesting. For tax purposes, the Internal Revenue Service often recognizes two important concepts: (1) minority discount, and (2) control premium. Compute the value of 100% of the stock. Multiply the result by the percent holdings of the minority shareholder. Apply to that figure a discount from 15-40% recognizing the minority status.
Internal Revenue Service was in dispute with the Ahmanson estate. He had the controlling bloc of Newco. Let’s say that Newco stock was selling at $45
per share. What does that mean? It is the value of an atomized 100 share bloc
having no real factor in control. That’s
why most tender offers are at well above the NYSE price. They say to Ahmanson’s estate that a control
premium will be added because he has such a big bloc. According to the newspapers, the statute of
limitations for a refund claim had not run, and they used this doctrine to get around
the control premium! There’s an
interconnection here between tax and finance (and “everything else”). Nobody knows what the current situation in
Honigman v. Green Giant
is the Green Giant jolly? Green Giant is
a very old company, and the founding family took Class A stock that on a
share-for-share basis was just the same as Class B, except that Class A carried
1,000 votes per share as opposed to just one vote per share. Some call this kind of stock “founders’ stock”. If the company were liquidated, the Class A
stock held by the family would only get about 2-3%. However, they control. The family talked with investment bankers and
proposed this deal: call a shareholders’ meeting to amend the articles, under
which on a ten year basis we can exchange our Class A shares for Class B shares
and get our equity participation increased from 3% to 9%. In other words, they would be paid to be
egalitarian. This proposition was put to
the shareholders. The proxy statement
had full and fair disclosure. There was
overwhelming approval by the Class B holders.
Mrs. Honigman was a shareholder in
court held “pish tosh”, there is no fraud, no damage to creditors, no waste, no
illegality, full and fair disclosure up-front, and an overwhelming majority
voting for it. Therefore, under the
are two other places where Perlman v.
Feldmann doesn’t apply. You have an
amalgamation. The acquiring company
enters into contracts with many of the controlling persons of the acquired
company. Does this violate conflict of
interest law? Does it violate Perlman v. Feldmann? The answer is pretty well developed in
if you look through
will primarily be studying the Uniform Partnership
Act of 1914. The book has many
references to the Revised Uniform Partnership Act of the last 15 years. The Revised Act has notes that are very good
research tools; so does the original. In
what is a partnership? Read §§ 1-8 and
you get the picture. Partnership is
created when there is co-ownership of a business
for profit. If you’re in the
not-for-profit realm, look at R.C. Chapter 1702 and go to a not-for-profit corporation! Never use unincorporated business forms for a
not-for-profit association! On the other
hand, the definition of business in
the cases is broad.
Partnerships come in two flavors: today and tomorrow we will discuss advertent partnerships. On Wednesday, we’ll talk about inadvertent partnerships. It is malpractice for a lawyer to recommend a plain vanilla UPA general partnership today! Use the LLC or a corporation! But aren’t a lot of law firms set up as LLPs? Those are general partnerships with some limitation of tort liability but no limitation of tort liability. That’s just wrong and bad! They should be LLCs instead. But don’t worry unless you’re going to become a partner. There is no such thing as an inadvertent LLC or corporation.
Richert v. Handly
does the statute of frauds apply to partnerships? A famous
Assumed name statutes
If you are doing business under an assumed name, you are supposed to file an assumed name certificate. As to a partnership, the statute is especially demanding in that if you are a partnership and the firm name contains less than all of the names of all of the partners, the county recorder is not to accept real estate documents unless there is an assumed name certificate filed. If the firm name is Smith & Jones and there is only Smith and only Jones, you’re okay. But if you’re in Baker & Hostetler, there are a lot more partners than just Baker or Hostetler.
property can still be partnership property even if it’s in the name of one of
the partners. You don’t want to run a partnership
that way; you want to put partnership property in the partnership name. Before the Uniform Partnership Act of 1914, partnership
property had to be held in a cotenancy by partnership. The Uniform Partnership Act of 1914 says you
can clearly hold partnership property in the partnership name. Common name statutes in
We have a Paul Bunyan at the bar, and a capitalist comes up. He just bought a timber-cutting agreement. He says: “Let’s chop some wood!” Bunyan asks: “How much timber is there?” Bunyan looks, comes back and says: “You’re 30% too high.” But they agree anyhow, explicitly agreeing on a 50-50 profit split. They also explicitly agree that sweat equity (Bunyan) was to use his tractor and other equipment. He was to be paid “above the line”, that is, before computation of net loss, and he was to be reimbursed for the use of his tractor. Nothing was said about interest about capital, meaning that there shall be no interest on capital. Nothing was said about the partner’s salary.
this agreement void because it was not in writing? No, because it was fully performed already. A general partnership was created. The timber was cut and sold. Each party had a capital account. The capital account goes up by the assets you
contribute and by your share of the net profits. It goes down by your share of the net
losses. This was a partnership for one transaction: the timber under the
timber lease. The tax return was
prepared by a CPA, who gave copies to both parties. The partnership agreement may be subject to
amendment by conduct, including how the tax return is prepared. Either partner can sign, but the others are
entitled to a copy of the return and a statement of their distributive share of
all items. The CPA computed the return
and found that overall there had been a loss and that the loss is allocable
50-50 between the partners. Clearly, the
profits were to be divided equally. The
CPA, in effect, said that there was a negative balance in the capital account
of Sweat Equity. The purpose of the partnership
was completed. There was a
dissolution. With a general partnership,
very often you have to use the traditional method of accounting to settle
up. There is a major Ohio Supreme Court
case from the 1980’s and a major
was the problem? Bunyan thought that the
deal that had been cut was “profits: 50-50 and losses: 100-0”. Could that deal have explicitly been made as
between the parties up-front? Sure,
under § 18, which merely gives you default rules. If the parties had expressly so agreed up-front and there had been a tort liability,
would that bind the injured third party?
Would it have bound contract creditors?
No. Just read § 18 and you’ll see
that it will not bind those third parties.
But if all creditors have been paid and there are no tort liabilities,
then this is merely between the parties.
The Supreme Court holds that § 18 is clear: you agreed on the profit
ratio while your handshake agreement was silent on the loss ratio. In that situation, the loss ratio is the same
as the profit ratio. Bunyan isn’t
happy! But he does get a tax deduction. In
law firms have a “draw” against profits.
They set up a formula by which the partners can periodically draw out
about half of what the firm estimates will be the profits for the year. Note that if the draw against profits is
greater than what the profits turn out to be, the partner will get a note from
the senior partner asking for his check within ten days. If the draw is less, as it usually is, within about two weeks after the end of the
year, the partner will get the difference from the firm. Cautious law firms never borrow money to pay partners’
draws. With one big law firm in