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How to approach Business Associations on the California Bar Exam

Business associations as tested on the California bar exam is quite dense and loaded with substantive material. The initial approach to business associations is to parse out the broad subject into 1) Agency; 2) Partnerships, and 3) Corporations. Be mindful, as you will see below, that agency, partnerships, and corporations overlap in the sense that certain partnership/corporation essays warrant discussion of agency principles, based on the fact pattern.


Agency

When discussing agency on the California bar exam, it is important to begin with the formation of such a relationship. You should discuss capacity (principal’s contractual capacity and agent’s minimal capacity), mutual consent, method of formation (whether it’s by action, implied, apparent, by ratification, or by operation of law), etc. If the question asks whether the principal is liable for the contract, then below is a sample template you may use. You would start with something like this: In order to determine if the principal is bound by the contract, the agent must have had the authority to enter the contract and bind the principal. Then you should discuss actual express authority, actual implied authority, termination of actual authority (raise only if an issue), apparent authority, lingering authority (raise only if an issue), ratification, etc.


You should then discuss the various duties owed by the agent and also by the principal. Remember to discuss duty of loyalty, obedience, and the duty of care. You should then discuss the applicable remedies for the agent and principal. If applicable, discuss the tort/contractual liabilities as they relate to the principal-agent relationship.


Partnerships

Similarly, in partnerships, you should first discuss the governing law and the requirements of forming a partnership à CLACI: capacity, legal purpose, agreement, consent of all partners, and intent. Without such formalities, be prepared to discuss the factors to imply a partnership (i.e., intent of the parties and sharing of profits). You may also want to discuss partnership by estoppel, if applicable. You will then proceed to discuss the partnership property and analyze factors to determine whether property is within the partnership. Next, you will discuss the rights and duties of partners (management, control, distributions, remuneration, indemnification, contribution, inspection, lawsuits, etc.).


Next you will look to Duties à duty of loyalty and duty of care. Duty of loyalty includes accounting for all profits or other benefits derived by the partner in connection with partnership business, not deal with partnership as one with an adverse interest, and not compete with the partnership. Duty of care includes refraining from engaging in negligent, reckless, or unlawful conduct and refrain from engaging in intentional misconduct.


Also discuss liabilities owed to third parties, if applicable. If there are liabilities owed to third parties, you will need to address the concept of authority. 1) Actual express authority: express authority is that authority contained within the four corners of the partnership agreement and those expressly granted by the partnership. 2) Actual implied authority: implied authority is authority that the partner reasonably believes she has as a result of the actions of the partnership. 3) Apparent authority: apparent authority exists if the partnership holds a partner out as possessing certain authority, thereby inducing others reasonably to believe that authority exists. The third party must reasonably rely on the holding out. Under R.U.P.A. apparent authority is the act of any partner for apparently carrying on in the ordinary course of the partnership business or businesses of the kind unless the partner had not authority to act for the partnership in the particular matter and the person with whom the partner was dealing knew or had received notification that the partner lacked authority.


Lastly, you should discuss dissociation and dissolution of the partnership. Specifically, the methods of dissociation and dissolution, terminating apparent authority, continued authority to wind up, and distributing assets.


Corporations

For corporations, the initial inquiry is the same such that you will be identifying the formation of corporation (distinguishing pre-incorporation contracts and formation of corporations de jure and de facto). Typical fact pattern: Corporation is not validly formed but there will be officers or directors who enter into contracts with various companies. The issue is whether the contract is enforceable against the corporation? Keep in mind that one of the main reasons to incorporate is to avoid personal liability for obligations that the corporation incurs. However, there are times when the corporation has not been validly formed but the corporation may still be liable – i.e., de facto corporation and corporation by estoppel.


Validly formed corporations will have met the formalities requirement such that the incorporators must file articles of incorporation with the secretary of the state. Typical fact pattern: The corporation has been validly formed and either an officer or director enters into the contract on behalf of the corporation. The issue is under what authority does that office or director have to enter into contracts for the corporation and can the other contracting party hold the corporation liable for the contract? (Tip: Agency cross-over). Here there are three issues you should initially raise (note it is best to raise all three types of authority): 1) express authority, 2) implied authority, and 3) apparent authority.


If warranted, you will then discuss how the corporation is issuing its stock. You will then look to directors/officers duties and liabilities. In the realm of director’s duties, you should discuss the statutory requirements, duties to manage the corporation, duty of care (business judgment rule), duty of loyalty (no self-dealing, usurping corporate opportunities, independent ratification, etc.). Your next inquiry will revolve around shareholders rights and liabilities, starting with shareholder rights: derivative suits, voting rights, dividends, inspection rights, controlling shareholder rights, etc. You should then identify any issues in regards to shareholder liabilities and discuss that shareholders are generally not liable for corporate obligations, with the exception of piercing the corporate veil (alter ego, undercapitalization, fraud, etc.). Typical fact pattern: The corporation is validly formed, but the plaintiff wants to hold individuals liable for the corporate obligations. Keep in mind that one of the main reasons for incorporating is so that an individual can avoid personal liability for corporate obligations, but there are times when those individuals do NOT deserve to use the corporation as a shield. T/f the arguments will be made under alter ego, inadequate capitalization at time of formation, fraud, etc.

You should then look to see if there are any issues with fundamental corporate changes, i.e., sale of assets, mergers (except short-form mergers), amendment of articles, liquidation and dissolution.


Lastly in the real of corporations we have federal securities laws. In this area, if applicable, you should discuss the common law duty and how such duties could be breached. Common law duty (owed existing shareholders and generally required “privity” as compared to transactions carried out on stock exchanges). Four fact patterns to look out for: 1) SH (shareholder) who illegally sells corporate assets for own benefit (remedy: disgorge profit), 2) SH sale to corporate looters. SH will be liable unless he conducted a reasonable investigation, 3) officers selling their office/job/position for private gain, and 4) controlling shareholders breaching their fiduciary duties to minority shareholders, etc.).


We then move on to Federal securities actions, specifically Rule 10(b)(5), which states that it’s illegal for any person to use any means of interstate commerce to employ any scheme to defraud, make an untrue statement of material fact (omission), or engage in any practice that operates as a fraud in connection with the purchase or sale of any security. Private plaintiff must show interstate commerce, fraudulent conduct, reliance, and damages. You will then look for any issues indicating insider trading, tipper/tippee liability and the misappropriation theory. You should then see if the fact pattern warrants any discussion of section 16(b) and the Sarbanes-Oxley act of 2002. In order for section 16(b) to be implicated, it requires a large corporation (traded on national exchange or 500 + shareholders and $10 million in assets), Defendant is either an officer, director, or 10% shareholder, purchase and sale of stock within six month period (highest sales are matches with lowest purchases to maximize recovery), and there are no defenses (e.g., good faith of defendant).


Take a look at our CBB materials on business associations here for more information.


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