Cheeseman Chapter 23

Business Law, 7e (Cheeseman)
Chapter 23 Transferability and Holder in Due Course
61) How does the definition of value for purposes of holder in due course differ from the definition of consideration? Why do you think there is a difference? Should there be a difference?
Answer: An unfulfilled promise qualifies as consideration, but is not considered value given under Article 3 of the UCC. This is because a holder has not actually performed the promise, and thus has lost nothing yet, and therefore does not need the protections that a holder in due course receives.
Diff: 2 Skill: Ethics and Policy

62) Why is fraud in the inducement treated as a personal defense and fraud in the inception treated as a real defense? Is this distinction justifiable?
On what grounds?
Answer: The assumption is that the victim of fraud in the inducement is in the best position to avoid the fraud by knowing the other party, verifying claims, and so forth before entering into the contract. The same might apply to fraud in the inducement, but the law treats fraud in the inducement as a real defense.
Diff: 2 Skill: Ethics and Policy

63) What is the purpose and effect of eliminating the holder in due course provisions for consumer credit transactions? Will doing so raise the cost of borrowing for these consumers?
Answer: The holder in due course rule allowed a merchant to sell defective merchandise to a consumer on credit, then sell the note to a holder in due course who would be entitled to collect from the consumer even though the merchandise was defective. This change might make the promissory notes of a seller's customers less valuable when trying to sell them to other parties.
Diff: 2 Skill: Ethics and Policy

64) Paul Painter agreed to paint Harry Homeowner's house for $5,000. Paul never planned to actually paint the house, but made a habit of entering into contracts, taking partial or complete payment in advance, and never doing the work. Paul got his friend, Beth, to talk to Harry about how competent and honest Paul was, and explain that Harry should not be concerned about the quality of work or paying Paul in advance. Harry wrote Paul a $3,000 check 1 week before the painting was to be started. Paul transferred the check to Allison in exchange for Allison's car, which was worth $2,800. Before Allison had a chance to deposit the check, there were several news stories about Paul and all the fraud he had been committing. Allison then transferred the check to Beth, who then transferred it to Cathy. Beth gave Allison value for the check, and Cathy gave Beth value. Explain the applicability of the shelter principle in this situation.
Answer: Assuming that Allison is a holder in due course (HDC), Allison can pass on the rights of an HDC to persons who would not qualify on their own as an HDC. Beth could not get
Allison's HDC rights because she was a party to Paul's fraud. Cathy could acquire Allison's HDC rights so long as she did not know of the defense to the instrument.
Diff: 3 Topic: Requirements for HDC Status Skill: Factual Application

65) A check is drawn "payable to Tami Thomas, M.D., in trust for Cathy Wilson." Dr. Thomas indorses the check to a computer store in payment for a computer that she personally purchased.
The computer store as indorsee has not adhered to the instructions on the check. Who is the computer store liable to and why?
Answer: The computer store is liable to Cathy Wilson for any losses that arose because of its noncompliance with the restrictive indorsement in trust as indicated on the check. This type of indorsement is sometimes referred to as a trust indorsement or an agency indorsement.
Diff: 3 Topic: Requirements for HDC Status Skill: Factual Application

Chapter 24 Liability, Defenses, and Discharge
71) How does the definition of value for purposes of holder in due course differ from the definition of consideration? Why do you think there is a difference? Should there be a difference? Answer: An unfulfilled promise qualifies as consideration, but is not considered value given under Article 3 of the UCC. This is because a holder has not actually performed the promise, and thus has lost nothing yet, and therefore does not need the protections that a holder in due course receives. Diff: 2 Skill: Ethics and Policy

72) Why is fraud in the inducement treated as a personal defense and fraud in the inception treated as a real defense? Is this distinction justifiable? On what grounds?
Answer: The assumption is that the victim of fraud in the inducement is in the best position to avoid the fraud by knowing the other party, verifying claims, and so forth before entering into the contract. The same might apply to fraud in the inducement, but the law treats fraud in the inducement as a real defense.
Diff: 2 Skill: Ethics and Policy

73) What is the purpose and effect of eliminating the holder in due course provisions for consumer credit transactions? Will doing so raise the cost of borrowing for these consumers?
Answer: The holder in due course rule allowed a merchant to sell defective merchandise to a consumer on credit, then sell the note to a holder in due course who would be entitled to collect from the consumer even though the merchandise was defective. This change might make the promissory notes of a seller's customers less valuable when trying to sell them to other parties.
Diff: 2 Skill: Ethics and Policy

74) Forger drafted a promissory note and forged Fred's signature on it. Before he could do anything with it, Thief stole it and transferred it to Commercial Loan Co., for value. Commercial usually did not buy commercial paper from people who walk in off the street, but business was slow, so the company took the note. Commercial had no notice of the forgery. On the note's due date, Commercial demanded payment from Fred. Obviously, Fred refused to pay. Commercial sues Fred on the note. Assuming the note qualifies as a negotiable instrument in all aspects not mentioned above, discuss the probable outcome of this suit.
Answer: This is forgery and is a real defense, good against everyone, including a holder in due course. Commercial might have trouble qualifying as a holder in due course if the transaction was considered not to be in the ordinary course of business. Commercial loses, whether or not it is an HDC.
Diff: 2 Topic: Defenses Skill: Factual Application

75) Carl is the maker of a note on which David is the payee. David indorses the note in blank and delivers it to Edward, who then transfers it to Fred without indorsement. Fred then presents it to
Carl for payment when it becomes due, but Carl claims he signed the note base upon fraud in the
inducement.
If all of the transfers in question were for value and there are no other defenses available: a. Who has primary liability of the instrument? Who is secondarily liable on the instrument?
b. Who has warranty liability? Why? Explain.
c. From whom can Fred try to collect now that Carl has refused to pay?
Answer: a. Carl has primary liability on the instrument. His defense is personal defense that cannot be used against a holder in due course. Fred would seem to be a holder in due course.
Anyone who indorses an instrument has secondary liability, so David would have secondary liability. b. David has warranty liability as does Edward, even though he did not indorse the instrument.
c. If Fred cannot collect from Carl, he can collect from David based on his secondary liability or from Edward based upon warranty liability. If David or Edward pays, either can recoup their payment from Carl.
Diff: 3 Topic: Defenses Skill: Factual Application

76) Terry has a business in which he visits with client's pet cats in the client's home while the client is out of town. The primary purpose is to prevent the cats from becoming psychotic due to the owner's absence. Terry contracted to visit Valerie's cat daily for a 2-week period
when
Valerie was on vacation. Because Terry charged by the hour, Valerie gave Terry a signed check with the amount blank for Terry to fill in based on $10 per hour. While visiting with Valerie's cat, Terry noticed a check on Valerie's desk that had the amount of $100 filled in, but no payee and no signature. Terry took the check, converted the $100 to $1,000 and signed Valerie's name.
Terry then filled out the check that Valerie had given him in the amount of $10,000, rather than the $200 he had earned at $10 per hour. Terry transferred both checks to a holder in due course, who later seeks payment from Valerie. How much must Valerie pay on each of these checks?
Answer: For the check that Valerie had given to Terry, Valerie must pay the full amount. Her defense of unauthorized completion is a personal defense that is not valid against a holder in due course. Valerie pays nothing on the check taken from her desk, as this is forgery, a real defense, even though Terry changed the amount. Valerie might be found liable for this check if she is determined to have been negligent for leaving the check out.
Diff: 3 Topic: Defenses Skill: Factual Application

Chapter 27 Secured Transactions and Security Interests in Personal Property perfection? Answer: Attachment and perfection are two different concepts. Because attachment addresses only the relationship between the creditor and the debtor, there is no need for others to have notice, thus there is no reason to have a filing requirement. Perfection, on the other hand, addresses priorities among multiple creditors, thus knowledge of preexisting creditors with rights in the collateral is necessary.
Diff: 2 Skill: Ethics and Policy

92) What risks are there for lenders who rely on the debtor's inventory for collateral? Although the rule that a buyer in the ordinary course of business takes the item free of an inventory security interest makes buyers more willing to purchase items from inventory, does it not discourage lenders from financing inventory? What can lenders, who rely on merchants' inventory for collateral, do to protect themselves?
Answer: This is where a lender can partially protect its interest with an after-acquired property clause. In addition, the lender would want to monitor the level of inventory relative to the amount of debt outstanding. Even with an after-acquired property clause, if the debtor is not buying more inventory, or if all newly purchased inventory is subject to purchase money security interests of a different creditor, the original lender may end up with too little collateral relative to the level of debt outstanding.
Diff: 3 Skill: Ethics and Policy

93) What is the purpose of an after-acquired property clause? In what circumstances could it be used abusively by creditors toward debtors?
Answer: It is generally used where the collateral is all property of a given type, such as inventory or equipment, of the debtor. It has been used abusively with respect to consumer goods where a debtor has fully paid the debt on all items but one, but the after-acquired property clause would allow repossession of all items.
Diff: 2 Skill: Ethics and Policy

94) What can a lender do to make sure it remains adequately protected when it has a floating lien? What types of collateral are appropriate for a floating lien?
Answer: The lender would need to monitor the levels of the collateral. Floating liens are most appropriate for pools of collateral that change over time, primarily inventory and farm products, and to a lesser degree, equipment.
Diff: 1 Skill: Ethics and Policy

95) Betty owns a home electronics store. Betty borrowed $100,000 a couple of years ago from
Thirdbank, and Betty granted a security interest to Thirdbank on "present and after-acquired inventory." Betty is a generous store owner. Each employee is able to select electronics and place them in his or her office. Most employees have put elaborate stereo systems in their offices, and some have even installed home theater systems. One manager often brings his family in late in the evening to watch rented movies. The understanding was that these systems would be sold as demonstrator units after a few months, but that has happened only once. Most of the systems have been in the offices since shortly after the store opened 2 years ago. Betty has also supplied several of her relatives with stereo systems at no charge, also with the understanding that she can take them back and sell them at any time, although she has not taken any of these back. Betty defaults on the debt to Thirdbank. Will Thirdbank be able to recover the electronic components in employee offices and homes, as well as in Betty's relatives' homes?
Answer: This is a floating lien and would cover all the present inventory of the home electronics store. It is a fact question whether these items are still part of inventory, with arguments on either side. Some of the electronics may have become equipment or consumer goods.
Diff: 3 Topic: Perfecting a Security Interest Skill: Factual Application
96) Kraco is a retailer of televisions and related products. Kraco buys its inventory from DEF, the manufacturer, on credit, giving DEF a security interest in this inventory. Beth buys a television from Kraco, paying cash. Beth also knows of DEF's security interest in this television.
Sometime later, Kraco defaults on its debt to DEF, and DEF wants to foreclose on its collateral, including the television purchased by Beth. Does DEF have a security interest in Beth's television? Discuss your reasoning.
Answer: Beth took the television free of the security interest of DEF even though she knew of the security interest, assuming that she bought the television in the ordinary course of business.
Diff: 2 Topic: Priority of Claims Skill: Factual Application

97) Harco is a retailer of appliances. Harco buys its inventory from RST, Inc., the manufacturer.
To finance its inventory, Harco buys appliances from RST on credit, signing a promissory note and giving RST a security interest in the inventory. RST perfects this security interest. Harco also needed cash for working capital, so Harco borrowed money form First Bank, giving First
Bank a security interest in Harco's inventory. First Bank perfected this security interest before
RST perfected its security interest. Harco cannot pay is debts, so both RST and First Bank attempt to foreclose on this inventory. Discuss who has priority and why?
Answer: Normally, the first to perfect has priority, but the holder of a purchase money security interest can obtain priority over a previously perfected security interest in inventory. This requires that the purchase money security interest holder notify the earlier perfected party (First
Bank here) prior to the debtor taking possession, which did not happen. Thus, First Bank has priority. Diff: 3 Topic: Priority of Claims Skill: Factual Application

98) Steve is known for buying everything on credit. He typically has a dozen regular monthly payments on installment debt. He might have couch payments, mattress payments, stereo payments, and coffeemaker payments all at the same time. He sells his dining room table and chairs to Bob, a friend of his. A couple of months later, the furniture company from whom Steve bought the table shows up at Bob's house to repossess the table because Steve has stopped making payments on the debt he incurred in purchasing the table. The furniture store claims it is entitled to the table because it was automatically perfected in the purchase money security interest, which Steve granted in purchasing the table. How would this case turn out?
Answer: Bob takes the table free of the purchase money security interest of the furniture store if he did not have actual or constructive notice of the security interest. Assuming that the furniture store did not file the security interest, it is arguable whether Bob had notice, given Steve's reputation. Diff: 2 Topic: Priority of Claims Skill: Factual Application
99) Sooner Enterprises needs a large new piece of equipment. Sooner has approximately
$100,000 in cash to put toward the $400,000 purchase price. Sooner goes to Adams National
Bank and borrows $250,000 for part of the purchase price. Sooner buys the equipment, using the cash from Adams, the $100,000 in cash on hand, and by drawing $50,000 on a preexisting unsecured line of credit. Sooner and Adams National Bank executed a security agreement on
March 1, but nothing was ever filed in connection with this security agreement. Adams extended credit and Sooner acquired the equipment on March 2. Two months later, on May 1, Sooner went to Baker National Bank and signed an agreement to borrow $50,000 which would be used to pay back the line of credit used to purchase the equipment. Baker extended the credit to Sooner on
May 3, and filed a valid financing statement on May 15. On May 10, Sooner went to Colter
National Bank and borrowed $75,000 using the equipment as collateral. On the same day, Colter properly filed a copy of the security agreement with Sooner. In June, Sooner defaulted on all of its debts. Discuss the priority of all its creditors with respect to this equipment.
Answer: Perfected secured parties take priority according to their date of perfection. By being the first to file, Colter has first priority, followed by Baker. Note that either the security agreement or a financing statement can be filed. Even though the security agreement of Adams has attached, it was never perfected. Because this purchase money security interest was in equipment, Adams had 10 days to file after Sooner took possession of the property in order to have first priority. Last in line would be the holder of the unsecured line of credit.
Diff: 3 Topic: Priority of Claims Skill: Factual Application

100) Northern Drilling is an oil-drilling company that has defaulted on several of its loans.
Petrogiant Oil Refining is owed $230,000 on a loan that is secured by some of Northern
Drilling's equipment. This equipment is worth around $180,000. Petrogiant has repossessed the equipment pursuant to its security agreement and has notified Northern that it proposes to keep the equipment rather than sell it. Northern does not want Petrogiant to keep the equipment and wants it to be sold. Discuss the legal issues in this situation.
Answer: Northern can give written objection within 21 days after the notice was sent, and then the creditor would be required to sell the collateral. Northern would be foolish to demand that the collateral be sold in these circumstances. If the collateral is sold, Northern could be held liable for a deficiency judgment. If the creditor retains the collateral, it is retained in satisfaction of all claims against the debtor. Because the collateral is worth substantially less than the amount of the debt, Northern should allow Petrogiant to retain the collateral.
Diff: 2 Topic: Secured Creditor's Remedies Skill: Factual Application

Chapter 29 Agency and Employment

81) Why can apparent agency be created only by representations of the principal, but not the supposed agent?
Answer: When a party represents that someone is her agent, the party making the representations is creating potential liability for herself, and the law will hold her liable. When someone makes representations that she is someone's agent, the person making the representations is creating liability for another. Assuming that the purported principal had no role in the representations, it would not be fair to impose liability on the purported principal because there would be no way for the purported principal to know about or control the representations of others claiming to be her agent.
Diff: 3 Skill: Ethics and Policy

82) Why is either party allowed to terminate a fixed-term agency arrangement prior to the end of the term?
Answer: Because contracts are considered consensual in nature, a principal should be bound by an agent's contract only if they both want the agent to be acting as such for the principal. The ability to collect damages in a wrongful termination protects the nonbreaching party.
Diff: 2 Skill: Ethics and Policy

83) Why is capacity required for the principal, but not for the agent?
Answer: The rule allowing a minor to disaffirm a contract is for the protection of a minor. If a minor could be a principal, the minor could do indirectly what the minor could not do directly.
An adult agent could take advantage of the minor principal. On the other hand, when a minor acts as an agent, any contracts that the minor enters into are binding on the adult principal, not the minor agent. Thus, a minor does not need protection here. If the adult has foolishly hired a minor to be his agent, it is the adult who must live with the consequences of that decision.
Furthermore, it might be wise for an adult to hire a minor who might be an expert on the subject matter of the transaction.
Diff: 3 Skill: Ethics and Policy

84) Mary has been hired to write courses for a Web-based training organization. Mary works at the offices of the organization. Mary is given content guidelines and a contract for each course that she writes, and is paid a flat fee upon completion of the course. It can take anywhere from 2 weeks to 6 weeks to complete a course. The organization wants the contractors to work in their offices during the regular 40-hour work week, unless they need to be elsewhere to do research.
The organization provides a computer to Mary. Mary also is able to use other employees at the organization for word processing and editing. Is Mary an employee or an independent contractor? Answer: Mary is probably an independent contractor because of being paid on an irregular basis upon the completion of each course. It is not quite clear how much control is exercised over how she does her work, but it appears that she has considerable freedom so long as she stays within the course guidelines. The requirement to be present during the work week and the availability of the computer and other employees would weigh in favor of Mary being an employee, but this would probably not overcome the other factors.
Diff: 2 Topic: Kinds of Employment Relationships Skill: Factual Application

85) Jan wants to buy a house, but her friend Ann is a much tougher negotiator. They devise a plan where Ann will tell the seller of the house that she is Jan's agent and will make all the decisions with respect to any purchase of the house. They also agree that Ann actually will have no such authority and that Jan is the only one who will make any decisions relative to purchasing the house. They meet with the seller, and Ann says that she is Jan's agent while Jan says nothing.
Has an agency been created?
Answer: Although an agent cannot create an apparent agency, Jan's silence would be treated as a representation that Ann's statements were true, thereby creating apparent authority.
Diff: 2 Topic: Formation of the Agency Relationship Skill: Factual Application

86) Ann has contracted to be Paul's agent for the sale of Paul's home. The contract provides that the duration of this agency is 120 days. Within the first week, Ann has found a potential buyer and is involved in negotiations. The following week, Paul notifies Ann that he is terminating the arrangement, but Ann proceeds to negotiate a sale with the potential buyer. Discuss this situation. Answer: Paul had the power to terminate the agency, thus Ann no longer had any authority and the sale contract is not valid. Because Paul did not have the right to terminate the agency, Ann could recover damages, most likely the amount of her lost commission. The buyer could recover any damages from Ann caused by her falsely indicating that she had authority.
Diff: 2 Topic: Termination of an Agency Skill: Factual Application
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87) Agnes is an agent for Pepe for maintaining Pepe's antique car collection, including the sale and purchase of antique cars. Agnes has had this position for several years, but recently Agnes has developed a cocaine habit. She recently sold one of Pepe's cars and kept some of the money herself to buy some cocaine. Soon thereafter, Agnes was declared bankrupt. The state then notified Agnes that she had sold the maximum allowable number of cars in a year without getting a dealer's license. Shortly thereafter, Pepe was on a secluded island and died, which no one knew about until 2 weeks later. Discuss the effect of these events on the existence of the agency. Answer: Although the actions of Agnes in using the proceeds of the one sale to buy cocaine was illegal, the purpose of the agency remained legal. The bankruptcy of Agnes would not end the agency. Once the sale of cars required a license, there would be no authority for such sales until the license was obtained. The agency ended at the moment of Pepe's death.
Diff: 2 Topic: Termination of an Agency Skill: Factual Application

Chapter 30 Liability of Principals and Agents
75) Generally, if an agent negligently injures a third party within the scope of the agency, the principal can be held liable even if the agent was violating the instructions of the principal. Is this fair to the principal? What is the justification for this rule?
Answer: If the principal could avoid liability simply by having a rule against certain conduct, there would be no incentive for the principal to see that the rule is followed. This also gives an incentive to hire persons who will follow such rules.
Diff: 3 Skill: Ethics and Policy

76) Why does the law in some states hold principals liable for the intentional torts of employees under the work-related rule for torts motivated by personal concerns? Aren't these matters that an employer does not have control over? Which do you think is the better rule for employer liability for intentional torts of employees? Why?
Answer: This rule provides various incentives that reduce the risk of these injuries. Employers have an incentive to try to screen out violent persons in the hiring process. The rule also encourages employers to train employees to minimize the risk of these acts, and to assign employees likely to engage in such an act to areas where they do not interact with the public.
Diff: 2 Skill: Ethics and Policy

77) With the increasing incidence of workplace violence, what should the rule be for employer liability for violent acts of their employees? Should it be any different than for intentional torts generally? Why might you want a different rule in these cases?
Answer: In some of these situations, the violent act is one that could not have been foreseen by anyone, including the employer, even with the most thorough screening process. The work history of the individual often provides no warning to the employer.
Diff: 2 Skill: Ethics and Policy

78) Why would an agent not disclose the existence and identity of the principal when negotiating a contract, given that doing so would avoid agent liability on the contract? What should an agent do when the principal does not want to be disclosed?
Answer: There are many business situations where it is in the principal's interest for his or her identity to remain unknown. An agent should be aware of the liability risk and factor that into the amount of compensation charged. Alternatively, the agent might be able to put a liability release clause into any contracts with third parties, although this would not be possible in an undisclosed principal situation.
Diff: 2 Skill: Ethics and Policy

79) Does the frolic and detour rule make sense? Is it too subject to manipulation and subjective interpretation? Is there a more workable rule that you can think of?
Answer: A more precise rule would be difficult to formulate because of the variety of situations where an employee negligently injures a third party.
Diff: 1 Skill: Ethics and Policy

80) Anne was hired by Peter to sell a condominium in San Francisco. The asking price for the modest two-bedroom unit was $2,300,000. Peter told Anne he would go as low as $2,100,000, but no lower, but that she should try to get as high a price as possible. If he couldn't get that much for it, he said he would use it as rental property. A good friend of Anne's was in the market for a two-bedroom condominium in San Francisco. In fact, this friend had come to Anne to help her find a place and negotiate for it. Anne's friend said that she could absolutely not spend more than $2,000,000. When Peter hired Anne to sell his condominium, Anne told her friend about it and the asking price. Anne told her friend, "Don't even bother. He won't go below $2,100,000, that is his bottom price." Anne's friend accepted that. Anne then proposed to her friend that they go in together, with Anne fronting some money through her friend, but not having Anne's name on the contract as purchaser. Before they could work out the details, Anne's friend received a raise and decided to buy the condominium. Anne negotiated a price of $2,100,000 on Peter's behalf. Peter later found out that Anne had told her friend about his bottom price, and about the plan for Anne to help buy the house. What claims, if any, does Peter have?
Answer: Anne at least started to violate the duty of loyalty by self-dealing. Her disclosure of the bottom dollar price was also a violation, even though it appeared that the friend could not have bought the property. This is because the friend could have passed the information further, and circumstances can change, as they did here, and because the actual contract was negotiated with the buyer having knowledge. Anne improperly acted as a dual agent.
Diff: 3 Topic: Agent's Duties Skill: Factual Application

81) Abe is an associate (employee) with that famous Denver law firm, Dewey, Cheatem, & How.
One Thursday Abe and another associate, Gabe, had to go to western Colorado for a client's deposition. The deposition is unexpectedly over in midmorning and they start driving back to
Denver. As they approach Vail, Gabe reminds Abe that the partners are in Aspen for 2 days and how it would be nice to be a partner. Abe says, "If they're in Aspen, that means they're not in the office in Denver. I hear the slopes calling for a half-day of skiing." They pull off I-70 and are skiing by 1 p.m. By chance, Abe runs into a client from Denver and they ski together and discuss the client's latest legal matters. As Abe is skiing with this client, Abe and the client both ski through a beginner ski lesson group as the beginner students practice their snowplow technique.
Abe and the client each injure one skier. Five claims are filed:
1. Abe's victim sues Abe.
2. Abe's victim sues the law firm.
3. The client's victim sues the client.
4. The client's victim sues Abe.
5. The client's victim sues the law firm.
Discuss the outcome of each claim, assuming Abe was solely negligent with respect to his victim and the client was solely negligent with respect to his victim.
Answer: 1. Abe is liable for his own negligence to his victim.
2. The law firm's negligence depends on if Abe was on a frolic and detour.
3. The client is liable for his own negligence.
4. Abe is an agent for his client, and is an independent contractor. Generally speaking, an agent is not liable for the torts of his principal.
5. The law firm is not liable here because Abe is not liable.
Diff: 3 Topic: Contract Liability to Third Parties Skill: Factual Application

82) Philip wanted to buy a new car. Philip did not know much about cars, but his 17-year-old daughter Andrea did because she had recently started driving and had drooled over new cars since she was 12 in anticipation of the day she would start driving. Andrea said she would go out and make the purchase on Philip's behalf if he would let her have the new car once a week. Philip agreed because he figured she'd probably manage to talk him out of any car at least once a week.
Philip told Andrea, "I don't want anything fancy. Something like a Ford Pinto should be sufficient." "Oh, Dad!" Andrea said, "They quit making Pintos in 1980. You know you don't want anything that small anyway. You even complained about the Taurus being too small."
Philip responded, "That's right, I guess. But, I don't need anything with all that power equipment and fancy stereos. Just get me a good, basic, comfortable car that isn't too small."
"I can do that," responded Andrea. "I'll find you the best car for your wants and needs."
"It's a deal," said Philip.
Andrea shopped around and ended up at a Pontiac dealer. Throughout the entire experience, she kept thinking that her dad needed a more sporty image. She was tempted to get him a Trans Am but thought this might be too much. Because she knew he wouldn't be comfortable in a small car, she decided on a full-size Bonneville sedan. After explaining to the salesperson that this car would be for her father, the salesperson talked Andrea into the sport model, which had a more powerful engine, special wheels, and suspension.
Philip was initially upset with this choice, but after Andrea correctly explained that the sport model was only about $1,500 extra, and that all Bonnevilles came with power windows and such, Philip cooled off and started driving the car. Six weeks later he returned the car to the dealer, explaining that his daughter was supposed to buy a basic model and the sport suspension on this car rode too roughly.
1. Can the dealer hold Philip to the contract? Give all reasons why or why not.
2. Can the dealer hold Andrea to the contract? Give all reasons why or why not.
Answer: 1. If there was authority for the transaction, Philip can be held to the contract.
Andrea, as a minor, can act as an agent. There was probably not authority for the transaction, but by driving the car for several weeks, Philip probably ratified the contract.
2. Although Andrea disclosed the identity of the principal, which normally would protect her from liability on the contract, she exceeded her authority and she could be held liable.
Diff: 3 Topic: Contract Liability to Third Parties Skill: Factual Application

83) Billy owns a bike shop in a coastal California town. His shop sells and repairs bikes. One of his employees was repairing a bike with one of those pesky intermittent problems that would never occur when the repair technician was around. The customer said that the gears periodically would not shift properly. The employee took the bike out for a test ride hoping to replicate the problem. The problem did not appear. Because it was approaching noon, the employee decided to ride the bike home to have lunch. On the way back to the shop, the employee hit a small child and injured her. Discuss the liability of the employee and Billy's bike shop for the injuries to the child. Answer: The employee is liable for his tort, as are all tortfeasors. The liability of the bike shop would be determined using the scope of employment test, considering all the facts and circumstances. On one hand, the employee was testing the bike, which would be in the scope of employment. On the other hand, the employee was returning from lunch (home) which would not be within the scope of employment.
Diff: 2 Topic: Negligence Torts Skill: Factual Application

84) Pat is the owner of Tarantula Skiwear of Boulder, Colorado. Tarantula is a new company that makes top-of-the-line products. Angela is the salesperson whose territory is the state of Utah. In an ordinary week, Angela, a Boulder resident, goes to the company office on Monday morning, takes care of paperwork, and in the late morning takes off for Utah. She stays in Utah until sometime on Friday, the exact time changing from week to week. Sometimes, she will stay in
Utah for the weekend to ski and save the drive to Boulder and back. More often, she will drive partway back to Boulder on Friday evening, stopping to ski at one of the larger Colorado resorts, and return to Boulder on Saturday or Sunday. In order to make a sale, Angela must often negotiate a discount from the standard wholesale prices.
Tarantula wants to maintain the exclusivity of its line in Vail, thus the company has a policy of selling at full wholesale list price in Vail and not negotiating. The salesperson, who covers Vail, follows the policy rigidly and, as a result, Tarantula Skiwear is available in only two Vail stores.
Angela thinks she could make a large sale by only cutting the list price slightly. One Thursday she drives from Salt Lake City to Vail. Friday morning she called on a large retail outlet in Vail.
The owner said he would love to have the Tarantula line, but just couldn't pay the full wholesale price. Angela takes the owner skiing, with both, of course, wearing Tarantula wear. Angela is demonstrating how good Tarantula Skiwear looks at high speed when she skis into someone just beginning to snowboard. The snowboarder sues Angela and Tarantula Skiwear. Assuming that
Angela was, in fact, negligent, can the plaintiff recover from Tarantula? Discuss the likely issues to arise and their likely resolution.
Answer: The issue is whether Angela was within the scope of employment when the injury occurred. On one hand, she was trying to sell the company's product, but this was not her territory. A court might find either the coming and going rule to apply, or folic and detour.
Diff: 3 Topic: Negligence Torts Skill: Factual Application

85) Jerry was employed as a blackjack dealer in a Las Vegas casino. One evening as he dealt, a patron became more and more abusive, insulting Jerry, using profanity, and finally making personal insults about Jerry's appearance. Jerry became very angry and hit the patron. The patron sued both Jerry and the casino. Discuss the liability of Jerry and the casino, assuming that Jerry's actions were not justified.
Answer: Jerry, like everyone, is liable for his own torts. The liability of the casino for this intentional tort of Jerry's depends on which test is applied by the state. The casino would not be liable under the motivation test, but would be liable under the work-related test. The casino might also be liable if its own negligence (such as improper supervision, or seeing Jerry get abusive, but failing to act) was a cause of the injuries.
Diff: 3 Topic: Intentional Torts Skill: Factual Application
86) Tim played first base for a minor league baseball team, the Salamanders. During a home game, a fan for the visiting team was seated near first base and heckling Tim. The fan said that
Tim's mother wore army boots, and that Tim played like he was in Little League. Finally, Tim had had enough, and threw his right shoe at the fan, injuring him. An hour after the game in a nearby bar, a drunk fan was threatening the Salamanders' right fielder, also their star hitter.
Although this person was too drunk to have inflicted injury, Tim punched him a couple of times in order to protect his friend and star. Discuss the liability of the Salamanders for these injuries.
Answer: The Salamanders would be liable for the injury during the game under the work-related test. If Tim threw the shoe because the heckling was interfering with his playing baseball, the
Salamanders would also be liable under the motivation test. The Salamanders would not be liable under the work-related test for the injury in the bar, but might be under the motivation test. The court might find, though, that the injury was too far-removed from work for liability.
Diff: 2 Topic: Intentional Torts Skill: Factual Application

Chapter 34 Entrepreneurship, Sole Proprietorships, and General Partnerships
63) How might an entrepreneur take steps to minimize the unlimited liability of a sole proprietorship? Answer: Before limited liability companies were authorized, many proprietors did not want the expense and complexity of forming and operating a corporation. With limited liability companies, there is less reason to not form an entity with limited liability. For those operating as a proprietorship, liability insurance is one way that the liability risk can be sharply reduced.
Insurance will protect against many, though not all, losses that can occur.
Diff: 2 Skill: Ethics and Policy

64) Why do you think that there are so many available types of business entities today? What was the motivation for the passage in the late 1980s and early 1990s of statutes authorizing limited liability companies?
Answer: The large number of entity types is a result of political support for statutes creating them. Where in the past an entrepreneur had only a few entity choices, and those required taking an entire set of characteristics, some desirable and others not, today the wide choice of entities allows an entrepreneur to get the exact mix of characteristics desired. One motivation for the limited liability company statutes was the change in the tax laws in 1986 that made partnership taxation more favorable than corporate taxation in many more circumstances than previously.
Diff: 2 Skill: Ethics and Policy

65) Lorna has recently developed a software program tailored for the upscale coffee shop industry. Lorna has begun marketing her program and has had some success selling to small independent stores. She is now ready to begin marketing to franchisees of the national chains, with the hope that a franchisor might make the software part of its required franchisee package.
Lorna wants to keep the business separate from her personal affairs, so she has set up separate checking accounts, separate phone lines, and has set up a fictitious business name that does not use her name. She has filed a fictitious business name statement in the appropriate state office.
She has written a will in which she has declared that in the event of her death, her business and personal assets and liabilities are to be kept separate, just as they were during her life. Her personal checks say, "Lorna Lones, personal account only." Discuss the extent to which Lorna has insulated her personal assets from any business losses.
Answer: Lorna, as the sole owner of a business that has not filed as any other type of entity, is operating as a sole proprietorship. As a sole proprietorship, none of the steps that Lorna has taken will alter the general situation that her personal and business assets are considered to be a single pool of assets. Lorna could easily form a limited liability company in many states, or incorporate. Absent that, on individual contracts she might be able to get the other party to agree to not hold her personally liable, but her merely requesting this might cause some parties to not do business with her. She would be unable to take similar steps with respect to tort liability.
Diff: 2 Topic: Sole Proprietorship Skill: Factual Application

66) Maria has started a computer accessory manufacturing and sales business that she really became involved in accidentally. She never planned to have a business, but had made a certain accessory that her friends thought was interesting, and she made some for them. Suddenly people were paying her, and then she started selling through a Web site. She has never formed any type of business entity. Now that Maria wants to sell these accessories in Japan, she thinks she might need to look into the choice of entity. Discuss Maria's options for her business in the United
States, and how she might operate in Japan.
Answer: Maria could form a corporation, or, in those states allowing it, a limited liability company with a single owner. Both would give her limited liability. With the corporation, she could elect S status if she wanted to be taxed as a partnership. With the LLC, she could choose corporate or partnership taxation. For her Japan expansion plans, it would be easiest to hire a sales agent or representative. A subsidiary would protect her U.S. assets for losses of the Japan operations. Diff: 2 Topic: Sole Proprietorship

Chapter 35 Limited Partnerships

64) What are the advantages and disadvantages of the recently increased ability to limit one's liability when operating a business? Do the advantages outweigh the disadvantages? Should certain kinds of businesses not be permitted to operate with limited liability?
Answer: With several new forms of business organization becoming available in recent years, business owners can more easily find a form of organization that contains all of the characteristics that best meet their needs. As long as there is proper notice of an entity's limited liability, most businesses should have that option. Some businesses, notably some of the professions, cannot operate with limited liability. In these cases, most owners protect themselves with liability insurance, although such insurance does not cover losses caused simply by poor business conditions.
Diff: 2 Skill: Ethics and Policy

65) Is it ethical for someone who is forming a risky business to use a form of business that limits that person's personal liability, when the person doing so knows that this will increase the chances that the creditors of a business will not fully collect amounts due to them? Explain your reasoning. Answer: There are risks in all business transactions, and as long as all concerned parties are aware of who can and who cannot be held liable in a situation, then this should probably be left to the marketplace in most instances.
Diff: 2 Skill: Ethics and Policy

66) Why should the amounts contributed by both general and limited partners be required to be included in the certificate of limited partnership? Isn't this too much detail?
Answer: One of the risks in a limited partnership is that the general partners will invest very little compared to the limited partners. Worse is when the general partners make oral promises or statements (which cannot later be documented) about the amount they have invested or will invest. This requirement reduces these abuses by making contribution amounts public.
Diff: 2 Skill: Ethics and Policy

67) Lisa entered into a limited partnership as a limited partner by investing $25,000 in cash.
There was a total of 50 limited partners and 20 general partners. The partners elected a management committee that included two of the general partners and Lisa as one of the limited partners. The certificate of limited partnership was completed, but was filed with the wrong office. The partnership then commenced business. Some of the parties with whom it conducted business assumed that the partnership was a general partnership because they searched the records of the secretary of state and found no certificate of limited partnership or any other record. Others assumed that it was a general partnership but had not actually searched the filings.
Still others assumed that it was a limited partnership. In addition, among those who assumed that it was a limited partnership, some assumed that Lisa was a general partner and others did not.
Discuss Lisa's situation with respect to personal liability for partnership debts.
Answer: Lisa would have personal liability to those who, due to the defective formation of the limited partnership, believed in good faith that this was a general partnership at the time that party entered into the transaction with the partnership. The third parties would not need to have searched the filings to meet the good faith requirement. In addition, those parties believing that this was a limited partnership could recover from Lisa on the basis of a reasonable belief, based on her conduct, that she was a general partner.
Diff: 3 Topic: Formation of Limited Partnerships Skill: Factual Application

68) Hank is a limited partner in a limited partnership. Hank has considerable expertise in the partnership's business, thus Hank has been hired as a consultant for the limited partnership. Hank noticed several problems with the management of the business. Hank then made several recommendations, including removing one of the general partners, expanding into an additional line of business, and borrowing substantial money to finance the expansion. At a partnership meeting to discuss Hank's recommendations, Hank voted in favor of removing the partner, expanding the business, and borrowing the money to do so. In order to get the loan on more favorable terms, Hank executed a personal guarantee on the indebtedness. The partnership expanded but could not generate sales to support the expansion. Upon dissolution, the partnership's debts exceed its assets. Numerous creditors claim that Hank should be considered a general partner. Discuss Hank's liability.
Answer: Hank's activities were all within the allowable activities for a limited partner to undertake without being considered a general partner. Hank will have no personal liability except for the personal guarantee.
Diff: 3 Topic: Operation of General and Limited Partners Skill: Factual Application

69) The Good Times limited partnership has already seen all of its good times pass by. Its partnership agreement set the order of distribution as first to general partners, second to creditors, last to limited partners. Assuming there were no further details in the agreement, explain in detail the priority of distribution.
Answer: Normally creditors are paid first. Although partners can provide for a different distribution than that called for in the RULPA, they cannot change the creditor's first priority.
Most likely, the amount each partner is due would be calculated based on the partners' capital contributions. Then, amounts due to general partners would be paid before amounts due to limited partners.
Diff: 3 Topic: Dissolution and Winding Up Skill: Factual Application

Chapter 36 Domestic and Multinational Corporations
100) What is the purpose of having preferred stock in addition to common stock? How is preferred stock similar to and different from common stock and debt?
Answer: In some cases preferred stock is a better source of financing for a corporation than either common stock or debt. Common stock receives a fixed payment like debt, but it is not a legal obligation, making it more like the dividend on common stock.
Diff: 2 Skill: Ethics and Policy

101) What additional factors should one consider in deciding whether to incorporate a business when the business will operate internationally?
Answer: Most businesses operated internationally should have limited liability for the owners.
One factor to consider is whether the other nation(s) will recognize the limited liability of the entity chosen.
Diff: 2 Skill: Ethics and Policy

102) One of the characteristics of corporations, especially large corporations, is a separation of ownership and control. Why is there this separation of ownership and control? What are its advantages and disadvantages? What risks does it pose and to whom?
Answer: With so many owners possible in corporations, it is simply impossible to have all shareholders hold the power to manage the corporation. This allows the corporation to be more efficiently managed, but the management might become isolated and nonresponsive to the shareholders. Diff: 2 Skill: Ethics and Policy

103) Betty is considering forming a business in Colorado. She is thinking about a business that would rent in-line skates to customers and transport them to the top of Mount Evans, west of
Denver. The road up Mount Evans is the highest paved road in the United States and reaches just over 14,000 feet above sea level. Customers could skate from the top at 14,000 feet to a point in a nearby town at about 8,000 feet above sea level. The customers would skate about 35 miles, nearly all of which is downhill. Betty is considering whether or not she should form a corporation to operate this business. What are the advantages and disadvantages of forming a corporation? Is there any way she could avoid or compensate for any of the disadvantages?
Answer: Limited liability is Betty's biggest advantage, especially considering the risks of this business. The primary disadvantages may be double taxation and the costs incurred in forming a corporation. The centralization of management and free transferability of shares may not be that crucial if Betty is planning to put up all the money herself. She could get around the tax problem, if it is a problem for her, by electing S corporation status. If she did not want to incorporate, she could protect herself from liability by obtaining insurance, something she would likely do even if incorporated. In many states, she could form a limited liability company.
Diff: 3 Topic: Nature of the Corporation Skill: Factual Application

104) Jane wishes to create a corporation to operate an art gallery. She completes the articles of incorporation and mails them to the appropriate state office. Then, she leases space, hires a receptionist, buys supplies, and contracts with artists to exhibit their artwork, all on behalf of her corporation. Sometime later, the state issues its certificate of incorporation.
A. Discuss the liability of Jane and the corporation with regard to these contracts Jane has made.
B. Discuss novation based upon the above fact situation.
Answer: A corporation is liable on contracts of a promoter only if it adopts the contracts. Under the Revised Model Business Corporation Act, the corporation's existence began when the secretary of state approved and filed the articles of incorporation, presumably at that time it issued the certificate of incorporation. Any contracts entered into by Jane, as a promoter, will be binding on Jane unless she, the corporation, and the third party enter into a novation, by which the corporation assumes liability and Jane is released.
Diff: 2 Topic: Promoters' Activities Skill: Factual Application

105) Henry wants to form a business that rents chain saws and tree climbing equipment to persons who desire to do major tree-removal work themselves rather than hire others to do the job. Henry had not planned to incorporate this business because he had always heard that forming a corporation was difficult and expensive. A friend suggests that he might want to incorporate in order to have limited liability. Briefly describe the steps for Henry to incorporate.
Answer: Henry might need to find other shareholders and might need to enter into contracts as a promoter. Henry would need to file articles of incorporation including the name of the corporation, the number of shares it is authorized to issue, the corporation's initial registered office and registered agent, and the names of all incorporators. Henry would then need to hold an organizational meeting and at that meeting elect officers and adopt bylaws.
Diff: 2 Topic: Incorporation Procedures Skill: Factual Application

106) Donna formed a corporation several years ago by issuing 500 shares of stock. There are 10 shareholders, with the smallest shareholder owning 25 shares, and Donna holding the most at
100 shares. The corporation needs additional cash, but the current shareholders do not wish to have any additional shareholders. What are their options and what additional factors should the current shareholders consider in raising the additional cash?
Answer: They could issue additional common stock to themselves, preferred stock, or borrow the money. Other factors include whether the existing shareholders could afford more common stock, how long the corporation needs the money, and how each option would affect income.
Diff: 2 Topic: Financing the Corporation with Equity Securities Skill: Factual Application

107) Acorn Corporation was formed 2 years ago at which time it issued 1,000 shares of stock in various quantities to 130 different shareholders. Three shareholders each hold 200 shares; the remaining 127 shareholders hold the other 400 shares of stock. The stated purpose of Acorn
Corporation is to "purchase new computers for resale to consumers and to conduct all business incident to the purchase and resale of new computers." Justin, Jessica, and Jeremy, the three shareholders of 200 shares each, were the promoters of the corporation and were intended to be the initial board of directors. The articles of corporation were properly filed, and a certificate of incorporation was received a short time later. Justin was named as the registered agent in the articles of incorporation. Justin, Jessica, and Jeremy assumed the duties of running the corporation, but never held an organizational meeting. They have run the corporation for 3 years, and none of the other shareholders has objected to the fact that the organizational meeting was not held. The business had been quite successful until the last year. In the last year, Justin,
Jessica, and Jeremy have made some changes in the business. They have begun accepting used computers as trade-ins, and have begun offering computer-training classes. In addition, they have been offering word-processing services and have also begun buying and selling used office equipment other than computers. All of these additional operations have been unprofitable thus far. A group of the other shareholders has sued in an effort to stop the carrying on of these other businesses. Do they have a basis for such a suit, and if so, what remedies would they have?
Answer: These other business activities are ultra vires acts because they exceed the powers of the corporation as stated in the articles. As shareholders, they can sue for an injunction to stop the ultra vires acts and for the damages caused by them. They also could request the attorney general in the state of incorporation to enjoin these other operations or to dissolve the corporation. Diff: 3 Topic: Corporate Powers Skill: Factual Application

Chapter 37 Corporate Directors, Officers, and Shareholders
99) Shareholders agreements are entered into by the shareholders of many closely held corporations. What are the purposes of such agreements? What are the risks for shareholders of entering into such agreements? Under what circumstances should a court refuse to enforce such agreements? Answer: The primary purpose of these agreements is to give shareholders control over who else can become a shareholder of the corporation, much like partners have. The restrictions can affect the market value of the stock, although a well-drafted agreement can reduce that problem. Courts generally enforce these agreements so long as they are not unconscionable.
Diff: 2 Skill: Ethics and Policy

100) The management of corporations frequently solicit proxies for a management-supported board of directors. What is the risk to shareholders of blindly granting these proxies?
Answer: The officers and directors of a corporation are supposed to answer to the shareholders.
If the shareholders do not take a sufficiently active role in selecting the directors, management might propose board members who have the best interests of the officers, not the best interests of the corporation, primary in their actions.
Diff: 2
Skill: Ethics and Policy
101) How broad should the business judgment rule be in protecting officers and directors from liability for their actions? What is the purpose of the rule? What are the difficulties in its application? Answer: The rule protects the officers and directors from lawsuits for errors in business judgment. The rule does not mean that officers and directors have no responsibility for their actions. They can be fired or removed from their position. One of the difficulties in applying the rule is distinguishing between negligence and honest judgment errors.
Diff: 2 Skill: Ethics and Policy

102) Several recent college graduates perfect a new beer that uses large amounts of garlic in the brewing process. They form a corporation called Garlicbrew, Inc. to produce and market this beer. Nance buys 100 shares of the 10,000 shares in Garlicbrew's initial public offering. Nance wants access to corporate records in order to learn more about the company so she can be a more informed shareholder. She also wants to learn about Garlicbrew because she is considering starting a company to develop and market a beer that uses onions in the brewing process. The corporate officers refuse to let Nance have access to any records of the corporation. Can Nance force the officers to allow her access?
Answer: Nance has an absolute right to inspect shareholders lists, the articles, bylaws, and minutes of shareholders' meeting within the last 3 years. Beyond that, she would need to demonstrate a proper purpose, something she would have difficulty doing here.
Diff: 2 Topic: Shareholders Skill: Factual Application

103) Stableblades, Inc. holds a patent on an inline skate that differs from others on the market in that it has two rows of wheels. These skates are not quite as fast as regular inline skates, but are much more stable and are designed for older persons and persons who skate only occasionally.
Mary is a shareholder of Stableblades. Stableblades has been selling this product for several years, and there are no similar products on the market. Twice in the past couple of years,
Stableblades threatened litigation over patent infringement, successfully preventing competitors from introducing similar products. Recently, another competitor actually introduced a similar product that Mary believes infringes on Stableblades' patent. Mary has tried to get the board to take action, but they refuse to do so. Mary suspects that some of the board members would like to be elected to the board of the competitor some day, and this is the reason for their inaction.
Explain Mary's options in this situation.
Answer: Mary could file a derivative suit on behalf of the corporation, or she could file a suit against the directors for breach of the duty of loyalty if she can show that they are not filing the suit in order to gain personally. She could also get support of other shareholders and replace the board members. The board possibly could be protected by the business judgment rule.
Diff: 3 Topic: Shareholders Skill: Factual Application

104) Roger is a director of the RST Corporation, which is engaged in the business of creating and marketing toys and games. A proposal is made to the board to manufacture and market a toy bird that really flies. Market surveys have been done to indicate that the toy would be a good seller, and engineering studies have been done testing the feasibility of such a product. Roger reviews this information and votes in favor of producing this new toy. The vote was 7 to 4 in favor. RST produces and markets this new toy bird, but sales are very slow. After several years of losing money, RST discontinues this toy. Lynn, a shareholder of RST, thinks the toy bird venture was a waste of time and money. In fact, she thinks the idea was so bad, that she sues
Roger for breach of his fiduciary duty of due care in making the decision to proceed with the bird. Discuss the general standards of due care of a director of a corporation, and determine whether Roger is liable in this situation.
Answer: Roger is probably protected by the business judgment rule. The fact that six others voted in favor could help Roger support his defense that the idea was not so outlandish as to amount to a failure to exercise due care.
Diff: 2 Topic: Liability of Corporate Directors and Officers Skill: Factual Application

105) Ted has just been elected to the board of directors of Funfones Corporation at its January annual meeting. Ted has considerable business experience and will be a valuable addition to the board. Ted was heavily promoted for the board by Tim, the president of Funfones and owner of
24 percent of the shares of Funfones' common stock. Tim and Ted were fraternity brothers in college and have had business contact for almost 20 years. Less than a week after being elected to the board, Ted and Tim end up in a dispute over a bet on the Superbowl football championship. Tim properly gives notice for a special shareholder meeting to vote to remove
Ted from the board. At this meeting, the shareholders vote to remove Ted from the board. Ted objects. Discuss Ted's legal situation.
Answer: The shareholders are generally free to elect and recall board members for any reason or no reason at all. Assuming that Ted was not given a fixed-term contract as a board member, Tim and the shareholders were within their rights to remove Ted from the board.
Diff: 2 Topic: Rights of Directors Skill: Factual Application

106) Dawn is a director of the Manello Corporation. Bert, a friend of Dawn's and an inventor, creates a new product. Bert wants Manello to handle the production and marketing of this new product, so Bert discusses his new invention with Dawn. Dawn thinks the new invention will be a huge success, but in order to maximize her personal income, Dawn suggests to Bert that she handle the manufacturing and marketing, leaving Manello out of it completely. Bert agrees.
Discuss the propriety of Dawn's actions in this situation. Would the outcome be any different if
Dawn were merely a shareholder owning 4 percent of Manello?
Answer: Dawn has violated the duty of loyalty by usurping a corporate opportunity. Only if she presented this opportunity to the corporation and the corporation rejected it could she take this opportunity for herself. As a mere shareholder, Dawn would not have a duty of loyalty and would be free to take this opportunity for herself.
Diff: 2 Topic: Rights of Directors Skill: Factual Application

107) Bob is a shareholder in Gadgets, Inc. He owns 400 shares of the 10,000 shares outstanding.
Gadgets has been in business for 14 years and Bob has been a shareholder for the entire time.
Gadget has been profitable over the years, but has paid a dividend only once, and that was 8 years ago. The stock of Gadgets is not listed on a stock exchange. Gadgets has recently introduced a couple of unsuccessful products which have lost money. Bob wants to sue the board of directors for the losses caused by the unsuccessful products and to compel the payment of dividends. Discuss Bob's options and any other factors that might be relevant to the outcome of such a suit. What other options, if any, does Bob have?
Answer: Bob has no right to dividends, and cannot compel payment. The board's actions are probably covered by the business judgment rule, but the board members could be liable if they failed to exercise due care. If Bob could get the support of other shareholders, they could either pressure the board into paying a dividend or could replace the board members with persons who would declare a dividend. Likewise, Bob and other shareholders holding a sufficient number of shares could replace the board with persons whose business strategy more closely matches their own. Diff: 2 Topic: Rights of Directors Skill: Factual Application

108) Bob formed Bob's Brake Repair, Inc. in 1995. Bob has been the only shareholder since the corporation was formed. Bob has never worried about the corporate formalities since, as the only shareholder, he didn't worry about suing himself. He kept a single bank account and didn't always use the word "incorporated" on his signs and work orders. Recently, the brakes failed on a customer's car shortly after one of Bob's employees had repaired them. Can the person injured by the brake failure recover from Bob's personal assets?
Answer: The corporation is liable for any negligence on the part of its employees, and a court would likely "pierce the corporate veil" due to Bob's failure to follow corporate formalities. In piercing the corporate veil, Bob would be personally liable for the corporate debts, including any liability in connection with the failed brakes.
Diff: 2 Topic: Liability of Shareholders Skill: Factual Application

Chapter 39 Limited Liability and Limited Liability Partnerships
82) When choosing the form of business organization that a business will use, what additional factors should be considered if the business will be doing substantial business with entities in other nations?
Answer: One factor is under what circumstances the laws of the other nation will respect the limited liability of an entity that enjoys limited liability in the United States. Additionally, there might be other requirements, such as filing, that differ from those in the United States, and differ in the foreign nation depending on the type of entity.
Diff: 2 Skill: Ethics and Policy

83) Why do you think that the Internal Revenue Service adopted the "check-the-box" regulation allowing LLCs to choose their method of taxation?
Answer: Prior to the check-the-box regulation, an LLC had to structure its articles of organization precisely in order to achieve partnership taxation. This could usually be done, but a small error or oversight could result in unintended tax consequences. The IRS wisely eliminated the uncertainty and the complexity of choosing the form of taxation.
Diff: 2 Skill: Ethics and Policy

84) Maria is one of six members of a limited liability company. This is a manager-managed
LLC, with two of the members named as managers. Maria and Vanessa, one of the managers, executed a personal guarantee (both their names on one guarantee) for a bank loan to the LLC.
Although the LLC was successful for a couple of years, its debts now greatly exceed its assets and the members are considering liquidation. Discuss Maria's liability.
Answer: As a member of an LLC, Maria has limited liability. This means that Maria cannot be required to contribute to the satisfaction of the LLC's obligations based on her being a member.
This would be true even if she were a manager. As a guarantor, Maria has personal liability, but only on the debt guaranteed and only in accordance with the terms of the guarantee. Maria would have a right to recover Vanessa's share of the guarantee if Maria paid any of Vanessa's share.
Diff: 2 Topic: Nature of the Limited Liability Company Skill: Factual Application

85) Wally is a college senior with a business idea for a company to sell over the Internet. Wally has a generous aunt who has given him $10,000 for Christmas every year of his life. Wally has invested this money wisely and thus will not need other owners in his new company. Wally wants to form an LLC for its ease of operation, limited liability, and flow-through tax treatment.
Wally is also trying to decide where to live, because he can run this business from anywhere there is a phone line. Discuss Wally's situation.
Answer: An LLC will meet Wally's needs. Wally needs to be aware that some states do not allow LLCs with only one owner. Wally's LLC will be taxed as a sole proprietorship unless
Wally elects corporate tax treatment. The limited liability of Wally's company will not eliminate the need for liability insurance.
Diff: 2 Topic: Organizing Procedures Skill: Factual Application

86) Jake and Kate are two members of an LLC with 15 members. This is a member-managed
LLC with three of the members identified as the managers. Kate is one of these managers, though Jake is not. In reality, Jake and Kate together do most of the management for the LLC, contributing approximately equal amounts of time and energy. They both have spent some of their own money on behalf of the LLC. In one situation, Jake and Kate each put up $1,000 as a deposit on a contract entered into on behalf of the LLC that the other two managers voted to not perform. Jake and Kate want to be compensated for their time, want their expenses covered, and are worried about liability on the unperformed contract. Discuss their rights and liabilities.
Answer: As a manager, Kate is entitled to reasonable compensation for her time spent managing the LLC. Jake, as a mere member of a manager-managed LLC is not entitled to such compensation. All members are entitled to reimbursement for expenses, and to indemnification for losses. This would apply to the $1,000 deposit, as well as any losses or expenses incurred by
Jake or Kate if the third party sues them for the unperformed contract. This assumes that Jake and Kate had authority. Kate's authority would be based on her role as a manager. Jake's authority would be based on Kate's actions as a manager in allowing Jake to take part in the contracting. If their authority to enter into this contract had been limited by agreement, they would not be entitled to indemnification from the LLC, but unless known by the third party, would not limit the third party from recovering the amount from Jake and Kate.
Diff: 3 Topic: Operating a Limited Liability Com