March 03, 2014
Call for Paper: AALS Section on Agency, Partnerships LLCs, and Unincorporated Associations
Posted by Gordon Smith

Bringing Numbers into Basic and Advanced Business Associations Courses: 

How and Why to Teach Accounting, Finance, and Tax

Business planners and transactional lawyers know just how much the “number-crunching” disciplines overlap with business law.   Even when the law does not require unincorporated business associations and closely held corporations to adopt generally accepted accounting principles, lawyers frequently deal with tax implications in choice of entity, the allocation of ownership interests, and the myriad other planning and dispute resolution circumstances in which accounting comes into play.  In practice, unincorporated business association law (as contrasted with corporate law) has tended to be the domain of lawyers with tax and accounting orientation.  Yet many law professors still struggle with the reality that their students (and sometimes the professors themselves) are not “numerate” enough to make these important connections.  While recognizing the importance of numeracy, the basic course cannot in itself be devoted wholly to primers in accounting, tax, and finance.

The Executive Committee will devote the 2015 annual Section meeting in Washington to the critically important, but much-neglected, topic of effectively incorporating accounting, tax, and finance into courses in the law of business associations.  In addition to featuring several invited speakers, we seek speakers (and papers) to address this subject.  Within the broad topic, we seek papers dealing with any aspect of incorporating accounting, tax, and finance into the pedagogy of basic or advanced business law courses.

Any full-time faculty member of an AALS member school who has written an unpublished paper, is working on a paper, or who is interested in writing a paper in this area is invited to submit a 1 or 2-page proposal by May 1, 2014 (preferably by April 15, 2014).  The Executive Committee will review all submissions and select two papers by May 15, 2014.  A very polished draft must be submitted by November 1, 2014.  The Executive Committee is exploring publication possibilities, but no commitment on that has been made.  All submissions and inquiries should be directed to Jeffrey M. Lipshaw, Associate Professor, Suffolk University Law School jlipshaw@suffolk.edu (617-305-1657).

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December 18, 2012
AALS Section Meetings: Agency, Partnerships, LLCs and Unincorporated Associations
Posted by Gordon Smith

I will have to return before this meeting, but I wish I could be there for it ...

The Scholarship of Professor Larry Ribstein

    Moderator: Douglas K. Moll, University of Houston Law Center

    Speakers:

    Kelli A. Alces, Florida State University College of Law

    Matthew T. Bodie, Saint Louis University School of Law

    J. William Callison, Partner, Faegre Baker Daniels, LLP, Denver, CO

    Ann Ribstein, University of Illinois College of Law

    Roberta Romano, Yale Law School

    Commentators: Lyman P.Q. Johnson, Washington and Lee University School of Law

    Daniel S. Kleinberger, William Mitchell College of Law

    Jeffrey M. Lipshaw, Suffolk University Law School

    Larry Ribstein was a friend to many and a colleague to all of us in the academy. With his untimely passing, he left behind a pioneering and influential body of work across a vast range of subjects. Our program seeks to honor Larry’s legacy by focusing on his scholarship in the unincorporated area. Our speakers include invited presenters as well as presenters who responded to a Call for Papers on the influence of Professor Ribstein's scholarship.

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September 20, 2012
Teaching BA Without Bankruptcy: The LLP as an Illusion?
Posted by Christine Hurt

OK, so I'm rethinking how I teach BA.  Gordon and I have taken on a few writings in the area of partnership, and we knew that it would deepen our current knowledge of partnerships.  But I didn't think it would complete change my thinking.

So, when I teach LLPs, I do it in the traditional way, and a quick perusal of the numerous BA texts tells me I have lots of company.  In limited liability partnerships, partners don't have personal liability for partnership obligations.  In most states, for both tort and contractual obligations.  Partners' capital is at risk, but partners never have to write a personal check out of their own funds, unless the liability arose out of their own behavior (or those they supervised, etc.).  So, if a creditor has a claim that isn't satisfied out of partnership assets, the creditor suffers a loss.  End of story.  Except I'm not sure now that it ever happens that way.

I suppose there are instances where insolvent LLPs just dissolve and their creditors go on their way, but another option is that the creditors would force the LLP into bankruptcy (or the LLP would voluntarily file for bankruptcy).  And bankruptcy has its own rules.

LLP Shield v. Clawback:  So, in bankruptcy, the trustee can claw back amounts distributed to partners within two years under certain circumstances.  Because of this right to clawback, partners have an incentive to settle so that they can move toward financial and professional certainty.  So, we've seen settlement agreements with partners in Brobeck, Coudert Brothers, and now Dewey.  The "L" in LLP seems to be a little "l" at best.  Partners who are sufficiently prescient to leave 2.5 years are more before filing seem to fare much better at shielding themselves, even though they are no longer in the shield.

LLP Shield v. Winding Up v. Unfinished Business Doctrine:  If I ever write a BA casebook, I'm going to feature In re Brobeck, Phleger & Harrison LLP, 408 B.R. 318 (N.D. Calif. 2009).  So, Brobeck is teetering toward its eventual bankruptcy (filed September 2003).  Some smart folks there know that there is a California state case, Jewel v. Boxer, that holds that "in the absence of an agreement to the contrary, partners have a duty to account to the dissolved firm and their former partners for profits they earn on the dissolved firm's "unfinished business," after deducting for overhead and reasonable compensation."  The only way these partners are going to work again is if other law firms think they are bringing a book of business.  So, it suits everyone in the about-to-dissolve firm fine if they all go ahead and waive this right on behalf of the partnership.  They know that the unfinished business profits would just be going to Citibank (their major creditor) anyway.  Months later, Brobeck is in bankruptcy and its partners are safely tucked into other firms, just like the "L" in LLP intended.  (Other non-California courts have followed both the Jewel doctrine and the Jewel-waiver as fraudulent conveyance reasoning.)

But, the trustee sued the new firms anyway.  The court did a funny thing.  The court upheld the Jewel waiver as valid.  However, the court held that the Jewel waiver transferred a property right of the partnership (the right to profits) too close to bankrutpcy, so the waiver was clawed back.

So, I'm not sure when partners in an LLP get to walk away, as I have so blithely suggested in my BA case.  The shield seems to work best when the entity has enough assets to satisfy claims or when the entity has had so little assets that it hasn't made a distribution in a very long time.  Hmm.

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February 16, 2012
The Scholarship of Professor Larry Ribstein
Posted by Gordon Smith

CALL FOR PAPERS

AALS Section on Agency, Partnerships, LLCs, and Unincorporated Associations

The Scholarship of Professor Larry Ribstein

2013 AALS Annual Meeting

New Orleans, LA

Larry Ribstein was a friend to many and a colleague to all of us in the academy.  With his untimely passing, he leaves behind a pioneering and influential body of work across a vast range of subjects, including partnerships and limited liability companies, corporate and securities law, choice of law, financial regulation, white-collar crime, legal ethics, and the legal profession.

The AALS Section on Agency, Partnership, LLCs, and Unincorporated Associations seeks to honor Larry’s legacy by focusing on his work at the 2013 AALS Annual Meeting in New Orleans.  We are soliciting papers on a broad range of issues dealing with Larry’s partnership, LLC, and/or “uncorporation” scholarship.  Among the topics that might be addressed are:  

•      An evaluation of the impact of Larry’s scholarship in a particular area;

 •      A discussion of issues or positions that Larry changed his mind on over time, and how;

 •      An examination of how Larry’s work in other areas informed his work in the unincorporated sphere, and vice-versa;

 •      “Larry as blogger” and the influence of his web postings

Submission procedure: A draft paper or proposal may be submitted via email to Professor Douglas Moll at dmoll@central.uh.edu

Deadline date for submission: April 1, 2012

Form and length of paper; submission eligibility: There is no requirement as to the form or length of proposals.  Faculty members of AALS member and fee-paid law schools are eligible to submit papers. 

Registration fee and expenses: Program participants will be responsible for paying their annual meeting registration fee and expenses.

How will papers be reviewed?: Papers and proposals will be selected after review by the Section’s Executive Committee.

Will the program be published?: The section plans to contact the law reviews at schools where Professor Ribstein taught in the hopes of publishing the papers submitted for the meeting as a symposium.  At this time, however, no guarantees of publication can be made.

Contact for submission and inquiries:     Professor Douglas Moll, University of Houston Law Center. 713-743-2172 or dmoll@central.uh.edu

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February 08, 2011
Huffington Post Has Facebook Formation Problem
Posted by Christine Hurt

This week, the media is abuzz with the announcement that AOL is acquiring The Huffington Post for $315 million.  (In contrast, few people seem to have noticed that Ensco and Pride International are creating the second-biggest deep-water drilling company, at a pricetag of $7.3 billion.)  But, for corporate law scholars, the interesting twist is not who will own Huffington Post, but who owns it now.

OK, you can understand college kids not getting everything in writing, but middle-aged millionaires?  Really?  This month's Vanity Fair has an interesting article about the behind-the-scenes fight that officially began with Peter Daou and James Boyce sued Arianna Huffington and The Huffington Post.com in mid-November 2010 claiming that they were the creators of The Huffington Post.  (The complaint is here.)  They allege breach of contract, idea misappropriation, and most importantly to us business law professors, breach of fiduciary duties because they formed a "joint venture."  Bingo!  However, they don't want damages, they want the credit (and a donation to the charity of their choosing).

 So, is the claim a worthy one?  Well, according to the facts alleged in the complaint, there's a lot more there to hang one's partnership hat on than in Holmes v. Lerner (Urban Decay), which Gordon has blogged about before.  But, after the launch of site, neither Daou or Boyce's actions look like someone who believes that he is a partner in anything, unlike the other case where Patricia Holmes worked for the venture for a year with no salary.  The site apparently was the product of a brainstorming session on December 3, 2004 at Huffington's home, where she invited a group of disappointed Kerry supporters and Hollywood movers and shakers to discuss the creation of a "liberal Drudge Report."  However, prior to this breakfast confab, Daou and Boyce had dreamed up this idea in the hours after the presidential election and presented it to Huffington, their close friend.  On November 14, 2004, they gave to her a 15-page memorandum outlining the idea behind "1460," a blog they hoped would mobilize the Democratic base prior to the next election (there are 1,460 days between presidential elections).  Here is the November 14, 2004 proposal for "1460."  The two met with Huffington the morning before the Dec. 3 breakfast to prepare for the larger meeting, and then discussed the idea further with her and Kenny Lerer, who would end up financing the blog.  Lerer apparently did not like Daou and Boyce, and after he and Huffington asked the two to write up a strategic plan ("blueprint") for the blog, the blog was financed and launched on May 9, 2005, without them being investors or employees. 

(What is interesting to remember, way back then at the early stages of blogging, is that the crowd was very skeptical of professional blogs, including The Huffington Post.  Here was Gordon's first take; here was one of Ann Althouse's first thoughts.  Even Larry David, the actor and investor in The Huffington Post, said "“All I remember is Arianna telling me about this on a number of occasions and feeling sorry for her because I thought it was such a terrible idea.”  I guess we didn't call this one very well.  However, the launch of The Huffington Post was the beginning of the maturation of the blogosphere from when David Lat and Wonkette blogged for free to the current state of institutional, professional blogging.)

However, for six years, Daou and Boyce never complained about either not being credited as founders or receiving any sort of remuneration/ownership interest.  The two blogged from time to time on the site and never said an ill word to or about Huffington.  However, after Andrew Breitbart, a conservative blogger who wrote Huffington blog posts under contract at its inception, claimed to have founded The Huffington Post, Daou and Boyce were dismayed to hear Huffington say in public that Breitbart had nothing to do with the creation of the website, but not mention Daou or Boyce.  After bringing up this slight with Huffington via email, they were eventually rebuffed and redirected to "legal."  Of course now, one wonders if the timing coincides more with the market putting a price on the website.

So, how does this play out now that AOL has put a $315 million pricetag on The Huffington Post?  The lawsuit seems to fail on the de facto partnership front for no other reason than Daou and Boyce do not seem to have thought that they were partners for over six years.  The website received venture funding during that time, and the two were not involved in any of those conversations.  Had they believed themselves to be owners of the website, then surely they would have chimed in at that time.  I don't know enough about the "misappropriation of idea" cause of action to opine.  I have not been able to find a copy of the answer, which should have ben filed by now, but it might give more clues to the future of the claim.

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August 18, 2010
Gordon Smith on Manesh on "Delaware and the Market for LLC Law"
Posted by Gordon Smith

Mohsen Manesh's new paper, Delaware and the Market for LLC Law, is a fascinating project, and I am grateful to him for allowing us to feature his paper in the Junior Scholars Workshop. Like Larry Ribstein and Bob Lawless, I admire Mohsen's scholarly ambition, but I feel like this paper has some distance to travel before it is complete.

Mohsen begins with the claim that Delaware lacks the sort of market power in the competition for LLC charters that it has in the competition for corporate charters. His evidence for this claim is the lack of price discrimination in LLC taxes. Like Larry and Bob, I am skeptical of this claim, but I am willing to play along for the sake of argument. I am more interested in his examination of contractability and indeterminacy under LLC law, and my interest in these arguments eventually leads me back to Mohsen's initial claim regarding Delaware's supposed lack of market power.

Indeterminacy in corporate law is often said to play a crucial role in enhancing Delaware's market power. On the nature of indeterminacy in corporate law, Mohsen observes: "Delaware corporate law, and in particular its judge-made law of fiduciary duties, tends to favor contextual, fact-intensive standards over bright-line rules." Note that the charge of indeterminacy is not necessarily an indictment of Delaware law. Indeterminacy is probably inherent and almost certainly desirable in fiduciary law. The somewhat counterintuitive claim that this indeterminacy enhances Delaware's market power is based on two observations: (1) indeterminate law is hard to copy, and (2) indeterminate law increases the importance of judges (and Delaware has the best judges).

So far, so good. Now the crucial move: Mohsen asserts that LLC law is less indeterminate than corporate law because LLCs are "creatures of contract." In Mohsen's words:

Virtually all of the default provisions specified in the Delaware LLC Act may be superseded or otherwise contractualized by the terms of a LLC’s governing agreement. As a result, many of the mandatory and indeterminate provisions that are imposed under Delaware corporate law—including the judge-made law of fiduciary duties—may be contractually waived, modified or clarified under Delaware LLC law.

According to Mohsen, one implication of this contractability is that LLCs can avoid the cost of uncertainty inherent in corporate law. I have several problems with Mohsen's argument.

First, Mohsen selects an unfortunate example to illustrate the mandatory indeterminacy of Delaware corporate law. He argues that DGCL Section 271, governing the sale of "all or substantially all" of a corporation's assets is a mandatory provision, meaning that it "cannot be modified, clarified or otherwise waived by the terms of a corporation's governing documents." While the statute does not expressly allow for contrary terms in the corporate charter, the process for selling assets is often subject to contractual specification. If powerful shareholders want a say in the sale of assets -- even when that sale constitutes less than "all or substantially all" of a corporation's assets -- they simply have to insert a negative covenant into their deal terms.

Second, while Mohsen illustrates how an LLC's governing documents could "contractualize" certain matters that, in a corporate context, might be evaluated under a mandatory, indeterminate, fiduciary standard, he does not provide evidence that LLCs routinely avail themselves of this opportunity. He rightly acknowledges that drafting highly specified contracts is expensive and difficult, and that should lead him to ask: would most Delaware LLCs invest in such contracts? The answer to this question depends on what these LLCs look like, and I agree with Bob Lawless that it would be nice to know more about this. Are most of these LLCs Mom-and-Pop businesses? Or are they non-operating companies? In any event, my guess is that the vast majority of Delaware LLCs are tightly controlled by one individual or parent company, thus eliminating the need for highly specified contracts.

Third, if one of the major advantages of LLCs is contractability, which reduces indeterminacy, why are so many LLCs formed in Delaware? Mohsen observes that many states have copied Delaware's LLC Act, which provides that its principal policy is "to give the maximum effect to the principle of freedom of contract." If contractability is the key feature of LLC law, why don't other states compete more effectively with Delaware? Under Mohsen's theory, contractability reduces indeterminacy, which implies that Delaware judges have no special advantages. Rather than puzzling over Delaware's lack of market power, I am left puzzling over Delaware's success in attracting LLC formations when its product has no discernible advantages.

By the way, Larry Ribstein disagrees with Mohsen on this point, arguing, "The contractual nature of LLCs increases the value of Delaware courts’ contract-enforcement technology." In other words, the important thing about Delaware is how the judges will interpret future contracts, and that feature of the Delaware system is not easily replicated by other states. This seems plausible to me, but it is in tension with the notion that contractability reduces indeterminacy and, thus, poses a significant challenge to Mohsen's paper.

Fourth, Mohsen dismisses the importance of the contractual duty of good faith and fair dealing too quickly, arguing, "the Delaware courts have made clear that the implied contractual covenant is doctrinally distinct and substantially narrower than the open-ended fiduciary duties imposed by corporate law." The Delaware courts have certainly made statements like this, but my sense is that the treatment of this doctrine is far more complex than Mohsen gives credit. Indeed, earlier this summer, I heard Chief Justice Steele address two distinct lines of cases involving the contractual duty of good faith and fair dealing and suggesting that these precedents were in serious conflict.

In the end, all of my points revolve around a single complaint, namely, that Mohsen exaggerates the extent to which the contractability of LLCs reduces indeterminacy when compared to corporations. Given that his argument rests on this claim, however, it is a point worth arguing.

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Larry Ribstein on Manesh on "Delaware and the Market for LLC Law"
Posted by Account Deleted

I am very happy to see somebody exploiting the theoretical and empirical potential of expanding the study of business organizations to fully include unincorporated business entities. And I applaud Professor Manesh’s selection of an intriguing question to study, something that I’ve been curious about but never pursued: Why do Delaware’s fees for forming LLCs look so much different than those for corporations?

To briefly summarize his thesis, Manesh argues that Delaware’s flat $250 fee for LLCs, compared to its much higher and graduated fees for corporations, indicates Delaware’s lack of market power in the market for LLCs. Kahan & Kamar (Price Discrimination in the Market for Corporate Law, 86 Cornell Law Review 1205 (2001)) theorized that Delaware’s scaling of corporate fees to firms’ capitalization showed price discrimination, something a producer can do with market power. Since Delaware doesn’t do that for LLCs it must not have market power in that area.

One problem with this analysis is that it assumes LLCs and corporations are comparable for purposes of pricing. But there is no reason to think this is the case. Corporations are standardized products. Delaware builds on this standardization to compute the corporate franchise tax in ways that apply fairly simply to all corporations in the state, as described in the article. LLCs’ main attraction, by contrast, is that they are not standardized, but rather creatures of contract, as Manesh discusses. LLCs’ capital structures depend on idiosyncratic contracts rather than statutory standard terms. If Delaware tried to apply something like the corporate franchise tax to LLCs they would simply engage in regulatory arbitrage to minimize the tax.

Why doesn’t Delaware force LLCs to be just as standardized as corporations so it can charge for them like it does for corporations? First, there just isn’t as much money in it because there’s much less variation in size of LLCs than corporations. Second, if Delaware forced LLCs to be as standardized as corporations, LLCs would lose a lot of their attraction, as Manesh himself argues. As a result, Delaware would get a lot fewer LLCs. By contrast, corporations, or at least large Delaware corporations, benefit from standardization apart from law compliance: they are traded in a public securities market, where variations cause information costs that would be reflected in securities prices. Corporations trying to arbitrage Delaware’s franchise tax would have to pay a penalty for being different.

(A broader problem with Manesh’s analysis is that the relationship between price discrimination and market power is less clear than Manesh assumes. See Kobayashi and Wright on Illinois Tool Works vs. Independent Ink on the non-inference of anti-competitive markets from price discrimination in the antitrust context. )

So, contrary to Manesh’s assumption, Delaware doesn’t necessarily lack market power in the LLC market just because it doesn’t price discriminate. But having made his assumption, Manesh then explains why the assumed fact about lack of market power is true: LLC law is based on the parties’ contracts and therefore is less indeterminate than its corporate law. Delaware therefore cannot attract LLC business to its courts through indeterminacy as it does for corporations.

I agree with Manesh’s observation about corporate vs. LLC indeterminacy – in fact I wrote and published that article a couple of years ago. I don’t necessarily buy K & K’s reasoning as to corporations. Rather, as discussed in my indeterminacy article, I think indeterminacy is inherent in the corporate form. But even assuming LLCs and corporations differ in this respect, I disagree with where Manesh goes from there.

Let’s begin with the evidence that Delaware does attract LLCs to its courts. Kobayashi and I find that Delaware is a massive winner in the national market for formations of large LLCs. Although this would be seem to suggest Delaware has power in the LLC market, Manesh doesn’t seem troubled by this finding, since he is relying on the absence of price discrimination. More interesting for present purposes is that Kobayashi and my regression analysis indicates that Delaware’s success is not because of any feature of Delaware’s law that we could find. Indeed, Manesh also notes that the feature that one might expect would attract LLCs to Delaware – the statutory provision allowing freedom of contract – has been replicated by other states. This suggests that large LLCs are attracted to Delaware because of Delaware’s legal infrastructure of courts and lawyers.

So why are LLCs drawn to Delaware’s courts if, as Manesh concludes, there’s relatively little those courts need to do for LLCs?The answer is that courts do have a lot to do for LLCs – that is, enforce their contracts. The contractual nature of LLCs increases the value of Delaware courts’ contract-enforcement technology. It is easy for a state to say in its statute that its courts will enforce contracts, but much more difficult to actually follow through on that promise, and to come up with intelligible and coherent contract-enforcement jurisprudence. As I have discussed in several writings, including my indeterminacy article above, my book (Rise of the Uncorporation and a number of blog posts (e. g. , Delaware courts have developed a very sophisticated approach to contract interpretation and enforcement in unincorporated firms. Other states can’t pick up formation business simply by linking to Delaware’s law because they also need to provide assurances as to how they’ll decide future cases.

In other words, LLCs are not flocking to Delaware just because it enforces contracts, but because of the way it enforces contracts. Although Manesh thinks that the “network” of Delaware’s cases is all about interpreting mandatory rules, in fact it is at least partly about applying any rules, whether or not contractual, to necessarily unpredictable fact situations. If Delaware were to follow Manesh’s suggestion and become more indeterminate to compete for LLCs, this would threaten, not solidify, its dominance in the market for LLCs.

(As an aside, I have a quibble about Manesh’s analysis of “network externalities” as a reason for the attractiveness of Delaware law. This confuses network effects in business association law and network externalities. My article with Kobayashi about choice of form, which Manesh cites a couple of times, shows some pretty good evidence that these aren’t network externalities. Contrary to Manesh’s brief discussion of this paper, this holds for both choice of form and choice of law, since the basic constraints are the same in both areas. )

Finally, Manesh discusses interest group pressures that might promote indeterminacy. He argues that lawyers would favor indeterminacy plus low LLC taxes to attract LLCs to Delaware and then produce more work for lawyers. I have also theorized that lawyers work on their states’ laws to attract clients to their states, and that lawyer licensing gives lawyers a kind of informal “property right” in their state’s law. However, it does not follow that lawyers would seek to attract business by promoting indeterminacy. If the market for business organizations is competitive (and, as shown above, Manesh hasn’t shown otherwise) lawyers can accomplish this goal by promoting laws that are not too indeterminate. Also, even if lawyers do seek more work from the clients Delaware attracts, this may mean different things to transactional lawyers (who want to encourage contracting by having contracts enforced) and to litigators (who want to undo contracts through litigation).

In conclusion, I applaud Professor Manesh’s choice of topics. This is a good start. I would encourage him to follow up this early draft with more extensive reading and analysis. Rather than putting all his eggs in the price discrimination basket, I would urge him to step back and keep an open mind about why competition in the corporate and LLC markets might differ, and alternative reasons why Delaware prices these products differently. I think the time spent on this reading and analysis will be rewarded by more robust conclusions.

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August 10, 2010
Fiduciary Duty to Partners v. Anti-Discrimination Laws: Which Protects Better?
Posted by Christine Hurt

So, the media has been abuzz with two different law partner stories in the past few weeks.  First, that a new study has found that female law partners at elite firms are paid, on average, $66,000 less per year than their male law partner counterparts, who make up 80% of all law partners.  Second, that the Third Circuit has held that a female "Class A Shareholder" at law firm Dickie, McCamey & Chilcote, a Pennsylvania professional corporation, could not proceed with her discrimination claims under Title VII or the Fiarl Labor Standards Act because she was an "employer," not an "employee."  (2010 WL 2780927, or Law.com story here.)  So, this leaves me wondering, if a female law partner believes that she is being discriminated against by her other partners on the basis of gender, does she have any recourse at all beyond exiting the partnership?

First, there is the question of whether a law partner (or shareholder in a professional corporation) could ever be an employee for purposes of employee discrimination laws.  The courts seem to look at the common-law agency test for whether someone is an employee, which focuses on control.  The Seventh Circuit in EEOC v. Sidley Austin Brown & Wood seemed to leave that door open as to whether a partner could be an employee, particularly for partnerships with hundreds of partners and a self-perpetuating Executive Committee that had plenary power (settled, so no legal conclusion).  But, Alyson Kirleis was found not to be an employee in a firm with 61-69 Class A Shareholders, all of whom were a director on the Board of Directors, in a firm run by an Executive Committee elected by the Board.  So, if you aren't promoted from Associate to Partner on the basis of gender, you may have a claim, but once you're a partner, you may not.

So, the second question would be whether a partner in a general partnership or a shareholder in a professional corporation would have any other remedies against the firm.  Particularly, could partnership fiduciary duties or shareholder oppression doctrines provide some sort of safeguard?  We all know from studying business associations that a minority partner or a minority shareholder, particularly in a closely-held enterprise where one's livelihood is part of the bargain, can be put in a less-than-economically pleasant situation by the majority. 

Fiduciary Duty.  We typically think that partnership duties will step in if the firm is a general partnership, even if safeguards such as voting are not effective.  However, does discriminating against a partner on the basis of gender violate the duty of care?  The duty of loyalty?  Perhaps if compensation determinations were made unfairly, that would be self-dealing?  I'd be interested to know if any BA casebook writers have found any of those cases.  Lack of transparency in allocating partner compensation might be a Duty of Disclosure issue, but that just gets you information.  But hostile environment claims don't seem to fit in anywhere.

Good Faith.  Perhaps if compensation decisions aren't being made exactly as the partnership agreement mandates, this might be a breach of contract claim, or at best a breach of the duty of good faith and fair dealing, as good as that goes.  But a claim that says that compensation decisions under the partnership agreement have a disparate impact on childbearing women because of its weight on billables and client origination?  That doesn't seem to be a fiduciary duty or other duty-type claim.

Shareholder Oppression.  As we know, some states recognize this doctrine to save shareholders in closely-held situations from losing their livelihoods and having their investments captive without hope of dividends, etc.  So, if the professional corporation statute is governed by the jurisdiction's for-profit corporation act, which includes some shareholder oppression remedy, then perhaps this is an option.  In Ms. Kirleis' situation, she was one of over 60 Class A Shareholders, so that may not be a closely-held corporation under a particular state law.  And, she wasn't fired or demoted.  Presumably, she had some exit rights.  She was still receiving a draw.  Oppression may in fact be a much higher bar than discrimination.

So, perhaps the fact that only 20% of law partners are women seems to reflect the "exit" remedy.

Title 15 Corporations and other Unincorporated Associations

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May 04, 2010
Let us now praise agency and partnership law
Posted by Erik Gerding

Now that I’ve taught my last class for the semester, I thought I’d jot a few posts with reflections on teaching from the semester before I turn attention to grading and then writing.

Watching the SEC’s Goldman suit, the Senate hearings, and the financial reform legislation unfold has left me convinced that we business association teachers should consider teaching agency and partnership in the basic course (if we don’t already do so). Why? It is not just that many actual business entities are the “uncorporations” that Larry Ribstein writes about and not the “inc.s” in many law school class rooms. Consider the following two problems identified in the Goldman hearings or with respect to the financial crisis:

• Conflicts of interest (by Wall Street firms, rating agencies, mortgage brokers, mortgage originators etc.); and

• Lack of disclosure (to mortgage borrowers, investors in asset-backed securities etc.).

Of course there are lots of other potential areas of concern – like financial institution “safety and soundness,” but the two problems above are essentially about agency costs. As are two of the proposed remedies being discussed:

• Fiduciary duties (for mortgage brokers, or registered broker-dealers); and

• Greater disclosure.

We can have a discussion about whether these are the most important problems and the most pressing reforms in the wake of the crisis, but they are front–and-center in the current debate. To frame the basic tradeoffs involved, there are two analytical approaches and two approaches to teaching students. The first is to start deep in the weeds of specialized areas of securities and financial regulation. The second is to start with basic building blocks.

The place to go for those building blocks is agency and partnership law. It is funny how much of the public debate on the Goldman suit resembles debates in those chestnut fiduciary duty cases from a Business Associations case book. Could “sophisticated investors” protect themselves against conflicts of interest with greater diligence or harder negotiations on price? Or do they need (or would it be more efficient to give them) the protection afforded by fiduciary duties? And when we talk about fiduciary duties, even the basic Business Associations course should help students see that those duties could vary quite a bit from one context or form of business entity or state to another.

Perhaps it is just my own learning style, but if I had to take a Business Association class again, I’d prefer to start learning the basic concepts that Corporations borrows from Agency and Partnership rather than being parachuted into the world of staggered boards and poison pills. Don’t kids learn basketball by practicing lay-ups before moving to dunks?

We’ll see how I feel in the fall when I teach my first purely Corporations class.

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September 29, 2008
A Partnership Quiz
Posted by Gordon Smith
October 28, 2007
Moral Responsibility in Business
Posted by Gordon Smith

After promulgation of the first Uniform Partnership Act in 1914, William Draper Lewis of the University of Pennsylvania Law School, one of the principal draftsman of the Act, described the debate over the legal personality of partnerships at a meeting of the UPA drafting committee and commentators:

"[T]hose with the largest practical experience present were opposed to regarding the partnership as a 'legal person' because of the effect of the theory in lessening the partner’s sense of moral responsibility for partnership acts."

William Draper Lewis, The Uniform Partnership Act — A Reply to Mr. Crane’s Criticism, 29 Harv. L. Rev. 158, 172-173 (1915).

Does this concern over the "moral responsibility" of partners seem odd to you? It is an argument that often has been raised with regard to limited liability, but in the partnership context, the supposed effect ("lessening the partner’s sense of moral responsibility for partnership acts") appears to emanate merely from a change in the nature of the partnership relationship, rather than any change in actual liability risk.

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January 22, 2007
A Modern Day Meinhard?
Posted by Lisa Fairfax

I start off teaching my Business Associations class with a focus on partnerships and thus I am always looking for interesting partnership stories. I ran across one in the Chicago Tribune that seemed really intriguing. Rush Simonson brought suit against Kenneth Griffin, hedge fund manager of Citadel Investment Group—one of the biggest hedge funds in the country. Simonson’s suit indicated that he and Griffin were former partners, and that Griffin essentially breached their partnership agreement, continuing their “business” in Chicago and cutting him out of their profits. Simonson has abruptly dropped his suit claiming that while he was not being compensated for his action, it was the “right thing to do.” Nevertheless, the charges make for an interesting tale.

Apparently Griffin and Simonson had formed two partnerships while Griffin was in college at Harvard. Simonson claimed that he left a position in a brokerage firm to participate in their partnership businesses and provide Griffin with operational expertise. After graduation Griffin moved to Chicago and founded Citadel. Simonson also claimed that Griffin left with the secret intention of continuing their business in a different structure, and running the business without Simonson. Buttressing his claim, Simonson came across an article (while at the dentist) indicating that Griffin had started Citadel while in his college dorm. This kind of claim involves, among other things, a current day and interesting version of the Meinhard duty. In addition, assuming there was some violation of Griffin’s fiduciary duty, it raises some rather thorny issues of how one goes about parceling out the profits associated with a business that according to Bloomberg News made a trading profit of about $5 billion last year. Of course Griffin claimed all along that he properly ended the partnerships after graduation and Simonson’s suit was without merit. In dropping the suit, Simonson appears to validate that claim. But it still makes for good classroom discussion.

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November 22, 2005
Did Roger Simon Form a Partnership With Dennis the Peasant?
Posted by Gordon Smith

We have been quiet on Open Source Media, which is now Pajamas Media ... again. Frankly, I have a hard time getting excited about this story, though with a little encouragement from Ann, I did notice a business organizations angle. Take a look at Dennis the Peasant's account of his dealings with Roger Simon. The story bears a striking resemblance to the facts of Urban Decay, where a California appellate court held that two women who developed ideas for a cosmetics company had formed a partnership. Roger Simon responds:

Mr. Kelly [aka Dennis the Peasant] believes that somehow Charles Johnson and I have knifed him in the back in a business deal. He is indeed correct that we had several discussions with him and one meeting in Los Angeles. After that nothing substantive occurred. No contracts were ever signed. No investment was made. Nothing happened. Communications dwindled to zero. It was like the many preliminary business conversations that peter out before fruition in most of our lives, certainly in mine and probably in yours. Then Charles and I developed a different approach to the business. We found investment elsewhere and Mr. Kelly, when he heard about it, turned into an online stalker. He has threatened to sue me on several occasions. I invite him to go ahead and do it. I look forward to the contents of his website being read aloud in court.

Whether contracts were signed is irrelevant to the existence of a partnership. Same goes for the investment. But the portion of Simon's statement that I have italicized could be a crucial difference between Pajamas Media and Urban Decay. The key inquiry: Is Pajamas Media a different business than the one envisioned during those early talks between Simon, Kelly, and Johnson? If it is the same business, I could see a pretty strong argument for partnership under Urban Decay.

Stepping away from the result in Urban Decay, I think that Simon lands on the core issue in many cases involving inadvertant formation of a partnership, namely, whether the initial negotiations constitute formation of a business or merely preparation for incorporation. Every corporation or LLC is preceded by some planning, but such planning does not necessarily result in the formation of a partnership.

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October 02, 2005
Urban Decay
Posted by Gordon Smith

One of my favorite cases in my Business Organizations casebook features the cosmetics company Urban Decay (Holmes v. Lerner, 74 Cal.App.4th 442, 88 Cal.Rptr.2d 130 (Cal. App. 1999)). It is not a famous case, and I found it only because I was scouring recent partnership cases for a good formation issue. This case involves a disputed founding, and the facts are wonderful. Read an excerpt below the fold, and then I have a little story.

The following is an excerpt from the judicial opinion describing the earliest days at the company:

Sandra Lerner is a successful entrepreneur and an experienced business person. She and her husband were the original founders of Cisco Systems. When she sold her interest in that company, she received a substantial amount of money, which she invested, in part, in a venture capital limited partnership called " & Capital Partners." By the time of trial in this matter, Lerner was extremely wealthy. Patricia Holmes met Lerner in late 1993, when Lerner visited Holmes' horse training facility to arrange for training and boarding of two horses that Lerner was importing from England. Holmes and Lerner became friends, and after an initial six-month training contract expired, Holmes continued to train Lerner's horses without a contract and without cost.

In 1995, Lerner and Holmes traveled to England to a horse show and to make arrangements to ship the horses that Lerner had purchased. On this trip, Lerner decided that she wanted to celebrate her 40th birthday by going pub crawling in Dublin. Lerner was wearing what Holmes termed "alternative clothes" and black nail polish, and encouraged Holmes to do the same.(Fn 1) Holmes, however, did not like black nail polish, and was unable to find a suitable color in the English stores. At Lerner's mansion outside of London, Lerner gave Holmes a manicuring kit, telling her to see if she could find a color she would wear. Holmes looked through the kit, tried different colors, and eventually developed her own color by layering a raspberry color over black nail polish. This produced a purple color that Holmes liked. Holmes showed the new color to Lerner, who also liked it.

Fn 1 There were references throughout the trial to Lerner's "alternative" look and to "alternative" culture. Lerner, who referred to herself as an "edgy cosmetics queen," described "alternative culture" as "not really mainstream," "edgy," and "fashion forward." As an example, she noted her own purple hair. She defined "edgy" as not trying to be cute, and being unconventional.

On July 31, 1995, the two women returned from England and stayed at Lerner's West Hollywood condominium while they waited for the horses to clear quarantine. While sitting at the kitchen table, they discussed nail polish, and colors. Len Bosack, Lerner's husband, was in and out of the room during the conversations. For approximately an hour and a half, Lerner and Holmes worked with the colors in a nail kit to try to recreate the purple color Holmes had made in England so they could have the color in a liquid form, rather than layering two colors. Lerner made a different shade of purple, and Holmes commented that it looked just like a bruise. Holmes then said that she wanted to call the purple color she had made "Plague." Holmes had been reading about 16th century England, and how people with the plague developed purple sores, and she thought the color looked like the plague sores.(Fn 2) Lerner and Holmes discussed the fact that the names they were creating had an urban theme, and tried to think of other names to fit the theme. Starting with "Bruise" and "Plague," they also discussed the names "Mildew," "Smog," "Uzi," and "Oil Slick." Len Bosack walked into the kitchen at that point, heard the conversation about the urban theme, and said "What about decay?" The two women liked the idea, and decided that "Urban Decay" was a good name for their concept.

Fn 2 Plague is described as "rich violet with a blue sheen."

Lerner said to Holmes: "This seems like a good [thing], it's something that we both like, and isn't out there. Do you think we should start a company?" Holmes responded: "Yes, I think it's a great idea." Lerner told Holmes that they would have to do market research and determine how to have the polishes produced, and that there were many things they would have to do. Lerner said: "We will hire people to work for us. We will do everything we can to get the company going, and then we'll be creative, and other people will do the work, so we'll have time to continue riding the horses." Holmes agreed that they would do those things. They did not separate out which tasks each of them would do, but planned to do it all together.

The opinion proceeds to detail the development of the company and concludes that Lerner and Holmes formed a partnership. The case has many interesting features -- not the least of which is that Urban Decay seems to have lost its edge ... just take a look at some of the current products on its website. Another interesting feature is that the website does not mention Pat Holmes in the company history. A jury awarded Holmes over $1 million in compensatory and punitive damages from this case.

One of my students, Shakira Ferguson, was curious about this omission, and contacted Urban Decay, requesting an explaination. This was the response she received via email:

Pat Holmes was a friend of Sandy Lerner at the time Urban Decay was started. Many of Sandy's and Wende's friends contributed ideas, energy and enthusiasm to the business because people were excited about the prospect of a countercultural, revolutionary cosmetics company. Unfortunately, we are not able to mention all of the friends in the company history.

If you read all of the facts of the case, Holmes seems far from the trivial participant that she is portrayed as here, but it's hard to imagine what else the company would say. After all, the remedy did not include an injunction requiring Urban Decay to name Holmes.

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