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Business Organizations

1. Before you do anything else. Write your exam number at the top of each sheet of the exam. Check to make sure you have all __ pages.

2. Open book exam. You may have with you any inanimate thing.

3. The exam. The exam is divided into two parts. Write your answer to each question only in the lined space provided.

(1) Short essays. The first part contains 8 questions that call for short essay answers.
(2) Long essay. The second part asks for a longer essay, in which organization and succinctness will be at a premium.

4. Allocate your time. You will have four hours to complete the exam. Each question has a suggested time in parentheses; this is also the weight I will give each answer. Total suggested time:

Short essays 120 minutes (2 hours)
Long essay 60 minutes (1 hour)

This leaves you one hour to review your answers and revise them, as appropriate. I urge you to do this.

5. Write only in the space provided. Limit yourself to the space provided.

6. You may use abbreviations. You may abbreviate obvious names and words. For example, Arthur can be "A"; directors can be "Ds"; corporation can be "corp"; Section 38 of the Uniform Partnership Act can be "UPA § 38".

7. If you type. If you type, make sure you include your exam number on each page in a header. Number your answers clearly. Observe standard margins, and limit yourself to the line limits stated for each question.

8. When you finish. Place your exam in the box at the front of the room.
 

GOOD LUCK

SHORT ESSAYS - 120 minutes (2 hours)
 

Assume the applicable law for each question is that of New Columbia, a state which has adopted the Uniform Partnership Act (UPA), the Revised Model Business Corporation Act (RMBCA), the Uniform Fraudulent Conveyance Act (UFCA - as distributed in class).

The information provided in the questions is cumulative -- that is, you can use information in earlier questions to answer later questions. For each answer, cite any relevant statutory provisions and explain any assumptions.

Ben Cohen drives an ice cream truck in New Columbia. One day he and his friend Jerry Greenfield open an ice cream shop in a renovated gas station. They ask George, an unemployed accountant from New York, to join them. Together they invest $8,000 and borrow another $4,000 from a bank. They offer "super-premium" ice cream containing less air and more butterfat than regular ice creams, and they use Ben and Jerry's photos in their advertising -- "two real guys." The three write down nothing, but agree to share equally in any profits. In short, they become partners.

1. (15 minutes / 20 written or typed lines) Their ice cream shop thrives. "Politically correct" flavors are a big success: Rain Forest Mint, Global Warming Fudge, and Diversity Neapolitan. So much so that last month Haagen-Daz (owned by Pillsbury, a subsidiary of the British holding company Great Metropolitan) offered to buy their business for $2 million. George is anxious to sell their business, but Ben and Jerry refuse. In a huff, George says, "Well, I've never. I'm out of here." The partners had never discussed withdrawal nor had they agreed on a term for their business. When they originally formed the firm, though, George had toasted: "To our success, until we each make a million." Ben and Jerry had raised their cones in agreement. Please discuss whether George can withdraw and cash in his one-third interest.

2. (15 minutes / 20 typed lines) Your analysis on the last question was penetrating and clear. There's just one glitch. The facts are actually different. The business was incorporated as Ben & Jerry's Homemade, Inc. ("B&J" for short). Last year George had sent away for an "EZ Corp" kit from Info-Tel Products, after seeing their TV ad. The three partners filled out the forms, transferring the partnership assets to the corporation. Each partner became a director and officer; and each owns one third of B&J's voting common. George had broken out granola bars and said, "Well, this should limit our ole liability exposure." They filed the articles and elected S corporation status. Advise George on how he should cash in his one-third interest now.

3. (15 minutes / 20 typed lines) Your advice works -- and Ben and Jerry become 50/50 shareholders. Freed of George's infatuation with wealth, the two embark on a course of "enlightened capitalism." Their company gives employees generous benefit plans, free health club memberships, free child care, and employee "profit" sharing to which B&J contributes 5% of revenues (whether or not there are profits), not to mention 3 free pints of ice cream every working day. Minimum wage at the company is $8.50 an hour, twice that required by law. Meanwhile, B&J begins to struggle financially. The company closes down the second shift of its ice cream plant in Springfield for four months. Instead of laying off personnel, B&J pays employees full wages to do community work, like painting fire hydrants and winterizing homes for the elderly. B&J's banks are nervous. Ben and Jerry ask your advice. If B&J fails, would a court pierce the corporate veil and make the two shareholders personally liable for corporate debts?

4. (15 minutes / 20 typed lines) B&J rebounds from its doldrums. Soon there are B&J shops throughout New England. To finance an expansion into grocery stores, the company sells stock to public investors with ads in B&J shops that say "scoop up our stock." After the offering, public shareholders hold 80% of B&J's Class A common stock. Ben and Jerry, who now hold only 20% of the company's voting power, are nervous. But they have a plan, which the B&J board approves. The company issues new Class B shares (already authorized) as a dividend on the Class A common. Each Class A share, which has one vote per share, receives one Class B share, which has ten votes per share. The kicker is this: high-voting Class B shares are nontransferable, but can be converted into low-voting Class A shares, which are transferable. Over time, as Class B shareholders convert their shares to Class A to sell, only long-time shareholders (mostly New Columbia residents and employees loyal to management) will hold Class B shares. Cosmo, a B&J shareholder, challenges this issuance. Outline and support his one strongest argument against this dual-class recapitalization

5. (15 minutes / 20 typed lines) In the prospectus that B&J used to sell its stock to public investors, the company described the B&J corporate philosophy of enlightened capitalism -- "to make and sell only all-natural ice cream made from New Columbia dairy farms; to operate the business in a way that improves the quality of life for the community; and to operate the business to make money for shareholders and create career opportunities for employees." Soon after the successful offering, B&J begins to donate 31% of pre-tax profits to the B&J Foundation, set up to administer the company's charitable giving. Jerry, who loves to spread joy and give money away, runs the Foundation. Cosmo, B&J's biggest shareholder, says these gifts violate the directors' duties. Outline and support Cosmo's one strongest argument.

6. (15 minutes / 20 typed lines) Cosmo thinks little of the board's generosity to B&J Foundation and vows he will obtain justice: "It's the principle of the thing." Cosmo sends a letter to the board demanding that the directors stop the gifts. After waiting 4 months without an answer, he brings a derivative suit challenging the gifts. Ben and Jerry recuse themselves at a board meeting to consider the lawsuit; the three remaining directors (all long-time business friends of Ben and Jerry) decide the gifts promote B&J's image and make Jerry feel good. Further, the directors believe the gifts fulfill B&J's stated objective to benefit the community. On this basis, the directors ask the judge to dismiss Cosmo's suit. Outline and support Cosmo's possible arguments against dismissal.

7. (15 minutes / 20 typed lines) Cosmo's suit fails. Ben and Jerry begin to wonder whether enlightened capitalism really needs outside investors. They want to eliminate all non-employee shareholders and ask you (the company's lawyer) to structure an "employee buyout" (EBO) in which public shareholders will be cashed out for $30 a share and B&J employees will come to own the company 100%. B&J can borrow the money to do this from local banks. Ben points out to you that $30 is a 50% premium over the current market of $20, though he confides that he would be willing to buy at $50 a share -- if the banks were willing to lend that much. Do two things: (1) outline a transaction and (2) detail the process for its approval. Remember you want the EBO to withstand scrutiny.

8. (15 minutes / 20 typed lines) Your EBO plan looks good, and the B&J board approves it. But before the board announces its plan, Ben has an ingenious idea. It just might work. He suggests that B&J let Elaine xx (a well-heeled stock investor) know about the pending EBO, allowing her to buy lots of $20 stock on the market before the $30 buyout is announced. Elaine will get a big holding. If she votes for the EBO (an implicit quid pro quo for the tip), she will help ensure the EBO's approval. Elaine's buying will also signal to the market that something good is afoot. The board formally approves Ben's crafty plan. Will Elaine violate Rule 10b-5 if she trades on Ben's tip?

LONG ESSAY (60 minutes / 75 typed lines)

Debri Basura owns Wastinc, a recycling business incorporated in New Columbia, an RMBCA jurisdiction. Her forty-employee operation grinds newspapers, office paper and telephone books into ash, then processes and bales the product, and sells it. Basura says new markets for her product are springing up everywhere: "Chicken growers use it -- first for bedding and then for fertilizer. It's also used in interior insulation since it's flame-retardant and kills termites and other pests. It can even be used as mulch for road banks: just add grass seed and fertilizer."

Basura wants to expand, but paper recycling equipment is expensive. She runs into Bagley Carp, a venture capitalist, who says he might fund her expansion. Basura doesn't know much about venture capitalists and asks Carp some questions:

Q: What is a venture capitalist?
A: An active investor who looks for private companies with high growth potential -- an average 30-50% annual rate of return. Typically, I'll want a board seat and I'll help set strategy, recruit key employees, and find additional financing. Many venture capitalists are actually limited partnerships that invest in many projects, but some (like me) are individuals.

Q: What has been the track record of venture capitalists?
A: Over the last 20 years, US venture capitalists have invested only $3 billion annually, compared to $550 billion in annual corporate capital and R&D expenditures. Yet venture capitalists have nurtured the most important new businesses: Digital Equipment, Intel, Apple, Tandem, Compaq, Federal Express, Lotus Development, Microsoft, Genentech, Genetics Institute, Raychem, Teradyne, and Staples.

Q: You say you'll invest $20 million. How?
A: Usually I stage my commitment of capital. Rather than commit the full $20 million, I'll invest a modest amount up front, like $500,000, to finish engineering work and write a business plan. Then, I'll reserve the right to invest more in a second stage to build a pilot plant. Finally, if the project makes sense, I'll fund it all.

Q: How much equity will you want?
A: A lot, but at each stage, I'll make sure you and your employees keep a majority of the company's equity shares.

Q: What will you want of me, the entrepreneur?
A: First, you and other employees will be paid a modest salary and receive the rest of your pay as nonconvertible common. Second, I'll take convertible common. If the venture is a flop, I'll convert my shares into preferred shares with a liquidation preference, and you'll have worked for below-market pay and worthless equity.

Q: Are you sadistic?
A: No, just realistic. By staging capital and structuring pay, I'll give you incentives to stay at the project and to keep me from pulling out. And if things go well, we will all get incredibly rich. After a time -- let's say 5 or 10 years -- we can take the company public.

Q: Why should I choose to live with you breathing down my neck?
A: Well, you won't find a bank to finance your dreams -- they can't take a security interest. And if you go work for a big recycling company (like BCI), maybe you'd get financing for your ideas. But you'd only get a salary and a gold watch when you retire!!

Q: What if I went to another country with my idea?
A: Don't bother with Japan or Germany; they don't have venture capitalists. But you might get some funding in a few developing countries where venture capitalism is growing.

Basura listens and smiles. She thinks, "Well, I would guess that corporate law will protect me from this shark." She consults you (her lawyer) and wryly asks the following humdingers:

"First, how might corporate law (statutory and judicial) protect me from Carp's overreaching?"
"Second, how might Carp work around these protections?"
"Third, should corporate law impose any mandatory terms in a venture such as this one?"

New Columbia is an eclectic state that borrows caselaw on close corporations from many jurisdictions. "Boy, this is going to be fun," you think as you begin to mull your answer.