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Chapter 17
Law and Business Associations—II
Introduction
Chapter Seventeen addresses these questions:
• What is a corporation?
• How are corporations classified?
• How are corporations created?
• How are corporations financed?
• How do corporations operate?
• What are limited liability companies?
• What are some global dimensions of corporations?
Chapter Seventeen is important because it focuses on corporations and what power they
Achieving Teaching Excellence
One of the most valuable lessons instructors can pass along to their students is a love of
asking questions. Instructors ask questions, not because it is just a habit, but rather because every
answer they have seem to contain within it a set of unanswered questions, which are just waiting
to be explored.
One of the strongest forms of questions is to regularly be curious about context. Many of the
facts in a fact pattern for a legal case are crucial to understanding the case because those facts
Chapter Overview, Topic Outline, and Discussion Questions
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Chapter Overview
This chapter’s primary focus is on how corporations are classified, created, operated, and
financed. Most business students already understand what a corporation is so instructors may
want to focus on the more complex sections, such as fiduciary obligations and its cases. LLCs
Topic Outline
I. The Corporation
II. Classification of Corporations
A. Closely Held Corporation
B. Publicly Held Corporation
C. Multinational or Transnational Corporation
D. Subchapter S Corporation
III. Creation of Corporations
A. Brennan’s Inc. v. Colbert
IV. Financing of Corporations
A. Debt Financing
2. Secured Bonds
4. Convertible Bonds
6. AAA Bonds and Junk Bonds
B. Equity Financing
1. Classes of Stock
C. Consideration
V. Operation of Corporations
A. The Role of the Shareholders
B. The Role of the Board of Directors
1. In Re Abbott Laboratories Derivative Shareholders Litigation
C. The Role of the Officers and Managers
D. Fiduciary Obligations of Directors, Officers, and Managers
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2. Smith v. Van Gorkom
VI. Limited Liability Companies
A. The Uniform Limited Liability Act
B. LLC Characteristics
C. Creating a Limited Liability Company
1. Gatz Properties, LLC v. Auriga Capital Corporation
VII. Global Dimension of Corporations: A “Big Fat Greek” Bailout II and III
VIII. Summary
Discussion Questions for Chapter Seventeen
1. Evaluate this statement: The corporate form of business association is the most common
form.
2. Explain relationships between publicly and privately held corporations.
Publicly held corporations are those corporations whose stock is traded on the national
3. Explain relationships between subchapter S corporations and limited liability corporations.
The subchapter S corporation is a type of closely held corporation. It is a hybrid of the
corporation and partnership. It is organized and operates as a regular business corporation,
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4. Explain relationships between closely held and subchapter S corporations.
5. Evaluate this statement: Professional corporations enjoy limited liability.
The professional corporation is new, and is used by professionals such as doctors and
6. Why should the corporate form of business associations be studied carefully?
7. Explain relationships between debt financing and equity financing.
Debt financing means taking out loans in the form of notes, bonds, and debentures. Equity
8. Would an investor rather own common or preferred stock? Why?
9. How does the law of agency relate to this chapter?
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10. Explain relationships between the corporate opportunity doctrine and the business judgment
rule.
Both are common law rules that protect the corporate form of business association. The first
11. Explain relationships between the business judgment rule and piercing the corporate veil.
The business judgment rule says that corporate officers and directors are not liable for
honest mistakes of business judgment. Piercing the corporate veil is a legal doctrine used by
Answers to Critical Thinking about the Law Questions, Case Summaries,
Answers to Review Questions, Review Problems, and Case Problems
Suggested Answers to Critical Thinking about the Law Questions
1. No. Because Drill Baby Drill’s number one priority, as required by law, is to pursue profits,
it is easy to assume that the corporation would use its money to elect politicians that would
best help the corporation. Drill Baby Drill would want the politicians to have the
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2. Most corporations are seeking to represent different interests than the average citizen, such
as maximizing their profit or helping their interests internationally (in the case of MNCs).
3. Corporations are conglomerates of many individuals who already have the right to vote.
Allowing corporations to have political equality would give some individuals the ability to,
Case Summary—Brennan’s Inc. v. Colbert
The Brennan brothers are the shareholders of Brennan’s Inc., a close corporation. The
Brennan brothers retained attorney Edward Colbert and his firm, Kenyon & Kenyon LLP, to
represent Brennan’s Inc. All legal bills were sent to Brennan’s Inc., and the payments came from
the company’s checking accounts. Brennan’s, Inc. did not hold formal corporate meetings, but it
did maintain corporate books, hold corporate bank accounts, and file corporate tax returns. In
2005, Brennan’s Inc. sued Colbert and his law firm for legal malpractice. In its answer, Kenyon
& Kenyon demanded unpaid legal fees from both Brennan’s Inc. and the Brennan brothers
personally. The trial court found the Brennan brothers could not be held personally liable.
Kenyon & Kenyon appealed. The law firm argued that the court should pierce the corporate veil
because Brennan’s Inc. did not observe corporate formalities and the Brennan brothers did not
honor their promise to pay their legal bills.
Case Summary—In re Abbott Laboratories Derivative Shareholders Litigation
This case deals with the role of the board of directors. Abbott Laboratories, an Illinois
corporation, was fined for a civil violation of Food and Drug Administration (FDA) regulations.
The FDA regulated Abbott to take off 125 types of medical diagnostic test kits, destroy
inventory, and make certain corrective changes in the manufacturing procedures. Even after
repeated warnings Abbott failed to implement the changes following which its shareholders filed
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a suit against the directors for its repeated non-compliance with regulations and quality control
violations. This case was dismissed by the district court and the plaintiffs appealed.
Case Summary—Beam v. Stewart
This case deals with fiduciary responsibility. Beam brought suit against Martha Stewart, the
director, founder, and CEO of Martha Stewart Living Omnimedia (MSO). The image of the
company is tied to that of Stewart as a media personality and if her name were to be tarnished,
Case Summary—Smith v. Van Gorkom
The chapter includes this case to highlight the issue of a director’s duty of care. In this case,
a shareholder, Smith, became a plaintiff after he and other shareholders discovered that a board
Suggested Answers to Critical Thinking about the Law Questions
1. Two examples of ambiguous words are “fairness” of the $55 price per share, and
2. The court’s decision making is conclusory. The decision jumps right from the issues to the
conclusion without stating how the court got from one to the other.
Case Summary—Gatz Properties, LLC v. Auriga Capital Corporation
In 1997, Gatz Properties, LLC and Auriga Capital Corp., along with other minority
investors, formed Peconic Bay, LLC to lease and develop a golf course on property owned by the
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improvements and entered into a sublease with American Golf Corp. to operate the course. The
operation was never profitable. Knowing that American Golf would terminate the sublease, Gatz
had the property appraised. The improved land was valued at $10.1 million, but the development
value of the vacant land was $15 million.
A third party made an unsolicited offer to buy the property. Gatz was not cooperative. Gatz
sold the property at auction and Gatz Properties won the auction for $50,000 and assumption of
Answers to Review Questions
17-1. Notes are short-term loans, bonds are long-term loans, and debentures are unsecured
long-term corporate loans.
17-2. The various types of bonds are as follows:
• Unsecured Bonds—Usually called debentures, these bonds have only the obligation of
the corporation behind them. Debenture holders are unsecured creditors that rank equally
with other general creditors
• Secured Bonds—Secured, or mortgage, bonds provide the security of specific corporate
property in addition to the general obligation of the corporation.
17-3. A closely held corporation is a corporation whose stock is not traded on the national
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17-4. The text reminds the students that if a business is going to be paying its net profits to the
owners, the partnership formed prevents the double taxation problem of the corporate
17-5. A corporation is a business organization with an identity separate from that of its
17-6. The LLC is federally taxed, not as a corporation, but as a partnership, so taxes are paid
Answers to Review Problems
17-7. The appellate court concluded, inter alia, as follows:
a) Where an agreement is induced by fraud, the trial court has the equitable power to set
aside a provision of the contract in which the parties released all unknown claims. The
17-8. The district court found in favor of Lyons, concluding that there was a written contract to
perform the identified work for $19,810, as well as a series of binding oral agreements for
additional concrete work for $20,310. The Supreme Court of Montana affirmed the
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17-9. In this case Mr. Jones sold the ski shop franchise to Mr. Hamilton. Following that Mr.
17-10. Even in the absence of proper documentation the partnership agreement was valid as
Answers to Case Problems
17-11. The court held that there was a de facto merger of A World of Pets into A World of Pups,
and that the latter was responsible for the liabilities of the former. The court noted that the
hallmarks of a de facto merger are the “continuity of ownership; cessation of ordinary
business and dissolution of the predecessor as soon as possible; assumption by the
17-12. The appellate court ruled that the defendant’s motion to dismiss the complaint was
properly denied. In support of its decision, the court noted that a shareholder in a closely
held corporation may assert a personal cause of action alleging breach of fiduciary duty
17-13. The appellate court affirmed the district court’s order piercing Loop’s corporate veil. In
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support of its holding, the court noted that Illinois law permits veil piercing when two
separate elements are met: a) there must be such unity of interest and ownership that the
17-14. As the manager, Hoaas was responsible for the debt Grand Casino incurred from the
missing money and owes Griffiths that money. Griffiths, on the other hand, was
responsible for withholding profits and selling the casino without informing Hoaas. He
Thinking Critically about Relevant Legal Issues
1. The author concluded that corporations should be made illegal. To back that up, he cited
2. The author is only addressing large corporations that operate, many times, in many
3. The opposite view would include an account that corporations are the evolution of the “mom
and pop” and fall right into capitalism. To maximize profits, owners band together to create