Bar Exam Business Associations 2 — Questions and Answers

Question 1: Under the business judgment rule, which standard applies when a court reviews a corporate director's business decision?

Directors are strictly liable for any business decision that results in a loss to the corporation
The director must prove the decision was made in good faith and in the best interests of the corporation to avoid liability
Courts will not second-guess a director's business decision if the director acted on an informed basis, in good faith, and in the honest belief that the action was in the corporation's best interests (Correct answer)
Directors are subject to a negligence standard — they must exercise the care of a reasonable businessperson in all decisions

Correct answer: Courts will not second-guess a director's business decision if the director acted on an informed basis, in good faith, and in the honest belief that the action was in the corporation's best interests

The business judgment rule is a presumption that directors acted on an informed basis, in good faith, and in the honest belief that the action was in the best interests of the corporation. Courts will not substitute their business judgment for that of the directors, and the plaintiff bears the burden of overcoming the presumption.

The business judgment rule is the cornerstone of corporate law. Under the rule: courts presume that directors acted on an informed basis (did due diligence), in good faith (no self-dealing), and in the honest belief that the action was in the best interests of the corporation. To overcome the presumption, plaintiffs must show: (1) gross negligence (inadequate information gathering — Smith v. Van Gorkom, Del. 1985); (2) bad faith or disloyalty; or (3) a conflict of interest (interested director transaction). If the presumption is overcome: the burden shifts to the director to show the entire fairness of the transaction (fair dealing + fair price). The rule does NOT protect: self-interested transactions (require entire fairness review); decisions to entrench management; corporate waste (ultra vires gifts, decisions with no rational business purpose); or decisions made in bad faith. Delaware applies the most influential corporate law, but the MBCA (Model Business Corporation Act) governs on the MBE.

Question 2: Under partnership law, when does a general partner have apparent authority to bind the partnership?

Only when acting under the explicit written authorization of all other partners
When carrying on business of the kind usually carried on by the partnership in the ordinary course, unless the third party knows the partner lacked authority (Correct answer)
Only for transactions not exceeding a dollar threshold set in the partnership agreement
General partners never have apparent authority — only express authority from the partnership agreement

Correct answer: When carrying on business of the kind usually carried on by the partnership in the ordinary course, unless the third party knows the partner lacked authority

Under UPA § 301 and RUPA § 301, a partner is an agent of the partnership for the purpose of carrying on the business in the ordinary course. Acts within the ordinary course bind the partnership unless the acting partner had no authority and the third party knew or had received notification of the lack of authority.

Under the Revised Uniform Partnership Act (RUPA) § 301: (1) A partner is an agent of the partnership for the purpose of its business; (2) An act of a partner for apparently carrying on in the ordinary course the partnership's business binds the partnership, unless the partner had no authority to act for the partnership in the particular matter AND the person with whom the partner was dealing knew or had received notification that the partner lacked authority. Extraordinary acts (outside the ordinary course) require authorization by all partners. Examples of ordinary course acts binding the partnership: entering into contracts within the partnership's business, purchasing inventory, hiring employees in the usual scope of business. Acts requiring all partners' consent: disposing of partnership goodwill, acts making it impossible to carry on ordinary business, confessing a judgment, submitting a claim to arbitration, assigning partnership property. Apparent authority protects innocent third parties relying on a partner's usual authority — the partnership cannot silently restrict a partner's authority and then deny liability to good-faith third parties who were unaware of the restriction.

Question 3: Under Delaware corporate law and the MBCA, what is the standard of review for a controlling shareholder's transaction with the corporation?

Business judgment rule, because shareholders have the right to vote in their own interests
Entire fairness review — the controlling shareholder must show the transaction was entirely fair in terms of both process (fair dealing) and price (fair price) (Correct answer)
Reasonable person standard — courts ask whether the transaction was what a reasonable investor would approve
There is no special review — controlling shareholders have absolute discretion over transactions with their corporation

Correct answer: Entire fairness review — the controlling shareholder must show the transaction was entirely fair in terms of both process (fair dealing) and price (fair price)

When a controlling shareholder engages in a transaction with the corporation, it constitutes a conflict of interest that removes the business judgment rule's protection. Delaware courts apply the 'entire fairness' standard, requiring the controlling party to prove both fair dealing (the process by which the transaction was structured and approved) and fair price (the economic terms).

In Weinberger v. UOP (Del. 1983), the Delaware Supreme Court established the entire fairness standard for transactions involving controlling shareholders (those who own or control a majority of voting power). Entire fairness has two components: (1) Fair dealing: when, how, and who initiated the transaction; how it was structured and negotiated; how approval was obtained (independent committee, disinterested shareholders); and how the stockholders were told about it; (2) Fair price: all factors relevant to the value — assets, market value, earnings, future prospects, other elements affecting intrinsic value. Entire fairness shifts the burden to the controlling party — they must prove both components. Business judgment rule is restored if: (1) the transaction is approved by a properly functioning special committee of independent directors AND (2) the transaction is approved by an informed vote of a majority of the minority shareholders (MFW Shareholders Litigation, Del. 2014, adopted MFW framework). This dual protection restores the business judgment rule from the outset.

Question 4: Under RUPA, which of the following events causes a dissolution of a partnership?

A partner's temporary incapacity lasting more than 30 days
A partner's wrongful dissociation or dissociation by a partner who causes winding up of the partnership under the partnership agreement or by judicial decree (Correct answer)
Any change in the partners' profit-sharing arrangement
The admission of a new partner to the partnership

Correct answer: A partner's wrongful dissociation or dissociation by a partner who causes winding up of the partnership under the partnership agreement or by judicial decree

Under RUPA, dissolution and winding up are triggered by specific events: a partner's dissociation in circumstances that require winding up (such as rightful dissociation in an at-will partnership or dissolution by court order for improper conduct). Not every dissociation causes dissolution — RUPA allows the remaining partners to continue the business in a buyout situation.

RUPA separates dissociation (a partner leaving) from dissolution (winding up the partnership business). Dissociation events (RUPA § 601): voluntary withdrawal, expulsion, death, bankruptcy, etc. Dissociation does NOT always cause dissolution. Dissolution triggered by dissociation (RUPA § 801): (1) In an at-will partnership, a partner's rightful express will to withdraw causes dissolution; (2) In a term or undertaking partnership, unanimous consent of remaining partners, expiration of term, or completion of undertaking; (3) Judicial dissolution (RUPA § 801(5)): court order for wrongful conduct, impracticability of carrying on business, or oppression of minority partners. Wrongful dissociation (RUPA § 602(b)): breaching the partnership agreement or dissociating in violation of a term/undertaking partnership — the dissociating partner is liable for damages but the partnership may continue without them. If dissociation does not cause dissolution: the partnership must buy out the dissociating partner's interest at the greater of the liquidation value or the value based on the going concern (RUPA § 701).

Question 5: Under LLC law, which of the following best describes the 'charging order' remedy available to a creditor of an LLC member?

The creditor may force a sale of the member's interest to satisfy the debt
The creditor receives the right to receive distributions that would otherwise be paid to the debtor-member, but cannot become a member or exercise membership rights (Correct answer)
The creditor steps into the shoes of the member with all voting rights and management rights
The creditor may attach and seize any assets of the LLC to satisfy the personal debt of a member

Correct answer: The creditor receives the right to receive distributions that would otherwise be paid to the debtor-member, but cannot become a member or exercise membership rights

A charging order is the exclusive remedy available to a judgment creditor of an LLC member in most states. It gives the creditor the right to receive distributions paid to the debtor-member — like a lien on the economic rights — but it does not give the creditor membership rights (voting, management participation).

The charging order is a key LLC protection concept. In most states and under the Uniform LLC Act, a personal creditor of an LLC member (with a judgment against the member personally, not against the LLC) may only obtain a 'charging order' — not take the member's interest outright. Effect of a charging order: (1) The creditor receives distributions that would otherwise be paid to the debtor-member; (2) The creditor does NOT become a member — no voting rights, no management participation, no right to inspect books; (3) The creditor cannot force distributions or liquidation. This means a creditor gets only what the LLC voluntarily distributes — if the LLC makes no distributions, the creditor gets nothing (and may even owe taxes on the LLC's income under IRS rules since the creditor holds an economic interest). In many states, the charging order is the exclusive remedy — the creditor cannot foreclose on the membership interest. Some states (like Delaware) allow foreclosure of the interest after a charging order, but the purchaser still only gets the economic interest (not membership/voting rights) unless the operating agreement permits or the other members consent.

Question 6: Under corporate law, the duty of loyalty requires a director to avoid self-dealing. Under the MBCA § 8.61, an interested director transaction is NOT voidable if:

The transaction benefits the corporation and the interested director recuses from the vote
The material facts of the transaction were disclosed to the board and it was approved by a majority of disinterested directors, OR approved by a majority of shares held by disinterested shareholders, OR the transaction was fair to the corporation at the time authorized (Correct answer)
The director owned less than a majority of the outstanding shares of the corporation
The interested director can demonstrate that the transaction was commercially reasonable based on market conditions

Correct answer: The material facts of the transaction were disclosed to the board and it was approved by a majority of disinterested directors, OR approved by a majority of shares held by disinterested shareholders, OR the transaction was fair to the corporation at the time authorized

MBCA § 8.61 provides three safe harbors for interested director transactions: (1) approval by a majority of qualified (disinterested) directors after full disclosure; (2) approval by a majority of disinterested shareholders after disclosure; or (3) the transaction was fair to the corporation at the time it was authorized. Any one of the three safe harbors validates the transaction.

Interested director (self-dealing) transactions were historically void under early common law. Modern law under MBCA § 8.60-8.63 and Delaware law validate such transactions if properly approved or fair. The MBCA provides three safe harbors (any one suffices): (1) Qualified director approval: a majority of 'qualified directors' (disinterested and informed) approves after full disclosure of the conflict and material facts — quorum is met if there are at least two qualified directors (or one, if that was all that could be assembled under MBCA § 8.62); (2) Qualified shareholder approval: shareholders who are not directors or parties to the transaction approve by a majority of voting shares after disclosure; (3) Fairness: the person asserting validity establishes the transaction was fair to the corporation. Under Delaware law, entire fairness review applies to interested transactions, with the burden on the interested party, unless one of the above processes cleanses it. The 'fairness' safe harbor shifts the burden to the plaintiff to show unfairness if shareholder or director approval was obtained.

Bar Exam Business Associations 2

Under the business judgment rule, which standard applies when a court reviews a corporate director's business decision?