Here is a little problem to warm up and introduce some basics of agency and partnership. Before attempting the problem, please read (!): Uniform Partnership Act (1914) §§ 6(1), 7(4), 9(1), 13, 15, 21(1), 29, 31(1)(b), 37, 38(1); Restatement of the Law (Third) Agency §§ 1.01, 1.04(7), 2.01, 2.03, 2.05, 3.01, 3.03, 4.01(1), 4.02(1), 6.01, 7.03, 8.01-03.
Louis comes to you in distress. He tells you the following:
“Kathryn and I have been operating a pizza shop here in Cambridge for years. From a business perspective, we are doing extremely well. Personally, however, things have not been going so well lately. We have been fighting a lot. Today, I received a letter from Kathryn’s attorney ‘demanding and declaring that the business be dissolved and all assets liquidated to pay off the debt.’ I have no idea what that means but I guess it’s serious?
“’All assets’ is a fancy term, too! It is essentially one big pizza oven that we bought a year ago. We lease the store and our three delivery cars. We just renewed the leases a year ago for a five-year term. They all include penalties for early resolution, and they are not assignable. I reckon the penalties would collectively amount to $50,000 if we had to terminate the contracts now! And that oven, there’s a problem there if we have to sell it now, too: it was custom-fit to our location, so I doubt we’d get more than $50,000 for it. But we still have that bank loan for about $100,000 that we used to finance it.
“Is that all? Well, actually, there is another issue that came up right after I received the letter. That guy Steve – he generally buys our veggies and stuff. Goes to the wholesalers every week, they know he works for us. He gets the stuff, they debit our account, and we pay them by check later. Of course, after I got the letter, I told him not to buy anything today – who knows if we’ll ever need it! But he just goes off and buys everything – and then crashes the car on the way back! Apparently he did major damage because now I am getting all these phone calls from various people and their attorneys demanding that I pay some crazy amounts. But I didn’t drive that car, or put in those orders. Why should I pay for them?
“And I sure hope I can keep the shop running. At least I don’t want to be settled with that bank loan if we do have to close. What do you think? Is there anything else you need to know?”
We just looked at Louis and Kathy’s pizza shop from a litigator’s perspective. Most of the work of corporate lawyers, however, is to avoid disputes arising in the first place, in particular to design procedures that will resolve conflicts without litigation. So let’s travel back in time six years.
Kathy and Louis ask you to set up the legal side of a pizza shop they envision. (Question: can you ethically represent both of them in this matter?)
Louis has been working as a baker in a local bakery for many years. He will give up his job to become the pizza shop’s general manager and, for the time being, only full-time employee. Kathy runs a marketing agency that does lots of business with mostly upscale restaurants. She will work on generating demand for the pizza shop in her spare time, while continuing to run her agency.
Kathy and Louis are childhood friends. They still spend a lot of time together. The idea for the pizza shop started at a recent dinner where they were both unhappy with the pizza. They concluded that they could do this better, and that there would be demand for better pizza in Cambridge. Over the next couple weeks, they worked out a business plan. They believe the pizza shop will be quite profitable.
They initially thought that Louis should set up the shop by himself, and that Kathy would just help out with the initial marketing. The problem is, however, that Louis doesn’t have the cash to make the required investments. To be more exact, Louis is totally broke. A bank is willing to lend $100,000 to buy the pizza oven (the single biggest expense), taking a security interest in the oven. But the bank is not willing to lend unsecured for the initial operating expenses (supplies, drivers’ salaries, etc.). Kathy and Louis are confident that the store will be profitable eventually. But they reckon it will take a couple months to get there. In the meantime, expenses will need to be paid, including Louis’s living expenses.
As a solution, Kathy offers to invest some of her retirement savings in the pizza shop. The number they envision – roughly their estimate of six months of expenses – is $60,000. She and Louis also hope that Kathy may eventually join the business full time if things go well – in the long run, they dream of developing a chain.
Question: How would you advise Kathy and Louis to structure their business relationship? What eventualities should they be prepared for? To make this more concrete, assume that the only reasonable entity to form is a corporation (in reality, they might use an LLC). Which, if any, provisions would you advise they write into the charter or into the bylaws?
Skim: model bylaws.
Optional: take a glance at DGCL 273 (joint venture dissolution) and 341 et seq. (close corporations).