Business Associations

Week 01 Coverage

Business Associations covers business entities from sole proprietorships to corporations, including formation, operation, dissolution, agency relationships, owner and manager duties, corporate financing, securities-law overlays, and SEC registration.

Week 01 establishes the starting framework: why business organizations exist, how entity law manages cooperation and risk, and why entity choice affects liability, tax, governance, control, capital, exit, and professional responsibility.

The sequence for the week is: business organizations as legal structures, the benefits and costs of working through others, agency cost, fiduciary duties, sources of business-organization law, entity selection, federal tax classification, and the lawyer's role when forming or advising an organization.

The Opening Question

The first week begins with a basic question: why do business organizations exist at all? The chapter answers that business organizations are legally recognized forms of association created for business and profit. They govern rights and responsibilities among the people inside the organization and the organization's relations with the rest of the world.

The subject divides roughly into three bodies of law. Corporate law governs corporations formed under state corporation statutes. The law of unincorporated entities governs forms such as general partnerships, limited partnerships, and limited liability companies. Agency law supplies general rules for relationships in which one person acts for another and subject to that person's control. Agency is a building block because business almost always requires acting through other people.

The materials emphasize that business entities solve relationship problems. People need structures for ownership, investment, work, management authority, profit sharing, liability, exit, and relations with outsiders. Without a legal structure, recurring questions about who controls what, who receives what, and who bears which losses would have to be renegotiated from scratch.

Chapter 1 also introduces juridical personhood. The entity can be treated as a legal person separate from its owners, which lets the law assign rights, duties, assets, obligations, lawsuits, governance powers, and liability rules to the organization rather than only to the human beings behind it. That fiction is the platform on which limited liability, centralized management, transferable shares, perpetual existence, and entity-level governance are built.

Why People Do Business Together

The materials do not treat cooperation as obviously easy. They begin from the idea that joint ownership can generate quarrels, opportunism, and conflict. The Kapauku example is used to show a society with money, credit, interest, sales, and capital, but no common ownership because people feared that co-ownership would invite conflict.

The first reason for business organization is scale: one person often lacks enough time, skill, labor, or money to carry out the business alone. Some businesses require more capital than any one entrepreneur can supply, and many businesses require multiple people with different skills.

The second reason is division of labor. Adam Smith's pin factory example shows that specialization can change production capacity completely: the transcript gives the figure of ten workers producing about 48,000 pins per day, or 4,800 per worker, where one worker alone might produce only one or a few. The legal lesson is that once production depends on coordinated people, capital, property, and authority, the law needs rules for who can act, who must obey, and who bears consequences.

The transcript links the same scale idea to Walmart. Sam Walton opened one store in Rogers, Arkansas in 1962. By 1972 Walmart had gone public with 32 stores at an initial public offering price of $16.50 per share. By 1982 it reached $1 billion in annual sales with 276 stores and 21,000 employees. By 1992 it had 1,960 stores and 400,000 employees generating nearly $50 billion in sales. By 2024 it had about one million employees worldwide, and the transcript says its finance department alone had 3,369 people. That kind of organization cannot run on handshake intuition. It needs delegated authority, oversight, financing, employment systems, compliance, and entity law.

The chapter also uses Henry Ford's automobile production as another division-of-labor example. The point is the same as the pin factory: once work is broken into specialized subtasks, a group can produce at a scale and efficiency that individuals working separately could not approach.

The third reason is diversification of risk. An entrepreneur who funds a business alone bears all the loss if it fails. Bringing in others divides upside but also spreads downside and frees the entrepreneur's own assets for other uses. The materials also connect one-person businesses to practical fragility: if profits depend entirely on the owner's work, illness, injury, vacation, or retirement can threaten the business.

These advantages explain why people accept the danger of shared enterprise. The course is not saying cooperation is sentimental or naturally harmonious. It is saying cooperation can create scale, specialization, capital, and risk-spreading, and business-organization law exists because those benefits bring predictable conflict over control, money, loyalty, exit, and liability.

Agency Cost

The central problem created by cooperation is agency cost. When a principal relies on an agent, the agent's personal interests will not perfectly match the principal's. The principal wants effort, care, loyalty, transparency, and productivity. The agent may prefer less work for the same pay, personal advancement, perks, job security, or opportunities to exploit information or property.

The textbook describes the basic example as Boss hiring Employee. Employee may shirk, steal, misuse property, exploit trade secrets, or steal clients. The transcript gives Wells Fargo as a concrete example: between 2002 and 2016, employees opened about 3.5 million unauthorized accounts under sales pressure, costing Wells Fargo more than $3 billion in fines and reputational damage. The point is not only that employees behaved badly, but that incentives were misaligned with the company's interests.

Agency cost is not limited to employees. In a multi-member business, managers may control resources supplied by investors. Managers may misuse that control, work less hard than investors would want, pursue personal interests, or take the business in directions that do not match investor goals. Different investors may also conflict with each other. Business organization law responds with monitoring, voting rights, disclosure, derivative suits, judicial review, and fiduciary duties.

The transcript's Justice Frankfurter point sharpens the analysis: saying someone is a fiduciary only starts the inquiry. The next questions are to whom the fiduciary duty runs and what obligations the fiduciary owes. That matters because a CEO, partner, lawyer, director, officer, employee, or promoter may be acting around multiple constituencies, but the legal duty is not always owed to every person affected by the conduct.

The chapter also flags a counterpoint: discussions of agency cost often focus on the agent's incentive to shirk and say less about the employer's incentive to exploit. The materials state that business organization law mostly leaves many employee concerns to other fields of law.

Fiduciary Duties And Business Judgment

Fiduciary duties are presented as the main legal response to agency cost. A fiduciary is someone legally obligated to act for another rather than for herself. Corporate officers are fiduciaries of their corporations, partners and many managers of unincorporated entities are usually fiduciaries of their firms, and agents are fiduciaries of their principals.

The two core duties are loyalty and care. Good faith is treated in the transcript as a component of loyalty rather than a separate third duty. The duty of loyalty is the more stringent duty. It requires the fiduciary to act for the principal's benefit and not use the position for unauthorized personal benefit. The duty of care requires reasonable competence, skill, and diligence in performing the role.

The transcript translates loyalty into five concrete rules. An agent may not take unauthorized benefits, such as secret profits or kickbacks. An agent may not compete with the principal during the relationship in matters within the agency scope. An agent who learns of a business opportunity through the agency must present it to the principal first. An agent must safeguard and account for the principal's property and may not use it personally without permission. An agent may not use or disclose confidential information for personal benefit during or after the relationship.

The transcript uses Theranos as an example requiring careful party identification. Elizabeth Holmes's investors may have securities fraud claims, but the fiduciary duty discussed in the course ran to Theranos itself. The disloyal act was bad-faith conduct toward the company, including deliberate deception of the board about the product.

Loyalty claims use a burden-shifting framework. First, the plaintiff establishes a conflict of interest, such as a direct financial interest, a close associate's adverse interest, or fiduciary duties owed to conflicting parties. Once a conflict is shown, the burden shifts to the fiduciary to prove fairness. Fairness means good faith, full disclosure of the conflict and relevant facts, and terms as good as the principal could have received in an arm's-length transaction. Fully informed consent can also validate the transaction.

Care claims are analyzed differently. Ordinary agents and employees must use the care, competence, and diligence of a reasonable person in similar circumstances, and professionals must exercise their special skills competently. Corporate directors and senior managers making business decisions receive the more lenient business judgment rule. Courts presume they acted in good faith, with due care, and in the corporation's best interests; plaintiffs must show gross negligence, not mere ordinary negligence.

The transcript uses Boeing's 737 MAX governance failures as the duty-of-care example. The oversight issue is board-level process, monitoring, and attention to mission-critical risks. The example does not mean every failed business decision creates liability; courts remain more suspicious of conflicts and self-dealing than of honest but failed business judgment.

RUPA Section 409 supplies a partnership version of the same fiduciary vocabulary. Partners owe loyalty and care to the partnership and the other partners. The listed loyalty duties include accounting for property, profit, or benefits derived from partnership business, use of partnership property, or appropriation of a partnership opportunity; refraining from dealing with the partnership on behalf of an adverse interest; and refraining from competing with the partnership before dissolution. That statutory language tracks the Week One theme: default business forms carry duties even if the parties did not draft them carefully.

Where The Law Comes From

Business organization law is mainly state law. Each state has its own corporation statute, LLC statute, partnership statute, and limited partnership statute. Because state rules vary, an analysis begins by identifying the governing state law.

The history moves from restrictive special charters toward general, enabling statutes. Early American corporations usually required specific legislative charters, often had limited purposes and limited lives, could be restricted in powers and capital, and sometimes carried unlimited investor liability. General incorporation statutes began appearing in the nineteenth century, including New York in 1811 and Connecticut in 1837, but broad flexibility developed later as economic pressure increased after the Civil War.

The chapter's theme is that state business organization law usually moved in the direction business planners wanted. Capital limits and prohibitions on stock ownership by corporations led to workarounds such as trusts, with Standard Oil given as an example. The broader movement was from suspicion and restriction toward permissive enabling statutes that allow broad freedom to tailor ownership, management, powers, and duration.

Delaware's dominance is treated as historically accidental but institutionally self-reinforcing. New Jersey first attracted corporations with permissive law, then Woodrow Wilson's reforms made New Jersey more restrictive, and companies moved to Delaware. Delaware's Court of Chancery, specialized equity jurisdiction, deep corporate case law, flexible statute, and corporate infrastructure made it the leading corporate-law jurisdiction. The transcript gives Delaware as home to 67 percent of Fortune 500 companies, more than half of all publicly traded U.S. companies, and more than 1.5 million business entities. It also states that Delaware generates more than $1 billion annually from corporate franchise taxes and fees.

The statutory supplement is the course's replacement for a purchased statutory supplement. It identifies official sources for the Restatement (Third) of Agency, RUPA, UPA, ULPA, the Delaware LLC Act, ULLCA, the DGCL, the MBCA, federal securities statutes and SEC rules, Rule 23.1, Business Roundtable materials, Delaware entity filing forms, SEC filing forms, and IRS Forms 8832 and 2553. Week One does not require memorizing that entire universe, but it does require knowing where each source fits.

The course will use representative sources rather than every state statute: the Model Business Corporation Act, the Delaware General Corporation Law, the ALI Principles of Corporate Governance, RUPA and other uniform unincorporated entity codes, the Restatement (Third) of Agency, and the ABA Model Rules of Professional Conduct. Federal securities law is an overlay for some corporate activity, but the basic internal affairs and governance law of business entities is state law.

The internal affairs doctrine appears in the transcript as the practical reason state-of-formation choices matter. The state of formation generally governs internal governance questions regardless of where the business physically operates. That is why choosing Delaware, a home-state statute, or another state is not just clerical filing work. It can decide the governance law that later applies to fiduciary duties, voting, litigation, and owner disputes.

Choice Of Entity

The lawyer's practical task is entity selection. The client may ask whether to incorporate, form a partnership, form an LLC, form a limited partnership, or do something else. The materials stress that no entity choice is perfect and no list of concerns is complete. The work is trade-off analysis tied to the client's business, risk profile, tax situation, capital needs, control preferences, and exit expectations.

Six factors organize the analysis. Liability protection asks whether owners can be personally responsible for business obligations. Tax treatment asks whether income is taxed once through pass-through treatment or twice through corporate-level and shareholder-level taxation. Governance and internal conflict ask who decides, how authority is allocated, and how disputes are resolved. Returns, liquidity, and exit ask how owners receive profit and whether they can leave or sell. Capital structure asks how the business will raise debt or equity. Red tape asks how much formation, recordkeeping, meeting, compliance, and formal maintenance the form requires.

Limited liability is powerful but bounded. A shareholder who paid $500 for corporate shares may lose that investment if the corporation fails, but corporate creditors generally cannot take the shareholder's house, car, or bank account just because the shareholder is an owner. The limit is personal conduct: the Hoagland citation marks that limited liability does not protect an investor who personally causes the corporation to commit a tort or other unlawful act.

The transcript makes the liability factor concrete by comparing businesses with different risk profiles. A manufacturer faces product-liability exposure. A contractor faces premises and job-site exposure. A professional services firm faces malpractice exposure. A lower-risk solo consultant may still want insurance and clean contracts, but the case for entity formation may be different. Entity selection is therefore not an abstract preference for LLCs; it depends on what can go wrong in the actual business.

Governance and internal conflict matter because ownership disagreement can deadlock a business. The corporate default separates shareholders, directors, and officers, which works well for many large passive-investment structures but may frustrate founders who each expect equal control. General partnership defaults are more flexible and give partners equal management rights unless varied by agreement, but that same flexibility comes with serious default consequences if the parties never write down their arrangement.

Returns, liquidity, and exit are separate from control. Corporate shareholders normally receive profits only if the board declares dividends, while partners can often agree to periodic distributions. Publicly traded corporate shares are highly liquid because they can be sold into an active market, but shares in a closely held corporation may be hard to sell at fair value. Partnership interests can also be hard to sell because managerial rights usually cannot be transferred without consent, but withdrawal may trigger a statutory buyout unless the partners have agreed otherwise.

Capital structure asks whether the business will use debt, equity, or both. Any business can borrow, but equity investment works differently across forms. Corporations can sell passive ownership interests without giving investors management rights or personal liability. A general partnership cannot do that cleanly because every equity investor is a general partner with management rights, rights in profits and property, and unlimited personal liability. The transcript also ties entity choice to compensation tools: stock options fit corporations, while profits interests fit partnerships and LLCs.

Red tape has both formation and maintenance sides. Sole proprietorships can begin without entity formation, and general partnerships can arise accidentally. LPs, LLCs, and corporations require state filings. Corporations usually carry the heaviest ongoing formalities: shareholder meetings, board meetings with minutes, stock ledgers, formal books of account, and separation of company money from shareholder or manager money. The chapter connects these formalities to later veil-piercing risk.

The transcript adds that entity selection intersects with the whole business picture. The lawyer needs to understand the value proposition, capital needs, marketing and branding, risk management, operating systems, talent and compensation needs, and exit plan. A technically correct entity recommendation can still miss the business point if it ignores those facts.

The final frame is that entity choice is not a one-time decision. A solo consultant forming an LLC has one problem set. The same client bringing in outside investors three years later has a different problem set. The materials repeatedly return to review and redesign because businesses change, tax consequences change, state-law consequences change, and the best structure at formation may not remain the best structure later.

Tax Classification And Planning

The materials give only a beginner's guide, but the basic distinction is pass-through taxation versus double taxation. In a pass-through entity, the entity calculates and reports income but generally does not pay federal income tax; income and losses flow to the owners. In a C corporation, the corporation pays tax on profits, then shareholders pay tax on dividends from after-tax profits.

The chapter's simple numbers assume a 10 percent rate. If a corporation earns $10, it pays $1 in corporate tax, distributes $9, and shareholders pay $.90, for a total tax burden of $1.90. If an equal partnership earns $10, the partners together pay $1, and the partnership pays no income tax.

Several simplifying tax rules matter for entity choice. Only profits are taxed. Pass-through businesses generally pass profit to owners. C corporations face double taxation by default. Salaries and interest are deductible business expenses. Dividends and owner distributions as owners are not deductible, though salary paid to an owner as an employee is deductible. The materials note that after the 2017 Tax Cuts and Jobs Act, the corporate rate was 21 percent, individual rates ranged from 0 to 37 percent, dividend rates ranged from 0 to 20 percent, and many pass-through owners could deduct 20 percent of passed-through income, with limitations.

Check-the-box rules changed planning. An entity created under a statute that describes it as incorporated or as a corporation is taxed as a corporation. A non-corporate entity with at least two members defaults to partnership taxation unless it elects corporate treatment. A single-member non-corporate entity defaults to disregarded status unless it elects corporate treatment. A change back within five years requires Treasury permission, and conversion from corporate to partnership treatment can be taxable.

The transcript cautions that pass-through taxation is not automatically superior. A corporation that retains and reinvests earnings may defer the second layer of tax. A flat corporate rate may be better than immediate individual pass-through tax in some high-growth settings. Corporations may also reduce double taxation by paying deductible salaries, paying interest on shareholder loans, and planning dispositions.

Form 8832 is the entity-classification election. The form says an eligible entity uses it to elect federal tax classification as a corporation, partnership, or disregarded entity. Its domestic default rule is important for LLC planning: a domestic eligible entity with two or more members defaults to partnership classification, and a domestic eligible entity with one owner defaults to disregarded-entity status. A new eligible entity generally should not file Form 8832 if it will use the default classification. The form also shows that a multi-owner entity may elect partnership or association-taxable-as-corporation status, while a single-owner entity may elect association-taxable-as-corporation or disregarded status.

Form 8832 also matters because election timing and consent are formal. The form asks whether the election is initial or a change, whether a prior election had an effective date within the last 60 months, the requested effective date, and signatures by authorized persons. The instructions state that an election generally cannot take effect more than 75 days before filing or later than 12 months after filing. That timing detail is a Week One reminder that tax classification is not just an idea; it is implemented by a filed form.

Form 2553 is the S-corporation election under Internal Revenue Code Section 1362. The form says the election can be accepted only if the tests are met, shareholders consent, an officer signs, and the corporation/entity information is supplied. It asks for the state and date of incorporation, the effective tax year, selected tax year, officer contact, and shareholder consent information. It also contains late-election and qualified Subchapter S trust pieces.

The S corporation is a tax election layered on a state-law corporation. The chapter gives the basic restrictions: one class of stock, no more than 100 shareholders, no non-human shareholders, and no nonresident alien shareholders. The transcript adds the employment-tax planning point. A shareholder-employee can receive a reasonable salary subject to employment tax and receive remaining profit as distributions not subject to employment tax. John Edwards is used as the famous example, with his practice earning about $25 million but paying only about $1.2 million as salary, producing major Medicare tax savings. Newt Gingrich is the companion example. The maneuver is legal only if the salary is reasonable for the services actually performed.

The modern check-the-box regime explains why LLCs became dominant. Before modern entity-classification elections, planners had to worry about whether an entity looked too corporate under federal tax classification factors such as centralized management, continuity of life, free transferability, and limited liability. The transcript says the 1997 check-the-box regulations changed the analysis: state-law corporations are corporations, but other eligible entities can often elect classification. That let LLCs combine limited liability with pass-through taxation by default, solving the historical either-or problem for many businesses.

The Main Entity Forms

A sole proprietorship arises automatically when one natural person starts doing business without forming a separate entity. The owner and business are legally the same. A trade name or DBA is only a marketing label, not a separate legal person. The advantages are simplicity, unilateral control, no formation filing, no entity-level federal income tax, and Schedule C reporting. The disadvantages are complete personal liability, full concentration of business risk, limited access to equity capital, self-employment tax, and the need to rely heavily on insurance.

A general partnership is created when two or more persons agree to act as co-owners of a business for profit. RUPA Section 202 makes the accidental-formation point explicit: the association can form a partnership whether or not the persons intend to form a partnership. Profit sharing creates a presumption of partnership unless the payment falls into an excluded category such as debt, wages, rent, annuity, interest, or sale consideration. Once formed, partners have unlimited personal liability for partnership obligations, equal management powers and profit rights by default, and fiduciary duties to each other and the partnership.

RUPA also explains why general partnership is risky. Section 301 says each partner is an agent of the partnership for its business, and an ordinary-course act in the partnership name binds the partnership unless the partner lacked authority and the third party knew or had notice of that lack. Section 306 says partners are jointly and severally liable for partnership debts, obligations, and other liabilities unless a claimant agrees otherwise or law provides otherwise. Section 401 gives each partner an equal share of distributions by default. Those defaults mean an informal two-person consulting venture can accidentally create authority, liability, profit-sharing, and fiduciary consequences.

A limited partnership has at least one general partner and at least one limited partner. General partners manage and have unlimited personal liability. Limited partners contribute capital, share in profits, and receive limited liability, but traditionally must remain passive. The LP requires a state filing, and failure to file properly can expose members to unlimited liability because the attempted filing may leave them with a general partnership. The transcript notes the common modern structure of using an LLC or corporation as the general partner to avoid individual exposure.

A limited liability company combines limited liability for all members, pass-through taxation by default, and flexible governance through an operating agreement. Wyoming enacted the first LLC statute in 1977, the IRS approved pass-through treatment for Wyoming LLCs in 1988, and all states had LLC statutes by 1996. The operating agreement is essential because it can address capital contributions, profit and loss allocations, distributions, management, voting thresholds, transfer restrictions, and buy-sell triggers. Forming an LLC without a proper operating agreement leaves the business to generic statutory defaults.

A corporation requires a state filing, usually articles or a certificate of incorporation. DGCL Section 101 says a person or entity may incorporate in Delaware by filing a certificate of incorporation with the Division of Corporations. DGCL Section 102 lists certificate contents, including corporate name, registered office and agent, nature of the business or purposes, authorized stock for a stock corporation, incorporator information, and optional governance provisions. DGCL Section 106 says corporate existence begins on filing. MBCA Section 2.02 similarly requires articles of incorporation to set out corporate name, authorized shares, registered office and registered agent, and incorporators.

The corporate governance structure has three tiers. Shareholders own stock, elect directors, vote on major structural decisions, receive dividends if declared, and have limited liability, but they do not directly manage the business. Directors set strategy, oversee management, hire and fire officers, approve major transactions, set executive compensation, and owe fiduciary duties. Officers run day-to-day operations, enter contracts, supervise employees, and also owe fiduciary duties. DGCL Section 141 states that the business and affairs of a Delaware corporation are managed by or under the direction of a board of directors unless the statute or certificate provides otherwise. DGCL Section 142 gives corporations officers with titles and duties stated in bylaws or board resolution, and MBCA Section 8.01 similarly makes the board the traditional center of corporate authority.

Corporations can be more flexible than the traditional three-tier picture suggests, especially for close corporations. MBCA Section 7.32 validates shareholder agreements that can eliminate or restrict the board, govern distributions, establish directors or officers, divide voting power, transfer management authority, resolve deadlocks, or require dissolution. The key formal requirements include approval by all shareholders at the time of the agreement, placement in articles/bylaws or a signed written agreement made known to the corporation, and conspicuous notice on share certificates or information statements. The chapter connects this to MBCA Section 8.01: the board is required except as an agreement under Section 7.32 provides otherwise.

The corporate form's advantages are limited liability, centralized and familiar management, perpetual existence, transferable shares, and flexible capital financing. Its disadvantages are formation and maintenance costs, formalities, and default double taxation. It remains the practical form for venture capital and conventional public offerings because preferred stock, cap tables, investor protections, and public-market infrastructure are built around corporate stock.

An S corporation is not a separate state-law entity but a tax election for an otherwise ordinary corporation. It can combine corporate limited liability with pass-through taxation, but only if it satisfies restrictions such as no more than 100 shareholders, only domestic individual shareholders, no nonresident alien shareholders, and one class of stock. The transcript explains the employment-tax planning opportunity: shareholder-employees receive reasonable salary subject to employment tax, while remaining profit can be distributed without employment tax. The IRS constraint is that salary must be reasonable for the work performed.

The chapter pauses over the confusing number of available entity forms. Its answer is not that every form has a deep conceptual necessity. State legislatures have added forms over time for politics, convenience, planning opportunities, and loopholes, and they have usually not repealed older forms. The practical sorting rule for Week One is simpler: every important entity form except sole proprietorship is statutory, and every important form except sole proprietorship and general partnership requires a government filing to be created.

Current trends from the transcript round out the entity-form picture. LLCs dominate new formations for most small and medium businesses and have displaced general partnerships for ordinary planning purposes. LLC case law has matured enough to make operating-agreement, veil-piercing, and fiduciary-duty advice more predictable than when LLCs were new. Online formation services make entity creation easy but can leave clients with thin or misunderstood governance documents. Remote work complicates multi-state tax and employment law. Delaware remains dominant, while Nevada and Wyoming market lower-cost alternatives. Benefit corporation statutes let some companies formally commit to stakeholder interests beyond pure shareholder profit maximization.

Chapter Questions And Answers

The chapters include end-of-chapter Test Yourself questions and in-text Think prompts. The answers below stay within the Week One source material. Where the textbook says answers are in an online supplement that is not in the folder, the answer here is built from the chapter, transcript, and statutory files actually provided.

Professional Responsibility

Business lawyers must ask who the client is. When a lawyer represents an organization, the entity is the client, not the CEO, founder, majority shareholder, board member, employee, or other constituent. This is difficult because the entity can act only through people, and those people often assume the lawyer represents them personally.

Model Rule 1.13(a) states the basic rule: a lawyer employed or retained by an organization represents the organization acting through duly authorized constituents. Rule 1.13(f) then requires the lawyer to explain the identity of the client when the lawyer knows or reasonably should know that the organization's interests are adverse to the constituents with whom the lawyer is dealing. The transcript emphasizes engagement letters, repeated clarification, advice to seek separate counsel when personal interests diverge, and documentation.

Rule 1.13(b) creates a report-up duty when the lawyer knows that an officer, employee, or other associated person is engaged in, intends to engage in, or refuses to act regarding a matter related to the representation that violates a legal obligation to the organization or violates law imputed to the organization, and the conduct is likely to substantially injure the organization. Unless unnecessary in the organization's best interest, the lawyer must refer the matter to higher authority, potentially the highest authority that can act for the organization.

Rule 1.13(c) permits reporting outside the organization only in the stated circumstances: the highest authority insists on or fails to address a clear violation of law, the lawyer reasonably believes the violation is reasonably certain to substantially injure the organization, and disclosure is limited to what the lawyer reasonably believes necessary to prevent that injury. Rule 1.13(d) carves out representation to investigate alleged violations or defend the organization or constituents against such claims. Rule 1.13(e) addresses discharge or withdrawal after report-up/report-out action.

Rule 1.13(g) allows a lawyer for an organization also to represent directors, officers, employees, members, shareholders, or other constituents, but only subject to Rule 1.7. Rule 1.7 starts from prohibition when representation involves direct adversity or significant risk of material limitation. Representation can proceed only if the lawyer reasonably believes competent and diligent representation is possible, the representation is not prohibited by law, the matter does not involve one client asserting a claim against another client represented by the lawyer in the same litigation or proceeding, and each affected client gives informed consent confirmed in writing.

Formation practice therefore has a professional-responsibility layer. When multiple founders come in together, the lawyer must decide whether she represents the entity, the founders individually, some subset of founders, or more than one client. If personal interests diverge over equity split, control, vesting, salaries, contribution obligations, exit, or deadlock rights, Rule 1.7 and Rule 1.13 determine whether the representation can continue and what disclosures or consents are required.

Chapter 2's Bill, Ted, Harold, and Kumar example sharpens the conflict problem. If a lawyer represents all four in setting up and operating a partnership, and Bill and Ted later ask how to circumvent Harold and Kumar's participation in management, Rule 1.6 points toward protecting confidences while Rule 1.4 points toward keeping clients informed. Representation scope, conflicts, consent, and possible withdrawal should be addressed before the clients' interests split.

Cases And Authorities

These notes cover the actual cases and cited authorities that appear in the Week One materials. Where the source gives only a short citation or a statutory-comment reference, the note stays at that level and does not add outside facts.

Study Checkpoints

• When a business dispute appears, ask first: who is the principal, who is the agent, what duties exist, and what conduct might breach loyalty or care?
• For loyalty, look for a conflict first. If one exists, the fiduciary must prove fairness or fully informed consent.
• For entity selection, do not jump straight to LLC. Walk through liability, tax, governance, returns/liquidity/exit, capital structure, red tape, state of formation, and whether the client expects outside investors.
• For accidental partnership risk, look for objective manifestations of co-ownership of a business for profit, especially shared profits, shared management, holding out, and joint property. RUPA Sections 301 and 306 then supply the authority and joint-and-several-liability consequences.
• For corporation questions, separate shareholders, directors, and officers. DGCL Section 141 and MBCA Section 8.01 make board authority the default, while MBCA Section 7.32 explains close-corporation shareholder-agreement flexibility.
• For tax classification, distinguish state-law entity form from federal tax status. Form 8832 handles entity classification; Form 2553 handles S-corporation election; LLC default classification and S-corp restrictions are different concepts.
• For organization-as-client questions, identify whether the lawyer represents the entity, a constituent, or both, and whether Rule 1.13 requires clarification, reporting up, or separate counsel.