Question

The Facts: Linda and Michael are the only shareholders of Investors, Inc. The corporation purchases property suitable for commercial development as shopping centers, office buildings or apartment complexes. It holds each property for a period of time to let it increase in value. It then sells the property for a profit to an unaffiliated commercial developer.

Investors, Inc. was properly formed as a corporation in full compliance with applicable law four (4) years ago. The Articles of Incorporation are silent concerning the corporation’s purpose and powers. One thousand (1000) shares of common stock are authorized. Linda owns 50 shares and Michael owns 50 shares. Linda and Michael are the only two members of the Investors, Inc. Board of Directors. At the organizational meeting of the Board of Directors Linda and Michael both voted as directors in favor of electing Linda as President and expressly giving her the authority to purchase commercial properties for the corporation. Michael was elected as Treasurer and Secretary.

The corporation is located in Duluth, Minnesota. It maintains its own offices, has separate records and accounts, letterhead and other corporate indicia. Linda and Michael are careful to always observe all corporate formalities, including holding regular directors and shareholder meetings. They consistently advise corporate creditors they are acting in their corporate capacities. Neither Linda nor Michael takes any salary. Distributions are only made to them if the corporation’s operating reserves after the distribution will cover at least three (3) months of normal operating expenses.

The corporation has funded all its property purchases through loans from Big Bank, located in Duluth, Minnesota. Each loan was negotiated and signed on behalf of Investors, Inc. by Linda as President. The property to be purchased serves as collateral (by mortgage) for the related purchase loan. Additionally, Linda and Michael have each given Big Bank a valid and binding personal guarantee. The guarantees state Linda and Michael are each individually unconditionally and primarily liable for all valid and binding indebtedness of Investors, Inc. to Big Bank.

The corporation has been very successful. It has already bought and sold five (5) different commercial properties, all located in Duluth, at a substantial profit. The corporation currently holds three (3) additional commercial properties, all also located in the Duluth.

This is the largest number of properties the corporation has ever held at one time. All three (3) properties have increased considerably in value since being purchased. At the most recent meeting of the Board of Directors, held one week ago, Linda said she believed the properties would continue to increase in value and the corporation should not sell any of them at the present time. Michael agreed. Michael reported that the corporation’s finances were sound. He explained that although the total loan balance with Big Bank was the highest it have ever been because of the unusually large property holdings, the corporation had substantial cash reserves and he expected no problem meeting the regular loan payments to due Big Bank.

Claude is putting together a project to purchase a large piece of undeveloped land 35 miles north of Duluth. He does not know either Linda or Michael. He does know they are the owners of Investors, Inc. Because he is aware of Investors, Inc.’s past success, Claude calls Linda to inquire whether she would be interested in making a personal investment in Claude’s project. He explains that although the land is currently zoned only for agricultural use, he believes there is a good chance it can be successfully re-zoned in the future to permit commercial uses thereby substantially increasing its value. The parcel of land is three times larger than any piece of land previously purchased by Investors, Inc. Without telling Michael, Linda personally invests and becomes a 30% owner in Claude’s project.

The Questions: Based on the above facts and limiting consideration to business organization and agency law, please discuss the following issue. When discussing the issues please explain concisely how you arrived at your conclusions through application of the relevant law to the facts presented.

(1) One year after Linda and Claude bought this land, it has been sold for a $300000 profit. Michael has now found out about that purchase and sale, and has caused Investors, Inc. to sue Linda for a share of that of that $300000 profit. Will Investors Inc. win or lose and why? You must provide a full explanation for your answer. (Worth 10 points)

(2) Assume that instead of investing personally, Linda, without telling Michael, makes the investment by purchasing the 30% interest in Claude’s project for Investors, Inc. Linda finances the investment by obtaining an additional loan from Big Bank. Because Investors does not own the property itself, Big Bank takes a security interest in the 30% interest in Claude’s project as collateral for repayment of the loan. All the documents relating to the investment and the loan are signed by Linda as President on behalf of Investors, Inc. Claude’s project fails and Big Bank sues Investors, Inc. on the loan. Will Big Bank win this lawsuit against Investors Inc. for the loss? Why or why not, you must provide a full explanation. (Worth 10 points)

Answer 1

(1): In this case Investors Inc. will lose because Linda has made the investment in her personal capacity and has not acted as the agent of Investors Inc. As per the agency law an agent cannot act on behalf of the principal on her/his own accord without the explicit permission of the principal. Here Linda acted and made the investment in her personal capacity and hence the agency law will not come into picture. No provisions of her contractual obligations with Investors Inc. were violated. As such Investors Inc. will lose.

(2): Yes, Big Bank will win this lawsuit against Investors Inc. for the loss. This is because in this scenario Linda made the investment and took 30% interest in Claude’s project as an agent of Investors, Inc. Another thing to be noted here is that Investors’ article of incorporation is silent with regards to the company’s purposes and powers. As such its purpose is not defined and set. Thus the investment made by Linda in her capacity as an agent of Investors Inc. will make Investors Inc. liable. Hence Big Bank will win this lawsuit.