Homer, single & Marge, married with one child, are starting a business to provide computer
consulting services and web design. They will initially locate in Los Angeles, California. They have
decided to call the business “Vircon.” Homer’s net worth is $100,000. Marge’s net worth is -0-. Homer
is willing to contribute $50,000 to the business. Unfortunately, Marge has no money to contribute, but
has the computer expertise, the essential contacts and is a graduate of the Anderson School. In fact,
Marge already has a possible client in Arizona. They would like to participate equally in making all
decisions. They estimate that $200,000 will be enough money to pay all expenses for 12 months at
which time they project that revenues will cover expenses. Homer and Marge plan on reinvesting most
of the earnings with the goal of expanding and going public within 5 to 10 years. Initially, they would
like to hire two persons, one web designer and one consultant. The consultant will have substantial
decision making authority, will work full-time at either the main office or at client sites, receive a salary,
use Vircon’s equipment and will not receive any fringe benefits, such as medical insurance. The web
designer will work from his/her home, use his/her own equipment, be paid hourly, will have other clients
and will not receive any fringe benefits, such as medical insurance. Neither have written contracts with
Vircon. Homer intends to keep his job at Robbem & Cheatem, a local law firm for as long as necessary
until the new business takes off. Currently, Marge is unemployed.
A friend of Marge’s, Jacques, feels the business will be very profitable and has offered to
contribute $30,000 to the business. He lives in and is a citizen of France. He only visits the United
States once a year. He would like to be a passive owner in the business.
On October 29, before a new business entity was formed, Homer signs a lease for a three year
term for “immediate occupancy” for the business. The lease was entered into on behalf of and in the3
name of the business. Thus, he signed the contract "Homer, agent for Vircon" The business was
subsequently formed, and they moved in on November 25 . The business paid the rent directly to the
4. What form of legal entity would you recommend for this business if only Homer and Marge
participate? What form of legal structure would you recommend if Jacques, Homer and Marge
participate? In your answers, explain the pros and cons of utilizing a general partnership, limited
partnership, limited liability company (“LLC”), regular corporation ( also known as a “C corporation”)
and S-corporation for Homer and Marge and also for Jacques, Homer and Marge . Exclude
LLLP’s and “close” corporations from your answer. (20 points)
Assume for purposes of answering questions 5-13 that Homer and Marge form a corporation and that
each owns 50% of the corporate shares. Marge is the president and Chief Financial Officer and Homer is
the Secretary. Both are on the board of directors.
Six months after the corporation is started, there was a cash flow problem and it is necessary for
Homer to lend $20,000 to the business to enable it to cover its operating expenses. Four months later they
hire, Helmut, as Vice President of Sales & Marketing.
Vircon now realizes that it leased too much space and subleased a small portion of its space to two
CPA’s, Rippoff & Shyster, LLP, a California limited liability partnership. Rippoff & Shyster, LLP
signed a 2 year lease with Vircon in the name of the LLP. A year later Rippoff & Shyster LLP move out
of the their office space, breaching the lease with Vircon.
During the next few years, the business did well. Vircon, however, never obtained liability
insurance. Homer and Marge keep meticulous records of receipts and payments, but did not document
certain corporate transactions, such as salaries and shareholder meetings. In one year the corporation
paid six of Marge’s mastercard bills because she was having severe personal financial problems and also
paid for her daughter’s college tuition for her first semester.
There are now five persons on the board of directors, Homer, Marge, and three outside directors,
Harry, Susan and Marvin and 50 shareholders. A few month later, the corporate Chief Financial Officer
of Vircon borrowed $60,000 from Nice Bank on behalf of Vircon, executing a promissory note in the
corporation's name. The corporation's secretary later sent a letter to Nice Bank confirming the promissory
note and the receipt of the loan proceeds. Thereafter, the board of directors, with knowledge of the loan,
authorized the use of the proceeds to acquire new equipment. Nice Bank presented the loan for payment,
but the corporation refuses payment arguing that the bylaws do not authorize its Chief Financial Officer
to borrow money. A few months later, Marge wishes to obtain a personal loan from her bank for
$100,000, but the bank requires someone to co-sign the note. Marge co-signed the note in the name of
the corporation and signs as the president. Later Marge defaults on the note, and the bank sues the
corporation for payment.
At one of the board of director’s regular meetings Homer & Marge attended, Harry was patched
in on a conference phone call, and Marvin gave his proxy vote to Homer. Homer, Harry and Marvin (via
his proxy) voted in favor of the motion to borrow $500,000 from Bank of America. Marge voted against
the motion. Susan who did not receive notice nor attend the meeting wants to challenge the validity of
the action passed at the meeting for, among other reasons, lack of proper notice. Vircon's Bylaws provide
that a majority of the authorized directors constitutes a quorum and any action passed at a board meeting
must be approved by a majority of those directors present.4
Marge also serves as an outside director on the board of directors of Cellular Information
Systems (CIS). CIS has five members on its board and approximately 500 shareholders. During a special
meeting of directors of CIS, all five directors present voted to declare a $100,000 cash dividend.
However, three of the directors learned through their position as CIS officers that CIS had just lost a
customer who was its chief source of revenue. This information was not disclosed at the meeting,
although all the other board members asked numerous questions about the financial situation of the
Recently, Helmut severely injured Thelma and her prize poodle Fifi in a car accident while he
was on his way back to work after visiting a new supplier, located about one hour from the office.
Thelma and Fifi live in Arizona and were only in Los Angeles, where the accident occurred, to get Fifi
groomed by her favorite stylist for her next show. Needless to say, Thelma is furious and plans to sue
Vircon and Helmut for at least $300,000. Remember, Vircon does not have insurance coverage.
On July 25, of the next year Vircon borrows $100,000 from Susan, one of its directors at the
prevailing interest rate for a term of three years. The loan was properly approved by the board at its
At the Board's October meeting, it seriously considers filing bankruptcy. On November 1, Vircon
paid back, in full, the money borrowed from Susan. At that time, Vircon had stopped making payments
on all its debts.
At the board of directors regular meeting held on December 20 , the Board properly voted in
favor of filing a petition for a Chapter 7 under the Bankruptcy Code. At that meeting the directors
invited outside legal counsel and its accountant to answer any questions regarding a Chapter 7 . The
Petition was filed on December 30 .
5. Is the consultant an independent contractor or an employee? Is the web designer an
independent contractor or an employee? What are the legal consequences of incorrectly
characterizing them? (10 points)
6. On what legal theories, if any, can Thelma sue Vircon for the injuries she sustained in the
accident? (5 points)
7. Assume that instead of getting into an accident with Thelma on his way back to work, Helmut
drives approximately another hour out of his way to do a personal errand. As he was leaving the
parking lot of the store, he negligently hit Pete’s car. Is Vircon liable in this case, why or why not?
8. What legal effect, if any, does the repayment of the loan from Susan have on Vircon's
bankruptcy? (5 points)
9. On what legal theory can Thelma sue Homer and Marge, individually, as shareholders of
Vircon? (5 points)
10. Discuss the personal liability, if any, of each of the CIS directors for approving the dividend(5
11. Is Vircon liable to Marge’s bank for the $100,000 personal loan? Please exclude the concept of
“ultra vires” from your answer. (5 points)
12. Is Vircon liable for the $60,000 loan made by its Secretary? (5 points)
13. On what legal basis can the shareholders of Vircon sue the individual members of its Board
of Directors and hold them personally liable if Vircon is held liable for $300,000 in damages to
Thelma. (5 points)
14. Amy asks Sue to drop off a package at the downtown office of Federal Express for overnight
delivery. Since Amy has a billing account with Federal Express, Sue was not required to pay any fees
when dropping off the package. However, because the Federal Express parking lot was full, Sue incurred
a $3 expense to park in a lot across the street. Sue's authority to incur the parking lot expense is said to
be (5 points) :
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