July 2016 Second Example Ten-point Answers to Virginia Essay Questions
July 2016 - QUESTION 2 – VIRGINIA BAR EXAMINATION
Porter Bass ("Bass") is the sole general partner of Westover Ale House, LP ("Westover"), a Virginia limited partnership and the country's fastest growing microbrewery. Westover has several limited partners, none of whom has any role in the business except Sam Stout ("Stout"), Westover's sales manager.
Last year Bass went on a three-month vacation and left the operation of Westover to Stout. Sales plummeted during Bass' absence, as Stout's time was consumed operating the business. In desperate need of operating funds, Stout applied to Craft Community Bank ("CCB") for a $600,000 line of credit for Westover. CCB knew that Westover was a limited partnership and that Bass was its general partner, but knowing that Stout was a sales manager who had been temporarily placed in charge, and over Stout's signature as sales manager, issued the line of credit to Westover.
Upon Bass' return, CCB demanded repayment of the loan unless Bass signed a personal guaranty of payment. Bass signed a personal guaranty and delivered it to CCB.
To compensate for the risk Bass had assumed by signing the guaranty, Bass prepared and executed a partnership resolution authorizing Westover to pay him a fee for guaranteeing the loan. So far, Bass has caused Westover to pay him over $30,000 in guaranty fees. The partnership agreement is silent as to Bass' right to receive a guaranty fee.
The winter of 2015-2016 was harsh for the craft beer business. The loan from CCB is now in default. CCB has filed an action against Westover, Bass, and Stout to recover the balance due on the loan. To make matters worse for Bass, the limited partners are upset that he has paid himself guaranty fees. Bass has countered that no one would have guaranteed the loan unless Westover had agreed to pay a guaranty fee, so it does not matter that Westover paid the fee to him rather than someone else.
|(a)||On what bases, if any, is Bass liable to CCB? Explain fully.|
|(b)||On what bases, if any, is Stout liable to CCB? Explain fully.|
|(c)||What recourse do the limited partners have against Bass for his receipt of guaranty fees, and what form of action should they employ to effect such recourse? Explain fully.|
July 2016 - QUESTION 2 – EXAMPLE ANSWER #1
(A) Bass is liable to CCB both as a general partner, and as a guarantor of the obligation. Under Virginia law, a limited partnership is an entity which limits the liability of the limited partners to their contribution to or investment in the partnership. In sharp contrast, however, general partners within a limited partnership remain personally liable for the partnership's organization, as with a general partnership. Moreover, Virginia suretyship law likewise defines the liability of a guarantor. A guarantor is liable on a particular obligation if he, for consideration, agrees to guarantee the loan. The consideration need not be paid to the guarantor by the lender, but can be paid by the debtor or can come in the form of the lender making a loan to the debtor they would not otherwise have made, absent the guarantee. A guarantor of collection is secondarily liable on the loan, while a guarantor of payment or a surety is primarily liable on the loan.
Here, Bass is undoubtedly liable to CCB as a general partner. As a general partner, he is personally liable for the partnership's obligations, including the loan secured by Stout. Although it is somewhat unlikely, Bass may also be liable as a guarantor. Here, it is clear that Bass guaranteed repayment of the loan to CCB and thus agreed to act as a guarantor. However, at the time that he agreed to act as guarantor, CCB had already made the loan to the partnership. As a result, there may not have been sufficient consideration for the suretyship, as the loan had already been given and Bass received no consideration from Stout or CCB for guaranteeing the loan. While it could be argued that not placing the loan into repayment constituted consideration, such an argument is not likely to suceed. As a result, while Bass may not be liable to CCB as a guarantor, he is unquestionably liable as a general partner.
(B)Stout is likewise likely to be liable to CCB on the loan. As stated above, in general, a limited partner such as Stout is generally not personally liable for the obligations of the partnership, and is liable only in the amount of their contribution to the partnership. A partner becomes personally liable, however, if he exercises dominion or control over the affairs of the partnership; in such cases, the limited liability ceases to exist. The limited partner, however, only becomes personally liable to third parties who reasonably believed that he was a general partner and entered into the transaction on such a basis.
Here, the facts clearly reflect that Stout assumed control and dominion over the partnership's affair. In Bass' absence, Stout alone operated the business for three months, and entered into a loan agreement with CCB for the partnership during that time. Stout's sole operation of the business in Bass' absence is likely to qualify as control of the business.
In much the same way, the evidence also suggests that CCB reasonably believed that Stout was a general partner and dealt with him on that basis. Although CCB knew that Westover was a limited partnership and that Bass was its general partner, the facts suggest that CCB dealt with Stout because he had been placed in charge, which is typically the role of a general, not a limited partner. Such facts suggest that CCB, even knowing that Stout was a sales manager, reasonably believed that he was an acting general partner, as a result of his being left in charge. Based on CCB's belief that he was at least an acting general partner, Stout could be held personally liable for the loan from Stout.
(C) The limited partners could gain recourse against Bass for the guaranty fees through a derivative action against Bass for a breach of his duty of loyalty. Under Virginia law, limited partners in a limited partnership are entitled to file a derivative action to protect the rights of the partnership at large. In order to do so, the limited partners must have been limited partners both at the time of the alleged occurrence or transaction and at the time of the institution of the suit. They must also demonstrate that they made a demand upon the general partners to defend the partnership's rights with regard to that particular transaction and that such a demand failed, or demonstrate why such an action would have been likely to fail if brought. If successful, the recovery from the derivative suit goes to the partnership itself, although the partners can recover reasonable fees and expenses from the partnership.
Here, the limited partners could likely file such a suit against Bass as a result of his breach of the duty of loyalty. As partners, both limited and general partners owe the partnership certain fiduciary duties, including a duty of loyalty and a duty of care. As part of that duty of loyalty, partners are prohibited from using partnership business or assets for their personal benefit without authorization; from competing with the partnership; from usurping the partnership's opportunties; engaging in self-dealing; and, engaging in like behavior. Here, it is likely that, by unilaterally imposing and collecting $30,000 in guarantee fess, that Bass has breached the aforementioned duty of loyalty. Generally, a resolution, unless otherwise stated in the partnership agreement, must be passed by a majority of the partners. Here, the facts state that the agreement made no mention of the right to receive guarantee fees. As a result, in order to have been entitled to such fees, Bass would have need the approval of a majority of the partners who can vote in order to approve the resolution and be entitled to guaranty fees. As a result of Bass' failure to do so, Bass breached his duty of loyalty to the partnership by engaging in self-dealing and using the partnership's assets - namely the $30,000 - for his own personal benefit without authorization. As a result, the limited partners would likely succeed in a derivative action against Bass for a breach of his duty of loyalty.
July 2016 - QUESTION 2 – EXAMPLE ANSWER #2
(a) Bass is liable to CCB for the entire loan amount.
Bass will be liable to CCB becuase he ratified his agent's contract, he is a general partner of Westover, and he signed as a personal guaranty.
Under Virginia law, an agent-principal relationship is formed when: the pricipal manifests assent to the agent; the principal is aware of the agent's actions; the agent acts under the principal's control; the agent manifests assent to the principal. Assent can be manifested through express assent, implied assent, or constructive assent. Principals are bound to contracts created by agents where the principal knew of all the material terms in the contract, the principal ratified the whole contract, and the agent assent to the contract. Additionally, general partners are fully liable for the liabilities of a partnership, while limited partners are only liably to the extent of their captial contribution.
Here, Stout is an agent of Bass and Westover. Stout is an employee, the sales manager of Westover, and therefore has express assent to act as an agent for Bass and Westover when acting within the scope of his employment. When Bass went on vacation, he left the operation of Westover to Stout and in doing so impliedly gave Stout assent to perform whatever actions necessary in the operations of the business. CCB loaned money to Stout becuase it knew that Stout was an agent of Westover who had been temporarily placed in charge of the business. Stout assented to the contract and signed as an agent of Westover. When Bass returned, CCB demanded repayment of the loan. Bass' interactions with CCB about the loan agreement suggest that he knew about the material terms of the loan agreement. In signing on as a personal guarantee, Bass ratified the entire loan contract with Westover. Bass will be liable for the loan because, as the principal in the agent-principal relationship with his employee Stout, he ratified the loan contract with CCB.
Bass will also be liable for the loan as a general partner of Westover and a personal guarantee on the loan. As a general partner of Westover, Bass is fully liable for the liabilities of the partnership. As a personal guarantee on the loan, Bass became liable for a second, personal contract declaring that he would satisfy payment as a guarantee once the loan was defaulted on by Westover.
(b) Stout is not liable to CCB either as an agent nor as a limited partner.
Stout is not liable to CCB as an agent because he contracted within the scope of his employment and with the assent of his employer. He is not liable to CCB as a limited partner because CCB knew that he was a limited partner when negotiating the loan.
Under Virginia law, employee agents are not liable for actions within the scope of their employment as long as they are acting with the assent of their principal. Under Virginia law, limited partners are only liable for their capital contributions to the partnership unless the limited partner contracts on behalf of the partnership and the contracting party believes that the limited partner is a general partner.
Here, Stout is acting as an employee within the scope of his employment to Westover when creating the loan agreement with CCB. Stout is acting with the implied assent of Bass, his employer, who told him to take care of "operation of Westover" while he was away. Taking out loans to keep the business afloat could reasonably categorized as actions within the scope of Bass' implied assent and therefore within the scope of Stout's employment. Therefore, CCB cannot hold Stout liable for the loan agreement becuase he was merely an agent contracting on behalf of a principal. Also, CCB cannot hold Stout liable for the employement agreement in his role as a limited partner of Westover. CCB knew during the contract negotiations that Stout was not a general partner and only a limited partner of Westover. In order for Stout to be held liable for that contract as a limited partner, CCB needed to believe they were contracting with a general partner and they did not.
Stout cannot be held liable by CCB for the balance due on the loan.
(c) The limited partners can bring a derivative suit against Bass for breach of the duty of loyalty.
The limited partners can bring a derivative suit on behalf of Westover for breach of the duty of loyalty to recover the guarantee fees that Bass paid himself.
Under Virginia law, a limited partnership is created when there is at least one general partner and one limited partner who file certification with the State Corporation Commission of their limited patnership. Under a limited partnership, general partners are liable as they would be under a general partnership. That is, general partners are fully liable for any liabilities of the partnership. General partners do not have a right to be paid for their duties to the partnership. General partners owe a duty of loyalty to the partnership. Under their duty of loyalty, general partners cannot advance any business interests adverse to the patnership, usurp a business opportunity available to the partnership, directly compete against the partnership, or in any other way materially benefit at the expense of the partnership. General partners also owe the partnership a duty of care. If general partners breach these duties, limited partners can bring a derivative suit on behalf of the patnership to recover money that should belong to the partnership.
Here, the limited partners can argue that Bass breached his duty of loyalty. In preparing and executing a partnership authorization that authorized Westover to pay him guarantee fees, Bass is materially profitting at the expense of Westover and advancing his own interest adverse to the partnership's. The limited partners should bring a derivative suit against Bass to recover the $30,000 in guaranty fees he receieved through his breach of the duty of loyalty.