Business Associations on the NextGen Bar Exam
Business Associations is the wild card. It's the newest foundational subject on the NextGen exam, which means there's a thinner bank of prior questions to study from compared to the other seven subjects. If you took a Business Organizations or Corporations course in law school, you have a real edge. If you didn't, this is the subject where baseline knowledge varies the most between candidates — and targeted study pays off disproportionately.
Agency law is the foundation that everything else sits on. Before you can analyze partnership liability, corporate authority, or LLC governance, you need to understand how agency works. The key distinction: actual authority (based on the principal's manifestation to the agent) vs. apparent authority (based on the principal's manifestation to a third party). The exam tests this constantly because it determines whether a transaction is binding. If an employee signs a contract on behalf of a company, the question is always: did they have authority? Actual authority comes from what the principal told the agent. Apparent authority comes from what the principal communicated (or allowed) to the outside world. Ratification is the safety valve — the principal can retroactively approve an unauthorized act.
Partnership is the default business form and most candidates don't realize that. Two people co-owning a business for profit? That's a general partnership — no filing, no agreement, no formalities required. And every general partner is personally liable for all partnership debts. Joint and several liability under RUPA means a creditor can go after any single partner for the full amount. This scares people in real life and it generates good exam questions. Limited partnerships protect limited partners from liability only as long as they don't participate in management — step into management decisions and you lose the shield.
LLCs are tested through their operating agreements. The critical fact to identify in any LLC question: is it member-managed or manager-managed? The default rules differ significantly. In a member-managed LLC, every member has authority to bind the LLC in ordinary business matters. In a manager-managed LLC, only the managers have that authority. The operating agreement can vary most default rules — so if the question specifies operating agreement terms, those control over statutory defaults.
Corporate fiduciary duties are the exam's favorite Business Associations topic. The Business Judgment Rule protects duty-of-care decisions: if directors act in good faith, on an informed basis, and honestly believe the action serves the corporation's best interest, courts won't second-guess the outcome — even if it turned out badly. The BJR is a presumption, and the challenger bears the burden of overcoming it.
But the BJR has a hard limit: it does NOT protect duty-of-loyalty violations. Self-dealing (director on both sides of a transaction), corporate opportunity usurpation (taking a business opportunity that belongs to the corporation without offering it first), and competing with the corporation all fall outside BJR protection. These are analyzed under the entire fairness standard — fair price AND fair dealing — and the burden shifts to the director to prove both.
Derivative suits are the procedural mechanism for enforcing fiduciary duties. The requirements are formulaic: contemporaneous stock ownership at the time of the wrongdoing, demand on the board (or showing demand futility), and adequate representation of the corporation's interest. The exam tests these requirements as a checklist.
Exam Tips
- Agency authority is the threshold question for any transaction-binding issue. Ask: actual authority (principal → agent) or apparent authority (principal → third party)? If neither exists, the transaction isn't binding unless ratified.
- Partnership trap: co-owning a business for profit = general partnership by default, even without any agreement. All general partners are personally liable for ALL partnership debts.
- Business Judgment Rule protects duty of care ONLY. It does NOT protect duty of loyalty violations (self-dealing, corporate opportunities, competition). Know which duty is at issue before applying BJR.
- LLC questions: immediately identify member-managed vs. manager-managed. The authority to bind the LLC and the voting rules differ significantly between the two structures.
- Derivative suit checklist: contemporaneous ownership + demand on board (or demand futility) + adequate representation. Miss any element and the suit is dismissed procedurally.
Key Rules to Know
- Agency: actual authority (principal's communication to agent) vs. apparent authority (principal's communication to third party) — determines if transaction binds
- General partnership: automatic formation when co-owning business for profit; joint and several personal liability for all partners (RUPA)
- Business Judgment Rule: presumption protecting informed, good-faith, conflict-free director decisions — challenger bears burden to overcome
- Duty of loyalty: self-dealing, corporate opportunity usurpation, and competing with the corporation — entire fairness standard (fair price + fair dealing)
- Derivative suit: contemporaneous ownership + demand or demand futility + adequate representation — suit belongs to corporation, not shareholder individually
Sample Practice Questions
TechVault Corp., a Delaware corporation, has a staggered board of directors. When RavenPoint Capital announced a hostile tender offer for 51% of TechVault's outstanding shares at a 40% premium, TechVault's board met the same day and, without conducting any market analysis or consulting financial advisors, immediately adopted a shareholder rights plan (poison pill) with a 15% trigger threshold. The board stated that the pill was necessary to 'protect the company's long-term strategic vision.' RavenPoint Capital sued, arguing the board breached its fiduciary duties. Under Delaware law, which standard of review will the court apply to evaluate the board's adoption of the poison pill, and what is the most likely outcome?
- The business judgment rule applies, and the board's adoption of the pill will be upheld because directors have broad discretion in managing corporate affairs.
- The entire fairness standard applies, and the board will likely lose because it did not negotiate with RavenPoint Capital before adopting defensive measures.
- Under Unocal enhanced scrutiny, the board must show it had reasonable grounds for believing a threat existed and that the response was reasonable in relation to the threat, and the board may have difficulty satisfying this standard given it conducted no investigation before acting.
- Under Revlon duties, the board must immediately dismantle the pill and conduct an auction to obtain the highest price for shareholders.
Show answer
Correct: Under Unocal enhanced scrutiny, the board must show it had reasonable grounds for believing a threat existed and that the response was reasonable in relation to the threat, and the board may have difficulty satisfying this standard given it conducted no investigation before acting.
Correct. Under Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), the board bears the burden of showing (1) reasonable grounds for believing a danger to corporate policy and effectiveness existed (the 'threat' prong) and (2) that the defensive measure adopted was reasonable in relation to the threat posed (the 'proportionality' prong). The board's good faith and reasonable investigation are critical factors. Here, the board acted without any financial analysis or advisor consultation, which undermines its ability to satisfy the first prong's requirement of a reasonable investigation, as emphasized in Unocal and its progeny. While poison pills are generally permissible under Moran v. Household International, Inc., 500 A.2d 1346 (Del. 1985), the process by which they are adopted must still satisfy Unocal.
Greenfield Manufacturing Corp. hired Dana as its regional sales manager with written authority to negotiate and sign contracts for the sale of industrial equipment up to $200,000. Six months into her tenure, Greenfield's CEO orally told Dana that, due to market conditions, her signing authority was reduced to $100,000 and that any contract above that amount required the CEO's co-signature. Greenfield did not notify any of its customers of this change. Dana subsequently signed a $175,000 contract with Baxter Industries, a long-standing customer that had previously completed three transactions with Dana in the $150,000–$200,000 range. When Greenfield refused to perform, Baxter sued to enforce the contract. Which of the following best states the likely outcome?
- The contract is enforceable against Greenfield because Dana had actual authority to sign contracts up to $200,000.
- The contract is enforceable against Greenfield because Dana had apparent authority to sign the contract.
- The contract is not enforceable because Dana exceeded the scope of her authority and Baxter had a duty to verify her current authorization.
- The contract is not enforceable because the CEO's oral limitation superseded Dana's written authority, and written authority can be modified orally under general agency principles.
Show answer
Correct: The contract is enforceable against Greenfield because Dana had apparent authority to sign the contract.
Under Restatement (Third) of Agency § 2.03, apparent authority arises when a third party reasonably believes that the agent has authority to act based on the principal's manifestations to the third party. Greenfield originally vested Dana with authority to sign contracts up to $200,000 and never notified its customers—including Baxter—of the reduction. Baxter had completed three prior transactions with Dana in the $150,000–$200,000 range, giving Baxter a reasonable basis to believe Dana still had authority to execute the $175,000 contract. A principal's undisclosed limitation on an agent's authority does not affect the rights of third parties who deal with the agent in reasonable reliance on the agent's apparent authority. See also Restatement (Third) of Agency § 3.11 (termination of apparent authority requires notice to third parties).
Alpha Corp. is a close corporation with three equal shareholders: Davis, Engel, and Franco. The corporation's valid shareholder agreement, signed by all three shareholders, eliminates the board of directors and vests all management authority directly in the shareholders. Davis and Engel, acting together, vote to terminate Franco's employment as the company's sales manager—a position Franco has held since the corporation's inception twelve years ago. Franco was an at-will employee with no separate employment contract. Franco sues, claiming the termination was undertaken to freeze him out of any return on his investment, since the corporation has never paid dividends and Franco's only financial benefit from the company has been his salary. Which of the following best states the likely outcome?
- Franco will prevail because shareholders in a close corporation owe each other a heightened fiduciary duty, and terminating his only source of return on investment constitutes an actionable freeze-out.
- Franco will not prevail because as an at-will employee, his termination requires no cause, and his shareholder status does not change the at-will employment relationship.
- Franco will prevail because the shareholder agreement eliminating the board of directors was invalid, rendering the termination decision void for lack of proper corporate authority.
- Franco will not prevail because a two-thirds majority of shareholders lawfully exercised their management authority under the shareholder agreement, and judicial review of internal corporate decisions is barred by the business judgment rule.
Show answer
Correct: Franco will prevail because shareholders in a close corporation owe each other a heightened fiduciary duty, and terminating his only source of return on investment constitutes an actionable freeze-out.
Under the landmark decision in Donahue v. Rodd Electrotype Co. (1975) and its progeny (including Wilkes v. Springside Nursing Home, 1976), shareholders in a close corporation owe one another a fiduciary duty substantially equivalent to the duty owed by partners. When majority shareholders terminate a minority shareholder's employment—and that employment represents the shareholder's sole means of receiving a return on investment in a corporation that pays no dividends—courts recognize this as a classic freeze-out. Under the Wilkes framework, the majority must demonstrate a legitimate business purpose for the challenged action, and the minority shareholder can show that a less harmful alternative existed. Absent a legitimate business justification, the termination is a breach of fiduciary duty.
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