Theory to Practice

Adams and Barker were two individual scientists engaged in research related to inventing a patentable pharmaceutical product. Once they had gained critical mass for the project, they convinced Barker's old college roommate, Cornelius, to invest $100,000 in exchange for an ownership share in a newly formed company called Pharma Corporation (Pharma). The parties agreed that Adams and Barker would continue product development until the company was ready to apply for a patent, then Cornelius would use his contacts to find a manufacturer to produce and market the patented drug. Pharma was structured as follows:

The parties hired counsel to incorporate Pharma, issue stock certificates, and draft bylaws. The corporate records were then turned over to Barker and she filed them in her desk drawer. No additional formalities were followed and the records were not maintained, nor were any directors' or shareholders' meetings held.

In year 2, Pharma's application for a patent was rejected. The rejection required Adams and Barker to hire an additional expert to help with research and would put the project behind by approximately 16 months. Adams hired Elliot, a well-known scientist, to help with the project. At this point though, Pharma's financial resources were drying up and, trying to keep the company afloat, Adams began to pay certain Pharma bills with his personal credit card and Baker would sometimes write out personal checks for lab equipment.

1. What category of corporation is Pharma and what are the options in terms of structure and raising capital?

2. Would Pharma be eligible to be an S corporation? If one of the shareholders objected, could the other two vote to become an S corporation without the third?

3. Did Adams have the right to hire Elliot without the others' consent? Suppose that Cornelius believes that Elliot is not a good hire for Pharma. Can he fire Elliot?

In year 3, the financial condition of Pharma continued to worsen. A representative of the dominant pharmaceutical company in the market, Multi-Drug (MD), approached Adams and Barker with an acquisition offer. MD offered to pay $50,000 to buy all of Pharma's assets and offered a five-year employment agreement with MD to both Adams and Barker. On the same day as the offer, Adams and Barker send a one-page e-mail to Cornelius informing him that they have voted to approve the sale of assets of Pharma to MD and the transaction would take place in one business day.

4. Suppose Cornelius is unhappy with the transaction. Does he have any say in the matter? Does he have the power to stop the sale?

5. Have Adams and Barker breached their fiduciary duties to Cornelius? If so, what duties, specifically, and how were they breached?

6. Are Adams and Barker protected by the business judgment rule? Why or why not?

7. What type of lawsuit, derivative or direct, would be filed by Cornelius to:

a. Force Adams and Barker to have a shareholders' meeting and formal vote.

b. Recover against Adams and Barker for damages Cornelius suffered as a result of an alleged breach of duty.