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I. Can Landlord recover the unpaid rent from Rita and Fred individually? Rita’s Kitchen, Inc. has closed and owes three months of back rent. Furthermore, four more years remain on the lease. Landlord seeks to recover from Rita and Fred, who signed the lease as promoters before RKI was incorporated. A. Promoter Liability Rita and Fred leased restaurant space from Landlord for Rita’s Kitchen. They signed the lease as “President” and “Secretary” of the tenant Rita’s Kitchen, Inc., “a corporation in formation.” B. The Contract At the time they signed the lease, Rita and Fred were acting as promoters for RKI. As promoters, Rita and Fred are liable unless the corporation adopts the agreement and the other party to the contract agrees to accept performance from the corporation. It is apparent that the lease does not contain any provisions absolving Rita and Fred from personal liability in the event of a default. In this case, although it is almost certain that Landlord has accepted rent payments from RKI, no other facts are present to show that Landlord released Rita and Fred from their possible future liability in the event that the business was unable to make the rent payments as they became due. RKI never formally adopted the agreement, and at no time did the corporation and Landlord reach a novation. C. Conclusion Landlord can recover from Rita and Fred. Unless Landlord’s acceptance of rent payments from RKI has gone on long enough to release Rita and Fred, they will remain jointly and severally liable to Landlord. II. Is the shareholder agreement valid? The 75 investors each purchased their shares and signed the shareholder agreement. Now it appears the corporation is insolvent. If the shareholder agreement is invalidated, presumably the shareholders will be able to pursue Rita and Fred personally for their losses. Given the facts presented, it is likely the agreement will be upheld as a valid, binding contract. A. The agreement Seventy-five of Rita and Fred’s friends agreed to invest in RKI. Attorney Art prepared the shareholder agreement, which specifically designated Rita and Fred as permanent directors and officers of RKI, and which set their salaries at 12 percent of the corporation’s earnings. On its face, there does not appear to be anything wrong with this contract. RKI is a close corporation in fact if not in name. Less rigorous corporate formalities are required under these circumstances. There does not appear to have been a formal shareholder meeting. This fact will not invalidate the agreement. B. Rita and Fred’s possible bad faith Irv was the duly appointed representative of the 75 investors. Irv participated in extensive discussions with Rita, Fred and Art about the operation of the business. Rita and Fred spoke with Art about the shareholder agreement outside of Irv’s presence. Thus it could be said that the sole representative of the investors was excluded from a significant discussion about RKI’s future. Art’s possible ethical violations in connection with this discussion are discussed below. A compelling argument can be made that Rita and Fred’s conversation with Art about the shareholder agreement was done in perfect good faith. First, since RKI was Rita and Fred’s idea in the first place, it makes sense that they would be permanent officers and directors of RKI. Furthermore, Rita and Fred’s salaries are based on a percentage of earnings, which means that Rita and Fred will not be paid in the event that RKI fails to make money. Rita and Fred have not committed fraud. They have not made any material misstatements, nor have they sought to profit unreasonably from the investors at the expense of the business. Most importantly, Irv and the other investors signed the shareholder agreement and paid for their shares, apparently without complaint. None of them objected to the terms of the contract, because the terms are reasonable. C. Conclusion The shareholder agreement is valid. III. Art’s Ethical Violations Art was the attorney who prepared the RKI incorporation papers, formed the corporation and prepared the shareholder agreement. Art may have committed ethical violations of his duty of loyalty and his duty of care. A. Duty of Loyalty Art’s duty of loyalty requires that he decline to represent parties who have an actual conflict of interest between them, and to secure the informed written consent of clients who face a potential conflict of interest. Art’s conduct requires us to consider a couple of different relationships. 1. Simultaneous representation of Rita and Fred Rita and Fred retained Art as their attorney to form the corporation. At no time do Rita and Fred appear to have developed a conflict of interest, even though RKI failed to make a profit. The facts are silent as to whether Art discussed the possibility of a future conflict, but the prudent practice certainly would have been for Art to discuss the issue with them and include a clause referring to that discussion in the retainer agreement. 2. Simultaneous representation of Rita, Fred and the Investors Rita, Fred and Irv met with Art and agreed that Art would represent Rita, Fred and all of the investors. Again, Art’s duty of loyalty requires that he obtain the informed written consent of clients who have a potential conflict of interest with other clients. In this case, one could make an entirely reasonable argument that the investors and Rita and Fred did not have adverse interests. All wished to see the restaurant succeed. Art’s violation occurred when he wrote the shareholder agreement without further discussion that included Irv, the representative of the investors. A part of the duty of loyalty is the Duty to Communicate, and Art’s failure to consult with Irv before writing the shareholder agreement falls short of proper ethical standards, both in California and under the ABA rules. 3. Conclusion Art’s failure to consult with Irv before writing the shareholder agreement is a violation of his duty to communicate. This violation does not appear to have contributed to the failure of RKI, nor has it caused any other damages. B. Duty of Care Attorneys must do competent work for their clients, which means they must exercise reasonable judgment in their professional dealings. In this case, Art’s violation of the duty to communicate also is a breach of his duty of care. Again, this violation appears to be technical in nature, because it did not cause any damages. Fred and Rita face potential liability under the commercial lease as promoters, as discussed above in Part I. Had Art done a better job representing his clients, RKI would have adopted the lease with the Landlord’s consent, or, perhaps preferably, RKI could have reached a novation with Landlord. C. Conclusion Art’s failure to discuss the shareholder agreement with Irv is a violation of both the duty of care and the duty of loyalty, but it did not cause any damages. Art’s failure to get Fred and Rita’s names off the lease violates his duty of competence. This breach of duty appears to have contributed to significant damages, which Art will be liable for according to proof. Art faces possible discipline for this violation under both ABA and California standards. This answer provided by Scott F. Pearce’s Master Essay Method, 866-449-EXAM, www.calbarexam.com.

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