Instructions:

1. The exam consists of 8 pages, including this cover sheet. Please check now that your copy is complete.
   
   
2. Your exam is due 8 hours after you pick it up, or at 6 pm, whichever is earlier. You must return your exam in person, and must return your copy of the exam questions at the same time. If during the exam you have any questions regarding its administration, you should contact the office of Registration Services.
   
3. The exam is open book; you are free to consult any written or electronic materials and are expected to have all assigned course materials available. Additional research is discouraged, and is unlikely to improve your exam performance.
   
   
4. Please follow the instructions for each question carefully. If your answers depend on facts not provided in the question, say so; and state clearly any additional assumptions you are making.
   
   
5. There are two questions on the exam, each with a separate 1500-word limit. To ensure compliance with the word limit, you must provide a word count for each question. You may not use any leftover space from one question in answering another; any attempt to use shorthand or nonstandard abbreviations will be counted as if full words were used. Answers exceeding the word limit will be penalized by reducing their score in proportion to the excess.
   
   
6. To ensure that you receive full credit for your answers, please be sure to
   
   • write or print your exam number on each page of your exam;
   • begin your answer to each question on a new sheet of paper;
   • use double spacing and adequate margins, so that I have enough room to make notations when grading your exam.
   
   
7. I recommend that you spend about 2 hours reading the exam, thinking about your answer, and outlining your response. Writing the exam should take no more than 4 hours. This leaves 1 hour to edit and proofread your answer and 1 hour for meals, traveling, etc.
   
   
8. I will notify you when grades are ready and will post model answers on the class website as soon as possible after that.
   
   
9. Good luck on the exam, and have a good holiday.
   
   

QUESTION 1:  (50% of exam, 1500 word limit).

Lotus Enterprises is a nonprofit corporation in Salt Lake City , Utah . It employs homeless people to construct prefabricated modular homes. The homes are constructed entirely within a Lotus manufacturing facility. A completed home is then shipped by truck to the buyer. The buyer is responsible for laying a foundation for the home and attaching it to local utilities.

Lotus's business was founded in 2001 by Rev. Robert Hewson, a local minister. Lotus was part of his effort to find a new way to tap the talents of the homeless, teach them skills, and help move them toward self-sufficient living.

Article I of Lotus's Article of Incorporation reads:

Purpose. This organization is organized exclusively for charitable purposes. To this end, the corporation shall employ homeless persons at a living wage. All funds, whether income or principal, and whether acquired by gift or contribution or otherwise, shall be devoted to said purposes.

Hewson, as the CEO of Lotus, received a small annual salary ($10,000). He relied primarily on donations and tithing by his religious congregation for financial support.

Although Hewson ran Lotus on a daily basis, he was responsible to a board of directors, consisting of local religious and political leaders. Hewson's employment contract with Lotus included the following provisions:

Duties: Lotus employs Hewson as President and Chief Executive Officer to perform the customary duties of those positions set forth in the Articles of Incorporation, and as Lotus, by action of its Board of Directors, may provide from time to time. During the term of this Agreement, Hewson shall devote his full time, ability and attention to the business of Lotus on a regular, "best efforts," and professional basis and at all times such efforts shall be under the direction of the Board of Directors.…

Termination for cause. The CEO of Lotus may be terminated for cause. “Cause” in this agreement means (i) intentional fraud, embezzlement, or other material violation of law during the course of employment; (ii) intentional damage to company assets; (iii) intentional breach of company policies; and (iv) willful failure to substantially perform assigned duties.

Lotus typically serves as a subcontractor on projects for which the general contractor is building a set of modular homes or a trailer park. Its business plan has both advantages and disadvantages in this line of work. The primary advantage is labor costs: the “living wage” paid to its workers ($10 per hour) is significantly lower than the wage paid by competing for-profit subcontractors ($15), who do not employ the homeless.

Lotus's primary disadvantage is the quality of its work. Because most of the workers have little experience in construction, they face a steep learning curve. As a result, it is difficult for Lotus to predict whether it will fully satisfy the expectations of general contractors. As a result, many general contractors are wary of awarding subcontracts to Lotus. But because it charges a lower price for its work than competing contractors, Lotus typically secures about ten subcontracts every year.

In June 2007, PSI General Contractors was awarded a contract to build a new housing community of eighty (80) modular homes on the foothills of the Rocky Mountains in Salt Lake City . The contract required several stages of work, including: (1) excavating land, (2) laying foundations, (3) manufacturing the prefabricated homes, and (4) installing the homes.

PSI sent “Project Bid Documents”—describing stages (1) through (4)—to local subcontractors and requested bids. Documentation for stage (3) included the following terms:

Timeliness. All work must be completed no later than July 15, 2008.

Installments. Homes should be delivered according to the following schedule: 25% of the contract quantity by October 1, 2007; 50% by January 1, 2008, 75% by April 1, 2008, and 100% by July 15, 2008.

Progress reports. Subcontractor must submit monthly progress reports that detail the work completed to date. Progress reports are due on the first business day of each month through July 1, 2008.

Fifteen subcontractors submitted bids for Stage (3) of the project. Lotus submitted a bid with the following language:

We hereby propose to furnish all labor, materials, equipment, shipping, fuel, taxes, permits, and related work as necessary to provide and complete 20 MODULAR HOMES per the Project Bid Documents, for a total price of $4,000,000 .

Lotus Enterprises offers quality work to general contractors, pays a living wage to our workers, and serves an important social need. To demonstrate our commitment to timely and high-quality performance: $1,100,000 has been placed in an account at Community Bank as a bond of our performance. This sum is payable to PSI in the event of breach by Lotus.

Lotus's bid was the lowest that PSI received. Three for-profit contractors—Acme, Buildup, and Covad—each submitted the next lowest bid of $5,000,000. Accordingly, PSI awarded a subcontract for 20 modular homes to each of these for-profit contractors. It responded to Lotus's bid by sending a Purchase Order containing the following language:

Thank you for your bid. We offer you the option to construct 20 Modular Homes per the Project Bid Documents, for the lump sum total price of $4,000,000, in consideration for $1,100,000, on deposit at Community Bank.

Hewson was pleased to receive this Purchase Order, because he had estimated that Lotus would earn a profit equal to $500,000 if its bid were accepted. Accordingly, he began work with a team of 20 workers, five of whom were hired for this project.

Progress was steady through March 2008. Five modular homes were delivered as promised on October 1, 2007. Another five were delivered on January 1, 2008. Lotus sent monthly progress reports during this period, each arriving at PSI at least one day before the first business day of the month. The March 2008 report, for example, arrived on February 28.

During late March, however, Lotus experienced sudden turnover as ten workers accepted jobs in another business. A local contractor had been impressed with their work on a prior job and offered them permanent positions. Although the workers' departure came at an inopportune time given Lotus's commitments to PSI, Hewson was happy for his departing workers. He saw their departure as a victory for his business, which had taken a crew from homelessness to self-sufficiency.

Because Hewson was busy searching for new workers, Lotus was unable to send the April progress report until that very day, April 1, 2008. The report reached PSI on April 3, 2008.

On April 10, 2008, PSI sent a letter to Lotus. It stated:

Lotus was late in delivering the April 1, 2008, progress report. On-time delivery was a condition of your option contract. PSI therefore concludes that you have allowed the contract to expire. Please direct Community Bank to transfer $1,100,000 to our account at Rockefeller Bank within 10 business days of this letter.

PSI immediately hired Acme to complete the work that Lotus had agreed to perform. Acme agreed to provide the remaining ten homes for a price equal to $3,000,000.

Upon receiving PSI's letter, Hewson contacted PSI by phone and mail, objecting to PSI's letter and announcing that he would not allow PSI to access funds deposited at Community Bank. PSI threatened to bring suit to recover the sum.

At this point, Lotus had already incurred costs totaling $2,500,000—$1,750,000 on the first ten homes; and $750,000 on the next ten homes, which were still in production. Hewson estimated that the unfinished homes had a scrap value equal to about $500,000. If the homes were sold for scrap, Lotus would incur a loss that would threaten its solvency.

Desperate to avoid insolvency, Hewson approached several realty developers, asking whether they might purchase the 10 modular homes currently in progress. Only one developer was interested, Quad Homes. It offered to pay $2,500,000 for the homes, provided they were all delivered by May 1, 2008. Hewson accepted this offer.

Because Lotus had lost half of its workforce but needed to complete the modular homes rapidly, Hewson widened his search for new workers. He interviewed homeless as well as non-homeless applicants. Though this was inconsistent with Lotus's ideals, Hewson felt that it was a necessary expedient in light of the situation. Ultimately, Hewson hired two homeless workers at $10 per hour and eight non-homeless workers at $15 per hour – the standard wage in the industry.

Lotus delivered the modular homes to Quad on May 1, 2008. Due to the higher wages and expenses generated by the rush to complete production for a new buyer, however, Lotus's costs rose substantially. While it had only spent $1,750,000 on the first ten homes it had delivered to PSI, it cost $2,600,000 to complete the ten homes delivered to Quad — $100,000 more than Quad had agreed to pay.

In mid-May 2008, the board of directors of Lotus held a special meeting to discuss Hewson's recent actions. A majority of the board felt strongly that Hewson had acted improperly by hiring non-homeless workers, and voted to terminate Hewson's employment contract. Stunned that he had been fired by his own corporation—a business he had created—Hewson decided to devote himself fully to his religious ministry.

The Lotus board has hired you to evaluate its rights and potential liabilities with respect to both Hewson and PSI. Please prepare a memo for them.

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QUESTION 2:  (50% of exam, 1500 word limit)

Stellar Quality Components manufactures precision machine parts. Over ten years ago, it began supplying parts to Bynar Technologies, a manufacturer of high-tech medical devices. Stellar manufactured the parts according to proprietary specifications provided by either Bynar or its customers.

This supply relationship required close collaboration between the two firms to ensure that inputs manufactured by Stellar would work compatibly with inputs produced by other suppliers. In addition, because of the high rate of technical innovation in the industry, Stellar had to be prepared to change its production lines on a regular basis in response to new designs.

Stellar and Bynar developed a good working relationship over the years. It helped that management turnover was infrequent at both companies. Stella, the CEO of Stellar, had held her position for over seven years; and Conrad, the owner and CEO of Bynar, had controlled his company from the beginning of the relationship.

In November 2003, Stellar and Bynar negotiated a new five-year contract to govern their relationship from January 2004 through January 2009. The agreement set prices for parts using a formula (an “escalator”) that adjusted prices in an amount proportional to future changes in material and energy costs. The parties also agreed that Bynar would pay Stellar a consulting fee in exchange for its assistance in troubleshooting new designs. The fee would be assessed on an hourly basis and vary with the seniority and expertise of the employees involved.

The Bynar-Stellar agreement did not specify quantities for any category of parts. Bynar, however, promised that it would not purchase from third parties any parts that fell under the contract description. Bynar also agreed not to undertake in-house production of such parts during the pendency of the contract.

The parties also agreed to a number of provisions intended to preserve Bynar's control over the proprietary designs. Specifically, Stellar promised that (1) it would not disclose the designs supplied by Bynar, or any technical information pertaining to such designs, to any third party either during the life of the contract or afterward; (2) it would not supply parts to any other buyer with regard to any product sold in competition with Bynar's products; and (3) upon Bynar's demand, it would promptly return any designs supplied by Bynar or its customers, together with Stellar's technical notes relating to such designs.

Soon after the parties inked the November 2003 contract, the high-tech medical equipment industry entered a period of intense international competition, downward pressure on prices, and mergers between some of Bynar's competitors.

By December 2005, Bynar found itself facing cash-flow problems. Bynar's CEO, Conrad, entered merger negotiations with several high-tech companies. One of these was Triad, a conglomerate that owned and controlled a variety of subsidiary firms, including Rhombus Inc. Like Bynar, Rhombus produced high-tech medical devices. Like Stellar, Rhombus also produced precision machine parts.

Nothing came of Conrad's merger negotiations, and competitive pressure in the medical equipment industry continued to build. In July 2006, Bynar contacted Stellar, asking for a price reduction. Stellar refused. Conrad then approached Rhombus, asking it to consider supplying the parts needed for Bynar's manufacturing process. Rhombus was initially open to the possibility, but lost interest when it learned that Bynar's contract with Stellar still had two and a half years to run.

Over the next six months, Bynar continued to pressure Stellar for a price reduction. Finally, in January 2007, after Bynar hinted that it might run out of cash and suspend orders, the parties agreed to rewrite their deal. They rescinded the earlier contract and entered into a new contract, to run from January 2007 to January 2012, under which Stellar agreed to reduce its price formula by a factor of 20%. During negotiations, Bynar proposed deleting the clause that restricted it from purchasing parts from third party purchases or engaging in in-house production. Stellar objected. The restriction was therefore retained. All other relevant terms remained the same. The new contract, like the old one, contained an entire agreement clause (also known as a “merger clause”) stating that all other understandings between the parties were superseded by the written contract.

Despite the price reduction, Bynar faced competitive difficulties. Its precision parts orders declined by 10% in 2007 and another 12% in 2008. Although Bynar generated profit on its overall operations, these profits were declining at a similar rate.

In November 2008, Conrad re-opened merger talks with Triad. He met with Dionne, the CEO of both Triad and Rhombus. This time, Dionne was more interested than she was in late 2005. During a lengthy meeting with Conrad on November 15, 2008, she proposed a transaction in which Triad would acquire Bynar as a wholly owned subsidiary, and Conrad would exit the firm but receive an attractive compensation package. Following the acquisition, Triad would direct Bynar to transfer its assets to Rhombus, which would consolidate Bynar's business with its own. After the consolidation, Bynar would formally wind down and cease to exist as a separate entity. (Each of these corporate transactions (transfer of assets, consolidation, etc.) is permissible under applicable state law.)

Because Rhombus already produced its own precision parts and had excess capacity, however, Rhombus would not continue purchasing parts from Stellar. This issue arose during the November 15, 2008, meeting, when Dionne asked Conrad to negotiate a release from the Stellar-Bynar contract. Conrad replied that no such release would be necessary, since the contract with Stellar would come to an end when Bynar did. Dionne replied that she was concerned that Rhombus, as Bynar's effective successor, might be held responsible for Bynar's obligations to Stellar. The parties compromised on the issue when Conrad agreed to (i) guarantee half of any payments that Rhombus might eventually have to make to Stellar and (ii) pay half of any legal expenses Rhombus might incur defending against Stellar's claims.

Conrad and Dionne did not complete their merger negotiations or execute any formal writing during the November 15, 2008, meeting. A number of important details remained open and Dionne needed formal permission from Triad's board of directors. Instead, they ended their meeting with a handshake and agreed to meet in ten days to finalize the deal.

When Conrad notified Stella and her management team of the upcoming merger with Triad, they were surprised and upset. They became livid when Conrad stated that Stellar would be asked to turn over its design notes for machine parts currently in production, so that Bynar could share them with Rhombus. Stella stated that her company would never have agreed to the January 2007 modification had Bynar indicated that it might sell itself to another company, and insisted that Bynar continue its contract with Stellar for three more years. Conrad tried to explain the need for the merger, but the conversation became heated and the meeting broke up soon after, with Stella shouting, “We'll see you in court!”

Following this meeting, Conrad began to worry. For the first time, he realized that he might need to expend significant resources defending against Stellar's claims. More importantly, the dispute with Stellar might jeopardize the entire merger if Triad's board of directors found out about it.

Conrad has come to you for advice on how to settle the dispute. Please advise him.

 

END OF EXAM