Outline for Business Associations – Fall 2005

Professor Brietta Clark

  1. Introduction to Business Associations
  1. BUSINESS FORMS
  2. What is a “business form”? A shorthand for legal and economic consequences of a particular business relationship

a)Focus on relationship between managers and owners

b)Focus on allocation of

(1)Risk & return

(2)Control

  1. What are primary business forms?

a)Sole proprietorship

b)Partnership

c)Corporation

  1. AGENCY LAW
  1. Principle of law that enables someone to act on behalf of another; could not have a business association without this principle

a)Owners elect officers to carry out day to day activities for a corporation;

b)Partners act on each other’s behalf;

c)Employees work for a sole proprietorship

  1. Agent’s can bind the principal and principal must follow through
  1. Risk associated with agency; why?

a)Loss of control

b)Bad business decisions

c)Cost to monitor

  1. TWO THEMES OF COURSE
  2. Internal agency costs and “other people’s money” problem
  3. Corporation as citizen and external costs of corporate decision-making; social interests vs. profit maximization
  1. INTRODUCTORY HYPOTHETICALS
  1. P decides to go into the business of preparing students for the LSAT. She plans to teach classes of up to 15 students and will provide them with written study aids for a fee. She puts up all the funds for the business herself (risk of loss to personal assest). Her initial expenses include the lease for office and classroom space, office equipment (copier, fax, computer), office supplies, and set-up of utilities. She begins soliciting students (employee, manager and investor) and teaching right away (no formal filing). P is a SOLE PROPRIETORSHIP.

a)What is her risk?

(1)Compensation not “fixed”; tied to how well business does

(2)Loss of personal assets

b)How could she avoid risk? Incorporate (but disadvantages w/ this)

  1. The number of students enrolling P’s class has increased quickly, and P decides she needs help. She mentions this to her friend, E, who just left his job teaching at Kaplan. E agrees to teach one of the classes for about 6 hours a week at $45 per hour (employee).

a)What is his control? Little if any; P has say over outcome

b)What is his risk?

(1)Loss of job

(2)Liability only if does not act within scope of employment; otherwise no personal liability

  1. Business continues to grow rapidly, and P decides to expand. She decides that she needs someone to manage the LA office since she’ll be gone a lot in order to open a new office in San Diego. She talks to another friend of hers, M, who has previous managerial experience (with Kaplan). M aggress to supervise the teachers, organize class schedules and materials, and work on getting students to enroll (manager). P agrees to pay him $50,000/year for these services.

a)What is his control? More than E b/c controls scheduling, materials

b)What is his risk

(1)Loss of job

(2)Liability? Greater exposure, but probably not personally liable unless exceeds scope of authority

c)What is P’s risk? Bad business decisions by M

d)How can P minimize risk inherent in agency relationship?

(1)Duty of procedural due care

(2)Duty of substantive due care

(3)Duty of loyalty

(4)Indemnification (see liability above)

(5)Monitor M (but cost associated)

(6)Incorporate (still some liability, but personal assets protected)

(7)M’s incentives (tie salary to performance; profit-sharing)

  1. Instead of rapidly growing, P’s business actually has been losing money. She sees potential, but needs more money to stay in business – about $5,000. P mentions this to her friend Paris, who says that she’s always wanted to go into that kind of business (creditor or partner?). In fact, Paris has an extra $5,000 just burning a hole in her pocket. So Paris gives P the $5,000 for the business and they begin working together on new ideas for growing the business (partner!).

a)How do we know Paris is a partner, not a creditor?

(1)Not a loan with interest

(2)More involvement in business than just money

(3)Anticipated return on investment

b)How do we know this is a partnership, not a corporation? No formal filing; “default rules” of partnership apply (see chart below)

  1. OVERVIEW OF CORPORATIONS VS. PARTNERSHIP

Partnership (“default rule”) / Corporation
  • No formalities; does not force the owners to think about legal consequences
/
  • Formalities; although routine matter, costs $$$

  • Personal liability
  • How to limit? include indemnity provision in partnership agreement; use LLP; buy insurance
/
  • Limited liability
  • Limitation? must “look” like a corporation; if not, may lead to “piercing the corporate veil”

  • Not freely transferable
  • like a marriage, cannot just step out and have a replacement
  • rules are created to protect the notion that people entering into p’ship know each other, have relationship
/
  • Free transferability of interest (shares)
  • Entity separate from the shareholders; continuity of the entity

  • Partners share ownership & control
/
  • Separation of ownership & control
  • success or wealth of business does not depend on identity of the shareholders
  • shareholders do elect officers; have vote on “big things” (e.g., sale or merger)

  • At-will existence
  • If a partner leaves, p’ship likely dissolves
/
  • Indefinite; no term or perpetual

  • Flexibility in how business structured
/
  • Not a lot of flexibility

  • “Pass through” tax
/
  • Double tax
  • Corporation taxed on income; shareholders taxed on distribution

  1. Liability Arising Out of the Principal-Agent Relationship
  1. Contract Liability
  1. Liability of Principal for Agent’s Acts

a)TWO QUESTIONS:

(1)Does an agency relationship exist?

(a)Mutual assent (P & A);

(b)A to act on behalf of P; and

(c)A subject to P’s control

(2)Did A act within scope of authority?

(a)P must “do something” to either give A actual authority, to manifest A’s authority to T, or place A in a position to act

(b)If actual authority—express or implied—only P is liable

(i)Implied actual authority subject to “reasonableness”

(c)If no actual authority, but can show apparent authority, P is liable OR P can seek indemnification from A

b)Actual v. Apparent Authority

(1)Actual authority (P  A)

(a)Express

(b)Implied– to carry out the task specifically authorized by P, A must also have authority to do additional tasks

(i)IMPLIED AUTHORITY (MillStreetChurch v. Hogan): Church elder hires BH to paint church; BH has done work for church in past and has been able to get help from brother SH when needed. Elder talked to BH about hiring someone to help, GP, but said GP “hard to reach.” Church supplied tools & materials. When got too difficult, BH hired SH to help. After SH starts working, falls off ladder and breaks arm. Church pays SH for time worked, but challenges SH’s worker’s comp claim on grounds SH is not employee of church. BH, as employee, had implied authority to hire brother to help.

(ii)Example: P, a movie producer, hires A as an assistant. P tells A to “hire a camera person” for a project. A hires the camera person at a competitive wage. A had actual express authority to hire someone and implied authority to set the wage.

(iii)How determined?

(a)Perception of A

(b)Present & past conduct

(c)Nature of the task (e.g., what is incidental to; usually accompanies; or reasonably necessary)

(iv)Can P seek indemnification from A?

(a)No; if there is actual authority, only P is liable; unless A acted unreasonably

(b)Example: P is not happy with the wage that A agreed to; nevertheless, P cannot get out of the contract b/c the wage is “competitive,” usual and customary in the industry

(v)Can A be liable to T?

(a)No, A is not personally liable on contract, unless

(i)A is a party to the contract; or

(ii)A fails to disclose, in making contract, that A was acting as representative of P (i.e., if P partially or undisclosed)

(b)See agent’s liability below

(2)Apparent authority (P  T)

(a)Example:A camera person, T, who is looking for work calls P about a job. P doesn’t like T’s work and doesn’t want to hire him, but doesn’t tell him that. She just tells T that A is in charge of the hiring and that T should give A a call. P immediately tells A not to hire T under any circumstances. A few weeks pass, and A is having trouble finding someone. A then decides to hire T after all. When P hears this, she fires A and refuses to honor the contract to T. T sues P to enforce the contract.

(b)How determined

(i)Disclosed or partially disclosed P

(ii)P’s manifestations (words or conduct) cause T to believe that P consents to have act done on P’s behalf;

(a)Example: Same conflict as above, except this time, P and T never spoke (directly or through P’s secretary). P still told A not to hire T, but T only spoke with A. A tells T that he is doing the hiring for P, and in fact T had already heard this. Now, there is no apparent authority because there are no manifestation’s by P of A’s authority to act on her behalf.

(iii)Acts otherwise usual, customary; and

(iv)Includes unauthorized acts if T does not know of the limitation; if P fails to correct or make clear any limitation in authority

(c)Can P seek indemnification from A?

(i)If A has no actual authority; and

(ii)A’s conduct exceeds scope of authority, duty of care, resulting in some loss to P

(d)Can T sue A if P refuses to honor the contract?

(i)No, A cannot be liable on the contract unless:

(a)A is a party to the contract; or

(b)P is an undisclosed or “secret” P

(ii)See agent’s liability below

(e)Policy: to protect T when acts are usual and customary and P fails to correct or notify T of any limitation

(f)Planning: In 370 case, what could Ampex do to protect himself from liability? It could

(i)have express contract provision that salesperson could not accept; and

(ii)make limits on authority clear to its salespersons

(g)NOTE: Can have both actual implied and apparent authority in one situation

c)Inherent Agency Power

(1)Watteau v. Fenwick – P bought beerhouse from A, but retained in A’s name & A’s license. Under agreement, A could not buy any goods for the business except bottled ales and mineral waters. Nevertheless, T gave credit to A and A bought cigars and nonalcoholic drinks form T. Because P was undisclosed, and A did something that was usual, customary for beerhouse manager, court held P was liable on the contract.

(2)Example: This time, P doesn’t want anyone to know that she is involved with the movie. P still hires A as an assistant and instructs her to hire a camera person, as long as it is not T. She also specifically tells A not to let anyone know that P is the one producing the movie. The same conflict results: A hires T anyway, P finds out, fires A and refuses to honor the contract. T then finds out that P is the movie producer on the project that T was hired to shoot, and T sues P for enforcement.

(3)How determined?

(a)Secret or undisclosed P;

(b)P entrusts business to A; and

(c)A engages in usual, customary acts.

(4)Policy:

(a)To protect T from “secret” P’s;

(b)Place burden on party who can prevent loss most efficient (i.e., P has information and thus in best position to prevent the loss)

(5)Planning: In Watteau v. Fenwick, to prevent liability, P could send signals to suppliers (e.g., change store name or put up sign)

(6)NOTE: Do NOT confuse this with principle of estoppel, whereby T must be misled into thinking he is transacting with P and must rely on that (mis)information to his detriment

d)Ratification

(1)Example: As in the above cases, P tells A to hire a camera person, as long as it is not T. A hires T anyway. However, this time when P finds out about the contract, she decides to give T another chance and doesn’t tell either A or T that there is a problem.

(2)How to determine?

(a)No agency relationship necessary; A must only purport to act on P’s behalf;

(b)P accepts benefits of contract

(i)EXCEPT: If there has been a material change in circumstances underlying the contract (e.g., contract to sell house that later burns down and P then tries to ratify)

(c)P intends to ratify; and

(d)P has knowledge of terms of contract

  1. Agent’s Liability on the Contract

a)Atlantic Salmon v. Curran – Δ did business w/ π, two salmon exporters. Π sued Δ for balance due on sales of salmon, but Δ argued he was not personally liable because at the time he entered into contracts, he was acting as a representative of MDI, Inc., corporation formed by Δ. However, when π sold salmon, it thought it was selling to “Boston Seafood Exchange,” another corporation formed by Δ. Π never knew of MDI, until it sued Δ for balance.

b)When?

(1)If A signs contract and agrees to be a party to the contract; or

(2)Undisclosed or partially disclosed principal cases—secret principal; A is automatically part of the contract if fails to disclose who entering into contract for; or

(3)A engages in active misrepresentation or fraud on T

(a)NOTE: This is different from A’s liability to P via indemnification. To be liable to a third party T, A must have done something “egregious.” Courts are generally protect against A’s liability, if P has put A in a position to act.

  1. Tort Liability of Principal for Agent’s Acts
  1. TWO QUESTIONS:

a)Is there a master-servant relationship?

b)When the tort occurred, was the servant/employee acting within her scope of employment?

  1. Servant v. Independent Contractor

a)RULES

(1)STAT § 220. Definition of servant

(i)Employed to perform services; and

(ii)Physical conduct subject to P’s control or right to control

(iii)Other factors to consider:

(a)Extent of control;

(b)Distinct occupation;

(c)Skill required;

(d)Who supplies materials;

(e)Length of time;

(f)Method of payment;

(g)Is work part of employer’s regular business;

(h)What do parties intend?

(2)RULE from cases: The right to control financially may be enough to give rise to the employer-employee relationship, whereby the right to control is concomitant with exposure to risk.

b)Employee: Humble Oil v. Martin – Customer left her car at S’s station for work. Car rolled down hill, striking a family. Court found for injured family, against Humble Oil, as operator of the station. Humble appealed on grounds it could not be liable for conduct of S because S was an independent contractor, not an employee. The court disagreed, holding S was in effect an employee: (1) Humble set the station hours; and (2) S was required to make “reports” to Humble. The court considered S “like a store clerk,” who happened to be paid by commission, not salary. But was this really enough to show a master-servant relationship? Maybe not, because S controlled the service part of the station; Humble sold gas and related products. However, court fashioned a rule: regardless of whether Humble chose to exercise control, it had the right and the ability to do so because it was so powerful financially.

c)Independent contractor: Hoover v. Sun Oil –Plaintiff sued the service station operator, his employee, and the oil company after he suffered injuries as the result of a fire in his car when it was being filled at the station. Sun Oil moved for summary judgment on grounds the service station operator was an independent contractor and thus it could not be liable for his negligence. Unlike Humber, the court here found the operator was an independent contractor: (1) he set his own hours, pay scale, and working conditions; (2) he had not obligation to submit reports to Sun Oil, or to follow its advice. Thus, the operator—not the company—exercised control over day to day operation and assumed risk of profit or loss.

d)Planning: How can the “master” avoid liability?

(1)Give up risk, but then must also give up ability to control profits/losses

(2)Specify areas of control

(3)Indemnity/insurance coverage

  1. Scope of Employment

a)RULES

(1)STAT §§ 228 & 229.What is within scope of employment

(a)Conduct within scope of employment

(i)Kind employed to perform;

(ii)Occurs within authorized time and place;

(iii)At least in part, motivated by purpose to serve master;

(iv)Use of force, if any, not unexpected by the master (e.g., owner of nightclub liable for injuries caused by bouncer)

(b)Not within scope

(i)Different from kind authorized;

(ii)Far beyond time or space;

(iii)Too little actuated by purpose to serve master

(c)Even if not authorized, may still be within scope of similar to incidental to conduct authorized

(i)Act commonly done;

(ii)Time, place, purpose are similar;

(iii)Previous relations between master and servant;

(iv)Master has reason to expect (foresee) will be done

(2)RULE from cases: Must the servant be motivated by a purpose to serve the master at the time of the tort, or is it enough that the tortious result may be foreseeable, based on the circumstances and scope of the servant’s employment? Courts may look to both—one or the other may not be enough to give rise to employer liability. There must be some connection between the act and employment purposes.

b)Within scope:Bushey & Sons v. United States – Drunk seaman caused damage to drydock upon return to the ship. Although his immediate purpose was not to serve the master at the time, his conduct was foreseeable under the circumstances and thus the master bore the risk of such injury.

c)Within scope:Manning v. Grimsley – Pitcher intentionally threw ball at onlookers who were heckling him. Court held ball club could be liable for the tort because the pitcher’s response was to conduct that was interfering with his ability to perform his duties.

  1. Distinguishing Agency from Other Relationships: Common Business Relationships that Don’t Fit Neatly Into the Legal Model of Agency
  1. Creditors: Jenson Farms v. Cargill – A group of farmers sued Cargill and Warren to recover on contracts Warren made with them for sale of grain. The trial court found for plaintiffs, against both C and W. C appealed arguing it was not a principal, but rather a buyer of W’s, and that it never consented to an agency relationship with W. The court affirmed, holding that the facts & circumstances demonstrated a unique relationship between C and W that went beyond a mere creditor-debtor relationship. There was sufficient evidence that a jury could conclude that C exercised control over W’s operation and thus could be held liable on contracts made by W for purchase of grain. What facts were significant to the court? (1) C’s veto power over W’s capital/debt decisions; (2) C essentially “propped up” W by continuing to extend credit, even though W was in severe financial distress. Although the parties did not agree to a principal-agent relationship, they nevertheless agreed to a relationship that gave C enough control that in effect, it acted as the principal. The court was also probably concerned with W’s deliberate falsification of its books and the farmers’ inability to recover unless C could be held liable.
  2. Franchisors

a)Rule from the cases: Courts view a franchise as a “special” relationship. Because the franchiser’s primary asset is its trade name and system, courts will tolerate some level of control greater than that in a normal independent contractor relationship. However, some relationships may go beyond a normal franchiser-franchisee relationship to create an agency relationship. The “rule” is based on the nature and extent of control agreed upon by the parties. If the franchisor exercises a day-to-day level of control, it must bear an increased level of risk.