Business Associations Outline – Professor Eakeley – Fall 2014
Introduction to Business Associations
Types of Business Organizations
1) Sole Proprietorship: In this type of firm, there is only one owner, the residual claimant
a. Residual Claimants:
i. Exclusive Claim to Profits: The residual claimant has the exclusive claim to the profits of the business
ii. Sole Monitor: She is the sole monitor of the other team members
iii. Power: She has the power to buy or sell assets and to hire and fire workers
iv. Liability: The sole proprietor is also personally responsible for all debts in the business
2) General Partnership: A general partnership has two or more residual claimants who share the monitoring role
a. Liability: Partners are personally liable for the debts of the business
b. Difference from Sole Proprietorship: A general partnership has multiple ownership
c. Partners Generally
i. Decisionmaking: The owners must agree in advance how to make decisions in the future and how to share the profits and other assets of the business
ii. Participation: The partners usually want to participate in management and have the power to veto important decisions, such as the admission of new partners.
iii. Dissolution: They also want rule specifying the consequences of each party’s withdrawing from (that is, dissolving) the relationship
3) Corporations: A corporation generally has many residual claimants who contract to allocate control and profits
a. Difference from Partnership: The owners in a corporation are passive and delegate to the corporation’s managers the responsibility for day-to-day operations
b. Not Actively Involved: Since owners are not actively involved in management, they are essentially fungible capital-providers and therefore shares in the business can be freely transferable
c. Limited Liability: Passive ownership is facilitated by limited liability
i. Definition: The owners are not personally liable for the debts of the business
4) Close Corporation: Sometimes the corporate contract combines partnership-type owner-management with corporate-type limited liability
a. Definition: Membership is limited rather than open to all, as in a publicly held corporation with freely traded shares
b. Examples: Such corporations normally include contracts similar to those found in a general partnership for allocating governance functions and controlling shirking
5) Limited Partnership: Limited partnerships combine attributes of both partnerships and corporations
a. Types of Owners
i. General Partners: Some owners are general partners and, like general partners in general partnerships, contract for active involvement in management and personal liability
ii. Limited Partners: Other owners are limited partners, and generally contract for non-management monitoring status and limited liability
b. Losing Limited Liability: However, limited partners can sometimes lose their limited liability if they take too active a role in the firm’s affairs
c. Generally: Limited partnership is usually viewed as a way to combine partnership-type taxation with corporate-type organization
6) Limited Liability Company: In an LLC, the owners enjoy the limited liability of limited partners and corporate shareholders, the flexibility to take on the management powers of general partners without jeopardizing their limited liability, and the flow-through taxation of general and limited liability partnerships
a. Modern Day: Over the last few years, this new form of business association has emerged rapidly through statutes
7) Limited Liability Partnership: The LLP is essentially a general partnership, whose owners, by filing a registration and complying with other formalities, obtain full or partial limited liability, depending on the statute
Choosing a Form of Organization
1) Partnership or Corporation: Often, it will make more sense to set the business up as a partnership
2) Nature of Partnerships:
1) Importance of Agency Law: Since most businesses, at one time or another, act through third parties, it is necessary to determine when an agent can bind the principal, when the principal is liable for the agent’s actions, and what the duties and obligations of agents are to principals
2) Agency Law Generally: Agency law is about when one party is responsible for the actions of another and what rights and obligations those parties have to one another
3) Types of Agents:
a. General Agent: An agent authorized to conduct a series of transactions involving a continuity of service
b. Special Agent: An agent authorized to conduct only a single transaction or a series of transactions not involving a continuity of service
c. Subagent: An appointee of an agent that acts with the authority of the principal in making the appointment. The subagent has two principals.
1. Appointing Agent’s Liability: The appointing agent is primarily liable for the acts of the subagent
2. Principal’s Liability: The principal is secondarily liable.
ii. Note – Unauthorized Agent: If the agent is not authorized to appoint a subagent but nevertheless appoints a person to perform a function for the principal, the appointee is not a subagent but rather the agent’s agent and the principal is not liable for the acts of the appointee.
d. Coagent: Coagents are two or more agents who owe duties to a common principal but not to each other. A coagent may be appointed by the principal or by another agent with the authority from the principal
i. Superior Coagent: If the coagent is directed by another agent, then the directing agent is the superior coagent and the other agent is the subordinate coagent
ii. Not Vicariously Liable for Other Acts: Since co-agents are not agents of the other, they are not vicariously liable for the wrongs committed by the other.
4) Types of Principals: Certain rights and liabilities under agency law depend on whether a third-party knew of a principal’s existence and/or identity
a. Disclosed Principal: A principal is disclosed if the third party with whom the agent is transacting business knows that the agent is acting for a principal and knows the principal’s identity
b. Unidentified Principal: A principal is unidentified if the third party with whom the agent is transacting business knows that the agent is acting for the principal but does not know the principal’s identity
c. Undisclosed Principal: A principal is undisclosed if the third party with whom the agent is transacting business does not know that the agent is acting for a principal.
5) Analysis of Agency Problems:
a. Agent-Principal: Is the problem between the agent and the principal?
b. Third Party Contract: Does it involve a third party trying to hold the principal to an agreement based on the agent’s conduct or an express agreement?
c. Third Party Torts: Does it involve a third-party trying to hold a principal liable for the agent’s torts?
1) Definition of Agency Relationship
a. Restatement Third of Agency Section 101: The agency relationship is the fiduciary relationship that arises when one person (the principal) manifests assent to another person (an agent) that the agent shall act on the principal’s behalf and subject to the principal’s control and the agent manifests assent or otherwise consents so to act
b. Restatement (Second) of Agency Section 1 – Agency; Principal; Agent
i. Agency Relationship: (1) Agency is the fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act.
ii. Principal: (2) The one for whom action is to be taken is the principal.
iii. Agent: (3) The one who is to act is the agent.
2) Restatement (Second) of Agency:
a. Section 2 – Master; Servant; Independent Contractor:
i. Master: (1) A master is a principal who employs an agent to perform service in his affairs and who co
6) ”On Behalf of the Principal”: The agent must be acting primarily for the principal’s benefit, not for the agent’s own benefit or that of another party.
a. Resulting Benefit Irrelevant: The agent need not produce an actual benefit for the principal so long as there was an expectation at the outset that the agent would strive to do so.
b. Types of Actions: The principal may retain an agent to perform almost any act.
i. Non-Delegable Duties:
1. Statute or Contract: When a statute or contract requires the principal to perform personally, the principal may not assign these non-delegable acts to the agent.
2. Illegal Actions: A principal may not validly delegate power to an agent to perform an act that is criminal, tortious or otherwise opposed to public policy
ii. Dual Agency Rule: An agent may not act on behalf of an adverse party to a transaction connected to the agency relationship without the consent of the principal.
a. Voidability: If neither of the principals were aware of the agent’s dual capacity, any transaction between them is voidable by either party.
b. Liability: The agent may be held liable to the principals for any resulting loss on grounds of fraud and breach of fiduciary duty
2. Single Defrauded Principal: If one of the principals had secretly retained the agent to deal with the second without disclosure, the defrauded principal can rescind the contract and/or sue either the principal or agent for damages
7) “Control” By Principal: A principal need not exercise physical control over the actions of its agent so long as the principal may direct the result or ultimate objectives of the agency relationship
a. Requirement: The requisite level of control may be found so long as the principal is able to specify the task the agent is to perform, even if the principal is unable to ensure that the agent carries out that task.
Illustrations of Agency Relationship
1) Gratuitous Actions (Gorton v Doty): An agency relationship can be based on merely gratuitous acts of kindness
a. Facts: Principal told agent that he can use her car if he drove it. Agent borrowed and drove the car and agent caused an accident where a passenger was injured.
b. Control Element
i. Condition Precedent: The Court found that the agent is subject to the principal’s control from the mere fact that she set a condition precedent on the use of the car.
c. Undertaking to Transact Business Irrelevant: The relationship does not need to involve a business matter, but only that where one undertakes to transact some business or manage some affair for another by authority and on account of the latter, the relationship of principal and agent arises.
d. Agency: Agency indicates the relation which exists where one person acts for another
i. Forms of Agency:
1. Principal/Agent: The relation of principal and agent
2. Master/Servant: The relation of master and servant and
3. Employer/Independent Contractor: The relation of employer or proprietor and independent contractor
e. Principal’s Duty: The principal is responsible for the acts of his or her agent
f. Irrelevant Matters: To have an agency relationship, a contract or compensation is not essential.