Thomas Klein
Business Organizations
Fall 2012
OVERVIEW
A business organization is one or more persons who work together for a common business purpose.
Cardinal Rules of Business Organizations
1. Don’t bother trying some new creative business finance scheme to cheat the government because it’s been done, and the feds have made rules that prevent it.
2. When it’s a blurry line (like whether a fiduciary), stay away and be conservative.
3. 50-50 is a bad idea (Recipe for deadlock).
4. Competition is the source of best outcomes.
Purpose of Business Organizations
· Agency Theory: University of Chicago says the rules of business organizations are designed to reduce agency costs (costs of hiring agents)
· Theory of the Firm (Coase): more efficient to adopt a business organization because rules are ready made and don’t require negotiation between all parties
AGENCY (equitable principle)
Common law foundation of business relationships whereby one party (agent) acts on behalf of another (principal). Examples: power of attorney, employee, etc.
gency Theory
· Separation of management and ownership leads to lost productivity of having someone do work for owners AND management incentive may differ from owner’s incentives; owner wants to maximize use of assets for profit, and managers want to maximize their own power in the company
· Business organizations designed to address these agency costs
Essential Questions
1. Is there a principal-agent relationship?
2. If so, is the question one of tort or contract?
Creation of Agency Relationship
Restatement 3D §1.01A
1. Fiduciary relationship
2. “Manifestation of consent” by principal that agent will act for him/her
3. Agent’s “manifestation of acceptance”
4. Understanding by parties that principal will control the undertaking
Principal Liability For Authorized Acts
Authority (R2d §7): power of the agent to affect the legal relations of the principal by acts done in accordance with the principal’s manifestations of consent to him.
1. Actual Authority (R3D §2.01) (express: words or conduct): (1) At time of taking action that has legal consequences for the principal, (2) the agent reasonably believes that the principal wishes the agent so to act (3) in accordance with the principal’s manifestations to the agent.
i. Creditor: A creditor who assumes de facto control of the conduct of his debtor’s business, as viewed in totality of circumstances, may become liable as principal for the acts of the debtor in connection with the business. [Cargill, Inc: grain company take-over]
b. Implied/Inherent Authority (subsumed by “Actual Authority” in R3d): conduct, acquiescence, etc.
i. Inferred: unless otherwise agreed, authority to conduct a transaction includes authority to do acts which are (1) incidental to it, (2) usually accompany it, or (3) are reasonably necessary to accomplish it.” [R2d §35]
ii. Incidental: As an incidental matter, the agent takes necessary steps and proceeds in the usual and ordinary way, as the principal would wish [R3d §2.02]
iii. Attorney: A client’s retention of an attorney DOES NOT in itself confer implied or apparent authority on that attorney to settle or compromise the client’s claim, BUT does give attorney power to bind the client to an in court proceeding [Koval: power of attorney].
2. Apparent Authority (2d §8): Third party reasonably believes principal authorized the agent based on manifestations between principle and third party.
a. MAJ – Client does not create apparent authority for his attorney to settle a case merely by retaining the attorney. [Fennel v. TLB Kent Co. (1989)]
b. MIN – Attorney appearing on behalf of client in court is an indication that the attorney has the authority to settle for the client. [US v. Int’l Brotherhood of Teamsters (1993)]
Principal Liability For Unauthorized Acts
1. Ratification: Principal may affirm a prior unauthorized act by another, whereby the act is given effect as if done by an agent acting with actual authority IF: (1) act is ratifiable, (2) person ratifying has capacity, (3) ratification is timely, (4) ratification encompasses act fully.
a. Ratifying Conduct: Where an agent acts without actual or apparent authority, principal may ratify agent’s acts through conduct that indicates consent. [Daynard v. Ness: Firm owes $ to professor retaining him as legal counsel]
2. Estoppel (R3d §2.05) (equitable doctrine, NOT agency doctrine): Agent’s acts were unauthorized by the principal, but a third party believed the agent to be authorized, AND:
a. the principal caused such belief, OR
b. the principal did NOT take reasonable steps to notify them of the facts.
Tortious Liability
Agents are personally liable for their torts, and principals may be liable for the agents’ torts.
1. E
3. Remedies: Breach of trust, Breach of contract, or Tort
4. Damages: All profits made by the agent in the course of the agency belong to the principalEven if principal is made whole
Agency in Action
1. Partners are agents of the partnership
2. Corporate directors are fiduciaries to the corporation and shareholders (but not by an agency relationship)
3. Corporate officers are agents and therefore fiduciaries of the corporation
Termination of Agency
· consensual agreement
· death or loss of capacity of either party
· bankruptcy of agent or principal
· (Don’t forget to terminate apparent authority)
SOLE PROPRIETORSHIPS
A business owned directly by one person who has sole decision-making authority, an exclusive claim to business profits, and direct ownership of all business assets. Most popular form in the US!!!
1. Actors: Owner and manager is the same person.
a. A sole proprietorship with employees constitutes a business organization.
b. Introduction of a second owner becomes a partnership.
Sole Proprietorship Formation and Operation
1. Simply start operating; No code/statute to say how it’s formed and regulated; low transactions costs
2. Only distinction in the law is that if you call it something, must file Fictitious Business Name statement with county, or else a nominal penalty (DBA)
Sole Proprietorship Ownership and Management
1. Owner conducting business under his name or fictitious name
2. Founder is owner/manager/initial investor
Sole Proprietorship Personal liability of owner
1. Owner has unlimited liability. No statutory protection; subject to common law
2. But could try to control with insurance or waiver
Sole Proprietorship Financing:
1. Owner? Friends/family? Investor group/professional investors?
2. Admission of new investors is problematic because of liability management relationship
