a) The Role of Agency Law
i) Definition: An agency is a fiduciary relationship that results from consent between the principal and agent that the agent shall act on the principal’s behalf and subject to his control.
ii) Problem: AB Software Co. A and B go into a small business together, with A putting up the capital and B providing the management. A wants to avoid being called on for additional capital and wants veto power over the important decisions affecting the business. Profits are to be divided equally after B is paid a salary. If A and B enter an oral agreement and B starts in, what form of business organization has been formed?
(1) A and B are both agents of the business entity. The entity is principal, and human beings are its agents.
(2) An agent could also be another entity, which will in turn employ its own agents (employees) to perform the tasks.
(1) Undisclosed principal: When a third party has no notice that the agent is acting for a principal. The agent is held fully responsible if the principal does not pay.
(2) Partially disclosed (“unidentified”) principal: When the third party has notice that the agent is acting for a principal but does not have notice of the principal’s identity. The agent is held fully responsible if the principal does not pay because the third party doesn’t know who to go after.
(3) Fully disclosed principal: When the third party has notice that the agent is acting for a principal and has notice of the principal’s identity. The agent is off the hook if the deal falls through; agency law prevents the agent from being responsible.
(1) Actual authority: The principal confers authority onto the agent. If the principal revokes the authority, it is gone.
(2) Apparent authority: When it appears to the rest of the world that the agent’s authority still exists. If the deal falls through, the third party can sue the principal under contract.
v) Master-servant relationship: A master is a principal who employs an agent to perform service in his affairs and who controls or has the right to control the physical conduct of the other in the performance of the service.
vi) Independent contractor: one who contracts with another to do something for him, but who is not controlled by the other nor subject to the other’s right to control w/r/t his physical conduct in the performance of the undertaking. The independent contractor may/may not be an agent.
(1) Employee distinguished from independent contractor
(a) The “independent contractor” classification is advantageous to employers because they are not responsible for benefits, and in general have much less responsibility for the agent’s actions.
(b) The IRS has a number of factors to distinguish employees from independent contractors.
2) BASIC BUSINESS FORMS
a) The subject is broken down into unincorporated associations (agency, partnership, etc.) and corporations. A further basic distinction can be made between “closely held” businesses (ones with a few owners) and “publicly held” businesses (with hundreds or even thousands of owners).
b) General Partnerships – governed by UPA
i) Formation: agreement between partners, either oral or written; no filing requirements; no “special name.”
ii) Structure: A & B are “general partners”; management pursuant to partnership agreement.
iii) Taxation: “flow-through” taxation (entity itself does not pay the tax).
iv) Liability: unlimited liability; this is more of a threat to A than to B. [Downs advice: never enter a partnership if the business is risky & might open you up to liability.] c) LLP (Limited Liability Partnership)
i) Formation: much like a general partnership. For those who want to transfer their partnership into an LLC, this is easier.
ii) Structure: management pursuant to the partnership agreement.
iii) Taxation: “flow-through”
iv) Liability: partners have no personal liability for firm obligations that exceed the assets of the general partnership; however, partners have full personal liability for claims arising from their own misconduct.
d) LP (Limited Partnership) – statutory scheme under Chapter 359.
i) Formation: must file a Certificate of LP with the secretary of state. Must have a LP Agreement, but no filing requirement.
ii) Structure: B is the “general partner” & A is the “limited partner.”
iii) Taxation: “flow-through”
iv) Liability: limited partners have limited liability; general partners have unlimited liability.
e) LLLP (Limited Liability Limited Partnership) – Section 359.172.
i) This is an LP with one difference: you can create limited liability for the general partners who would otherwise have unlimited liability.
f) LLC (Limited Liability Corporation) – these have made LPs virtually obsolete.
i) Formation: must have Articles of Organization and an Operating Agreeme
le may/may not comport with the respective contributions of each partner.
ii) By agreement:
(2) Partnership unit
(4) Salary (business expense)
(a) Default rule: partners are not entitled to salary/wages/compensation unless otherwise agreed.
(5) Draw (distinguished from a salary – if B takes a draw from the company and the company ends up losing money, B will owe the money back at year end).
e) Sharing Losses
i) Default rule (UPA § 18(a)): unless otherwise agreed, partners share losses according to how they share profits.
(1) Richert v. Handly: Richert contributed the purchase price of timber ($26,482), and Handly was to use his equipment (for a fee) in logging the timber. No written agreement. Proceeds were $41,000; Richert received back $10,000 and Handly received back $7016, but there was no more cash b/c the project had lost money. Court held that they were to share in the profits equally, so they each bore the loss equally. Here there was a net loss of $12,121, to be divided equally between the partners, so Handly owes Richert $10,781.
(2) The default rule always benefits the As of the world; B put in all the work and gets nothing in return.
ii) Today, courts are saying that the labor contribution is worth something & should count as a capital contribution.
f) Law Firm Partnerships
i) The Problem of Compensation
(1) The Lock-Step Formula: This was the old way of doing things. With an emphasis on tenure and seniority, it was intended to reduce competition within the firm (as far as acquisition), and reward those who worked hard. The formula ended up bowing to economic pressure when partners started leaving the firm for better pay.
(2) Standard (“Smith”) Formula: 10% profit.
(a) 60% work done. This makes it seem that if you work hard you will make a lot of money; but in reality the formula doesn’t work well for younger lawyers because it doesn’t factor in the following: