Business Organizations Outline
Professor Rosen
BUSINESS ENTITIES
I. “The Firm”
A. Coasean Firm—focuses on the distinctions between a firm and the market
1. Not the market—the market is a natural allocation of resources by the forces of supply and demand (Adam Smith’s Invisible Hand). Private parties decide what they want and suppliers react accordingly
A firm is the opposite of capitalism—people are making their own decisions (not natural regulation). Decisions may be impacted by the market but there is an unnatural injection of personal choice. Firm resources are allocated through the directions of the employer to the employee.
2. Market Forces
a. Public—governmental regulation
b. Private—individual choice determined by risk involved
B. “Nexus of Contracts” Firm (Principal-Agent Theorists—focus on contractual nature of the firm—not distinction from market)
i. Contracts between claimants to share the gross profits generated by the business
ii. i.e. employment contracts, supplier contracts, transportation contracts…
II. Agency
A. Creation of a firm
1. Created by unifying ownership and control of the team in the hands or one or more owners (principals) while other team members agree to serve as employees (agents)
i. Principals enter firm by investing capital to acquire the assets needed by the team and by agreeing to employ one or more agents to carry out the necessary work under the principles control (team members enter by agreeing to this control)
a. Principles—owner(s)
b. Agents—employees of the firm
(1) Have to determine the relationship of the employee—must be an agent to be held under obligation
(2) Independent Contractors have NO fiduciary duty unless both parties intend a relationship of special trust and confidence. (must be mutual, cannot be a one-sided allegation)
(i) Determining whether or not someone is an IC is a fact based question (nature of relationship). When evidence is not in conflict—matter of law to be determined by the court
(ii) “If the manner or means of doing the work or job is left to one who is responsible to the employer only for the result, the person is considered an independent contractor.”
ii. Mutual assent creates the agent-principal relationship
a. Both parties have agreed to enter into the relationship (accept obligations)
b. Unless agreed otherwise, the relationship can be terminated at the will of either party (“at will”) but while the relationship is continuing, the agent is subject to the principal’s control.
Cannot force to enter or stay—absent a contract outside the typical agency relationship
iii. Generally enter into a discrete contract detailing the rights and responsibilities of each party to offer the employee some protection against opportunistic discharge or threats.
Agency laws (fiduciary duty) and contract law impose some limits on the ability to discharge
B. Protecting Information—Fiduciary Duty
1. Fiduciary Limits on Agents
i. General Duty: must deal in total candor, must not use or disclose trade secrets, must not carry on competing business until after the relationship is terminated—required to prefer principal’s interest to his own.
“obliges a fiduciary to act in the best interest of his beneficiary and to refrain from self-interested behavior not specifically allowed in the employment contract.”
ii. Regulation
a. Public Ordering (ex post solution—after): body of jurisprudence developed by the courts (common law)
(1) Determination that a fiduciary duty is important even in the absence of contract
(i) Court does not want to create a situation where everything MUST be in writing
(ii) No way anticipate every potential scenario to fully protect yourself—safety net—public law inserts terms into the existing contract
(2) Often difficult to get agreement in a contract—fight over every issue, make transaction cost in relationship prohibitively expensive
b. Private Ordering (ex ante solution—before): parties can protect themselves by engaging in contracts fully clarifying the relationship
(1) Non-Competition Agreement (Robbins v. Finlay)
(i) Especially important to protect yourself against key employees with valuable inside knowledge
(ii) There are some limits on contracting
(a) Not enforced if the employee has not ability to seize the team-specific value to which the employer has a no claim.
(b) Job required little training, company invested little in employee—services were not special, unique or extraordinary (does not matter that he was just good at what he does)
(iii) An agreement will not be upheld if it does not serve the public interest
(a) Consider overarching fairness
(b) Was there a proper quid pro quo—were they compensated for giving up the right to compete
(c) Length of the restriction
(iv) court will enforce a non-competition agreement if it is reasonable in duration, geographical coverage and the nature of the employer’s risk from such competition
Balance employer’s legitimate interest in protecting business against interest of employee to redeploy human capital.
iii. Example: J produces product and S has developed a market
a. Once the market is established, J will no longer need S (think of it in terms of necessary information—once J has access to the information (market) he no longer needs S to provide it for him)
b. S must protect herself with a contract, otherwise she is in danger of being cut out
But there may be a broader public concern if the contract is too limiting on trade (cannot create monopolies)
iv. Soliciting Contracts Against Your employer (all about timing)
a. Community Counseling Service Inc. v. Reilly: Conduct PRIOR to termination (professional church fundraiser)
RULE: an agent has a fiduciary obligation under certain circumstances to his principal and cannot compete with the principle during the term of his employment.
(1) General Rule—a former employee, after the termination of his employment, may compete with his former employer, restrained only against using confidential information or trade secrets obtained from the employer (that competitive advantage belongs to the employer).
(2) But cannot take actions against your current employer PRIOR to leaving (question of timing). Cannot solicit clients away from employer while still working there—employer has a right to damages for action.
(i) While employed your duty is to prefer the interests of the principal over your own—cannot be disloyal by promoting yourself.
(ii) “Until the employment relation is severed, the employee must prefer the interests of his employer to his own. During such period, he cannot solicit for himself future business which his employer requires him to solicit for his employer.”
(iii) Does not matter if services were not actually delivered under termination, the act of solicitation violated his fiduciary duty to employer.
(iv) Bad policy to say does not matter if developed relationships during employment but never acted on them—don’t want to encourage this conduct at all, regardless of timing.
(3) In the absence of a non-compete agreement (no private ordering), one can directly compete with a previous employer upon termination of the previous employment
b. Hamburger v. Hamburger: MASSACHUSETTS Conduct AFTER termination (hardware store situation)
RULE: Cannot use your position as an agent to solicit business away from your employer, but you can use knowledge gained after termination to own advantage.
(1) NOT a breach of duty to arrange for financing and lease of space prior to termination—logistical arrangements are not active competition and disloyalty.
(2) Does not solicit employer’s customers WHILE employed, but uses knowledge after the fact to his benefit
No contract (at will)—no non-competition agreement
“Entitled to use general knowledge, experience, memory, and skill in establishing new business—including “remembered information.”
Customer lists are NOT “trade secrets” if available from published sources (business directory)
(3) No public ordering engaged—no breach of fiduciary duty
(i) Public policy will not force employee to keep information to self post-employment
(ii) May seem bad, but don’t want to restrict competition (free trade)
(a) Clearly suppliers and customers wanted to go elsewhere—were unhappy.
(b) Have to balance—don’t want to force customers to settle—hurt society as a whole.
(iii) Tortious Interference with Contracts (have to be more than free competition)
(a) No fiduciary duty after employment
(b) Have to be free to compete, otherwise there would be no competition in the market place which benefits society.
c. Northeast Ohio College of Massotheraphy v. Burke: OHIO
(1) FACTS: ∆s were instructors who quit and announced intention to open a rival school (court found that they were independent contractors)
(i) Therefore the breach of fiduciary duty claim fails as a matter of law—no fiduciary duty is owed by independent contractors (only employees)
(2) Other claims:
(i) Breach of good faith—there is no independent tort cause of action for a breach of good faith absent a contract—same thing as a breach of contract.
(ii) Deceptive trade—in the course of a person’s business they disparage the goods, services, or business of another by a false
is behalf (3rd party cannot have actual knowledge to the contrary, even if there is an appearance).
Agent is without actual authority but the principal manifested his consent directly to the 3rd party dealing with the agent (express or implied). Agent can bind principal only if the 3rd party reasonably believes the agent is authorized.
Principal intentionally or by want of care, caused the 3rd person to believe agent had authority.
Principal is responsible if allow agent to be in a position to perpetrate fraud on a 3rd party
c. INHERENT: broader social role—want 3rd party to feel comfortable regardless of whether there has been an affirmative representation that the agent is authorized.
Desire to protect the reasonable expectations of outsiders who deal with agents—implied term in contract between a principal and all who deal with his agents—gap-filling device used by courts to achieve a fair and efficient allocation from an agent’s unauthorized actions. (know your agents)
2. Two possible situations resulting from ostensible authority.
i. Principal knowingly uses agent dishonestly and then disclaims liability
ii. Principal does not know what the agent is doing (not authorized) and 3rd party wants to hold principal responsible
a. Court will allow, even though may seem unfair—principal has associated themselves with the agent and allowed the world to enter into the reasonable belief that they agent is acting on behalf of the principal (facilitated fraud)
(1) Cannot allow principal to disclaim liability because had no knowledge—never be liable
(2) Also the consideration that the principal may (although innocently) be reaping some rewards from the agent’s dishonest activities
(3) Court wants to impose an affirmative duty on principals to monitor their agents—encourage good management leads to more protection and better business (set up safeguards in advance to protect 3rd parties)
But there is a hesitation to extend this duty outside actual employees to people acting as though they are employees when they are not. Cannot hold responsible for actions of people they did not know they were even responsible for.
(4) “the principal is subject to liability under the rule although entirely innocent, although he has received no benefit from the transaction, and although the agent acted solely for his own purposes. Liability is based upon the fact that the agent’s position facilitated the commission of the fraud, in that from some point of view of the 3rd person the transactions seems regular on its face and the agent appears to be acting in the ordinary course of the business confided in him”
b. Principal is also source of money—3rd party wants actual recovery (not going to get from agent)
3. But there must be reliance on the agent by the 3rd party to implicate the principal (if 3rd party acts as though he is somewhat aware that the agent is acting outside his power—knowledge—then there is NO responsibility for the principal).
4. Cases
i. Blackburn v. Witter: CALIFORNIA widow depending on investment broker—court held that the ∆s were liable under idea of ostensible authority (put agent is a position to facilitate fraud—selling her stock in company that did not exist). Π was reasonabled in trusting and believing the ∆’s promises.
ii. Sennott v. Rodman & Renshaw:
a. FACTS: Father worked for brokerage house, and was aware of son’s fraudulent dealings (offering fake options)
b. But must establish reliance to argue estoppel and apparent authority (do not see reliance here)
(1) Π was aware that the transactions were not going through the ∆ and declined to talk about it
(2) Court could not find reliance or knowledge to impute actions to brokerage house
