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Business Associations/Corporations
University of Cincinnati School of Law
Chang, Felix B.

Professor Chang
University of Cincinnati
Spring 2012
UPA 1917
RUPA 1976 & Recent Amendments
RMBCA (1984)
I. CHAPTER 1: INTRO  Pp 1-30
General Concepts.
–       Creation and governance of the private legal entities that are the principal economic actors in the modern world.
–       Economic efficiency is the principal standard by which this law should be evaluated.
-certain to increase social welfare starting from a fixed starting point- an original distribution of resources
-can only be assessed on an individual basis
A.   Efficiency.
–       Modern law of organizational forms is premised on the idea that facilitating individuals’ efforts to create wealth is wise public policy.
–       Corporate law addresses the creation of economic wealth through the facilitation of voluntary, ongoing collective action.
–       Economic efficiency is the principal standard by which corporation law should be evaluated (assuming corporation law succeeds to the extent that it enables individuals to increase their utility).
–       Pareto Efficiency, i.e. “Pareto-optimal.” A given distribution of resources are efficient only when resources are distributed in such a way (within a group of territory) that no reallocation of resources can make at least one person better off without making at least one person worse off.
o   Problems: Not realistic because of the (1) original distribution of assets in society, and the fact that (2) some one is always worse off, even in voluntary agreements among private parties where third parties are likely hurt.
-everyone wins
–       Kaldor-Hicks Efficiency. An act or rule is efficient (i.e. leads to an overall improvement in social welfare) if at least one party would gain from it after all who suffered a loss as a result of the transaction or policy were fully compensated.
o   Occurs when the aggregate monetary gains to the winners exceed the aggregate monetary losses to the losers.
o   Refers to potential improvement, not the actual payment of compensation.
o   Still problematic because no consideration of (1) original distribution of wealth, and (2) impossibility of measuring the actual distributional consequences of policies.
o   However, as a balancing test, lawyers and policy makers can make use of the tool. 
-someone wins, someone loses/might not lose/loss borne by third party
B.    Efficiency v. Fairness.
–       Courts rarely use the efficiency concept to justify their decisions because determining what counts as a cost and what counts as a benefit inevitable involves guesswork, and judges are supposed to be applying law – not creating it.
–       Courts focus on fairness (generally of shareholders), because shareholders are the residual claimants to the corporation’s income and assets, protection of their interests through a fairness norm is generally consistent with increasing total corporate wealth and with moving toward a Kaldor-Hicks efficient state.
·         Characteristics of corporate form: extreme hierarchy, limitation of liability
·         In some societies, corporate form is small corporations (small/family corporate units)
·         Government is another major generator of wealth
–       Fairness refers to fairness to shareholders
–       Firms facilitate specialization allowing individuals to achieve greater productivity
–       Much economic activity is within firms and thus is not product of market transactions.
Why is corporate form efficient?
·         Flexibility
·         More resources/liquidity/
·         Division of labor- discrete tasks assigned; utilization of specialties
·         Checks and balances/accountability
C.    Economics of the Firm.
–       Adam Smith noted that firms facilitate specialization allowing individual to achieve great productivity, however, he noted that hired managers work less diligently than owners would.
–       Ronald Coase sees firms as innovations that permitted transactions, especially complex and reiterated transaction, to be accomplished more cheaply than could markets.
–       Transaction Cost Theory. Oliver Williamson sees owners of various resources as committing to some “contractual” governance arrangement, such as a firm, in order to reduce their transactions costs and share the resulting efficiency gains.
–       Agency Cost Theory. Jensen and Meckling explain that a transaction may be motivated, in part at least, to serve an interest of a controlling agency rather than the interest of her principal. An agency cost is any cost – explicit (salaries, benefits) or implicit (interests of agent not the same as principal) – associated with the exercise of discretion over the principal’s property by an agent.
–       Agency Problems: (1) conflict between managers/owners (2) ability of majority owners to control returns in a way that discriminates against minority owners (3) conflict between the firm and all other parties with whom it transacts.
D. Agency Cost Theory
– Agents are maximizers of their own interests
– Agency cost is any cost associated with the exercise of discretion over the principal’s property by the agency
1.        Conflict between managers and investors/owners
2.        Majority interest v. minority interest- maj. Controls returns in a way to discriminate against min. interst
3.        Firm and other parties with whom it transacts
– Principal aim of corporation law is the reduction of agency costs
– Sources of Agency Costs (borne by principal)
1.  monitoring costs: costs that owners expend to ensure agent loyalty
2.  bonding costs: costs that agents expend to ensure owners of their reliability
3.  residual costs: costs that arise from differences of interest that remain after monitoring and bonding costs are  incurred
Problem 1:  Proprietor Jonas utility maximizer- wants apartment if he is 1% shareholder; hotel if he is 100% shareholder
Basis for corporation law
1. Transaction cost reduction – concept of why we need corporation law
a.        Short name – searching for efficient system
2. Organization Law – standard set of legal relationship between participants
3. Problem of management inefficiency – can lead to excessive costs (inflated management salaries) and funny dealings (self-dealing)
4. Fiduciary duty – instead of having clear (& manipuable) rules, we have the fiduciary principle
A.   Generally.
–       Agency is the fiduciary relationship that arises when one person (a 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 to the act.” R3d Agency §101
–       Because it can create legal relationships between strangers, agency law must be part of the infrastructure established by legal fiat, and cannot be done through contract law.
–       Similar problems to those found in corporate law.
Agency costs: cost– explicit or implicit– associated with the exercise of discretion over the principal's property by an agent.
·         Special: limited purpose or thing
·         General: ongoing, more than 1 thing is considered, generally a range of activities
–       Can be disclosed, undisclosed, or semi-disclosed: important to know who you’re contracting with
–       Agency relations may be implied even when the parties have explicitly agreed to an agency relationship.
–       Principle question – authority
·         Employee: principal controls the details of the way in which the agent goes about the task
·         Independent contractor: principal’s rights of control are significantly less extensive
Three types of Agency Costs:
1.       Monitoring- costs owners expend to ensure agency loyalty
2.       Bonding- costs that agents expend to ensure owners of their reliability
3.       Residual- costs that arise from differences of interest that remain after monitoring and bonding costs are incurred
3 Major Agency Topics
1.       How do they form
2.       What impact on third parties
3.       Internal Relations between Agents and Principals (rights and obligations)
Undisclosed agency relationship- third party is unaware of an agency relationship
Disclosed- third party knows agent is acting on behalf of principal
Partially-disclosed- third party knows there is an agency relationship but doesn't know who it is
B.    Formation.
–       Consensual relationship between the principal, who grants authority to another to bind her in certain respects, and the agent, who accepts that responsibility.
–       The principals right to control the agent is the essential aspect of an agency, however, the right to control can vary substantially in the case of an employee versus an independent contractor.
–       Agency relations may be implied even when the parties have not explicitly agreed to an agency relationship.
C.    Termination.
–       Either party can terminate the relationship at any time.
1.       Actual authority: delegated by the principal (judged from perspective of reasonable A);
a.       Express authority – A’s authority stated explicitly
b.       Implied authority – what A reasonably believed that P meant when authority delegated
2.       Apparent authority: authority that P never meant to give but that a 3rd-party would reasonably believe A had (judged by the acts of a reasonable 3rd party)
a.       Black letter law: not reasonable for 3rd-party to rely on the statements of an A as a basis to establish the authority of the agent (need contact w/the P)
                                                                             i.            Two reasons for variations: intuition of fairness and idea of ex-ante efficiency
3.       Inherent authority (‘authority of position’): situations w/no actual or apparent authority:
a.       R§161 [20]: General A for disclosed/partially disclosed P subjects P to liability if other party reasonably believes A is authorized (e.g., other similar As would be authorized) and has no notice that A is not authorized
b.       R§161(a): Special A for disclosed/partially disclosed P has no power to bind P by s or conveyances if not authorized or apparently authorized unless P is estopped or unless the A’s only departure from given authority is for [examples] c.        R§194 [21]: General A who is undisclosed
►Jenson Farms Co. v. Cargill, In

uthorized to conduct; whether the customer believed the agent was authorized to perform those acts; and whether the customer had no notice that the agent was not authorized. Because D insured satisfied all these requirements, there was coverage.
-can be reconciled based on the theory of “cheapest cost avoider/least cost monitor.” Blaming the Thomas’s is legit…they already had doubts, etc. Gallant had more knowledge than insured.
·         HYPO: Accidental purchase of wrong land tract: should be enforceable through inherent authority.
Agency by estoppel or ratification: even where an agent’s act is not authorized by the principal or is not within any inherent agency power of the agent, the principal may still be bound by the agent’s acts by estoppel or ratification
F. Liability in Tort 
–  Through the doctrine of vicarious liability, principals are liable for torts committed by employees, but not independent contractors.
– Look to how much control one party has over another to determine if agent is employee or independent contractor.
– Agency principal of monitoring is at work. We don’t make everyone who hires someone independently liable in tort.
►Humble Oil & Refining Co.v. Martin (Tex. 1949)
Ms. Love parked her vehicle at the Humble Oil filling station for repairs. Humble owned the service station and its products. The station was operated by Schneider who was under contract with Humble. Shortly after the vehicle was parked at the station, it rolled off the property and hit Martin and his two minor daughters while they were walking into their yard. An employee of the filling station had not touched the vehicle prior to the car beginning to roll. The TC found Mrs. Love and Humble jointly and severally liable.
                Whether a principal is liable for the negligence of one who contractually operates its business?
-At trial, Humble contended it was not liable to respondents nor Mrs. Love, since the station was in effect operated by an independent contractor. However, the trial court disagreed due to the control Humble had over the details of the station work and specifically Schneider. From this the court ruled there was a master/servant relationship.
-station managers were the ones there, best able to monitor what goes on
-Humble’s control was shown in their contract with Schneider. Even though the contract specifically repudiated any authority of Humble over the employees, the court looked to the provisions that required Schneider “to make reports and perform other duties in connection with the operation of said station that may be required of him from the time to time by Humble.” Their agreement also held Humble liable for ¾ of all the utility bills, which the court concluded was the most important operational expense. In addition, the title to all the products being sold remained in Humble’s name until they were purchased by the customer. The court found there was a strict financial control and supervision by Humble, with little or no business discretion, except hiring, firing, payment and supervision of a few station employees. Humble furnished the important station location and equipment, the advertising media, the products and a substantial part of the current operating costs. The hours of operation were controlled by Humble. Their contract with Schneider apparently only gave him title to occupy the premises, which was terminable at the will of Humble. The agreement required Schneider to do anything Humble might tell him to do. The court compared Schneider’s situation to that of a mere store clerk who was paid a commission.
-The court distinguished this case from Texas Company v. Wheat, which the petitions rely on. In that case it was clearly a “dealer” type of relationship in which the lessee that was in charge of the filling station purchased supplies from his landlord, and sold as his own, and was free to set whatever price and on his own credit terms. Those contracts did not require the lessee to perform any duty The Texas Company might to see fit to impose on him, nor did the company pay any part of the lessee’s operating expenses, nor control the working hours of the station.