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


Felix Chang

Fall 2013

Corporations: for profit organizations with goal to make $; shareholders want to get money in the most efficient way possible.

Legal fiction: corporations are a legal fiction; can be held criminally liable.

Owners of corporation: shareholders (they give $), management operates affairs daily. Management is agent. Shareholders are principals. Principal can also be the corporation itself.

Common themes Corporations:

(1) What is motivation of the parties involved?

(2) What potential for opportunistic behavior? (management plundering?)

(3) Cost of opportunistic behavior

(4) Role of courts

Fairness & equity: should complicate decisions. Goal is wealth. Determine if wealth is generated by:

(a) Market

(b) Efficiency (if costs < gains).

Why are corporations efficient? Very hierarchical; strict delineations for tasks & makes steps faster & more efficient.

I: Introduction to the Law of Enterprise Organization

A. Wealth Creation and the Corporate Form of Organization

1. Concepts

Agency- the simplest form of business organization; terminable by principal or agent.

Economic Efficiency: two types:

Pareto Efficiency: where one party benefits and the other party is not worse off (status quo). (doesn’t care about 3rd party)

Kaldor-Hicks Efficiency: less stringent than Pareto efficiency: if the possibility for the parties involves to compensate other people exists (benefits > costs). How wide you draw the net; in deal w/ company management and shareholders, it may be Kaldor Hicks efficient for company but NOT for world. “A type of efficiency that results if the monetary value of society’s resources are maximized. This is achieved if the marginal willingness to pay by those who benefit from an action is equal to the marginal willingness to accept of those harmed.”

Transaction cost relationship: theory parties commit to contractual governance arrangements to reduce transaction costs and increase gains.

Agency cost- assumes that economic actors are rational, informed utility maximizers; focus on maximizing their own interests (not just the corporation). Three types of costs:

1. Monitoring costs: cost of owners ensuring agency loyalty (eg video surveillance)

2. Bonding costs: cost agents expend ensuring reliability to owners (sometimes expended before job starts (ex ante)

3. Residual costs: EVERYTHING ELSE!

Jensen & Meckling assume principal bears all these costs.

HOW TO MINIMIZE COSTS: communication; give employees shares for skin in the game, ex ante (beforehand) contract for cost of breaches

Agency theory conflicts:

1. Managers v. investors/owners

2. Majority v. minority

3. Firm v. 3rd party (eg pollution)

II: Acting through Others: The Law of Agency

A. Introduction to Agency

Agency: simplest form of joint economic undertaking; one person engages another to act for her and be subject to her control. Corporations is a network of agencies.

3rd Restatement informs agency law today.

Agency formation: can be formed in writing or orally; both parties must give consent. VOLUNTARY and terminable at will of either party.

Principal: can expand agent role to become special agent (agent w/ only single role) or general agent (agent for series of acts). Agents can be either undisclosed (3rd parties think agent is principal) or partially disclosed (3rd parties know of principal but not it is).

Employee: common agent/principal relationship. Also called servant; with less contract agent is an independent contractor.

Termination: principal revokes; agent renounces. Either party may revoke (potential $ damages)

B. Agency Formation, Agency Termination, and Principal’s Liability

AGENCY: 3rd Rest:§1.01: (a) manifest. of consent by 1 party to another (b) that other act on his behalf and is subject to his control (c) consent by that party to be so bound.

Some say consent & control not enough; need to ACT ON BEHALF OF.

Respondiate superior: 4 employer/employee, master/servant. 3rd restatement 2.04.

Employee: look at factors; KEY FACTOR: control! Hours & Time.



-furnish own equipment; no liability for repondiat superior; control own time, (benefits, union charges) (not paid as steadily –often on commission)

-Expend some $ in the beginning (Sun) to ensure they won’t abrogate safety

Vicarious: STRICT LIABILITY! If show scope of employment, employee, & damage.

-More expansive relationship; agency costs & liability costs. Salaries, FMLA, employee benefits; more control over day to day 2nd restatement 220

Liability for employee b/c (1) makes employers responsible over employees; deters problems (lowest possible cost for employers).

If liable for contractor: (a) discourages people from using contractors; (b) you’d have to be with them all the time! This is monitoring cost.

a. Jenson Farms Co. v. Cargill, Inc. (agency relations can be implied even where parties have not explicity agreed to an agency relationship).

FACTS: Warren owns grain solo, financially irresponsible & goes bust. Cargill is a secured creditor over Warren. 3rd parties go after Cargill saying he was Warren’s agent b/c Warren is judgment proof.

HELD: All 3 elements agency relationship exist!; Cargill factors:

(1) Cargill had right of first refusal.

(2) Salaries of officers needed approval by Cargill.

(3) Cargill wanted benefit of relationship without the costs.

Cargill is HUGE business; use Warren assets for their business!

CONSENT: Yes! didn’t intend agency, but circumstances impute agency BOTH PARTIES: objective manifestation consent. 1 yr. contract!

FN 4: some orders by Cargill not implemented: this against agency? Also, Cargil controls big decisions but not day to day

POINT: principal may be bound vicariously by agent’s tortious actions.

Actual authority: principal & agent agree to be bound; look to agent, b/c agent is important (3rd 2.01)

Apparent authority: 3rd party believes agent has authority to act for principal’s behalf. (3rd Restatement 2.03); P gives observers appearance that A has authority

Inherent authority: murky; 2nd rest. 161, 3rd Rest. 2.05) Agency by estoppel. When it is inherently wrong, 3rd person reaped benefits you are estopped from denying. Where A normally would have power to enter a contract & 3rd party doesn’t know otherwise. Power derived from agency relation and exists for protection of person dealing with a servant or other agent.

Restitution: 2.07 3rd Restatement: puts party at where they started again

b. White v. Thomas

FACTS: Employee lacked actual or apparent authority. No actual because not authorized; no apparent b/c people she did business with didn’t think she had authority. Buying and selling are different. Selling isn’t incidental. HELD: She isn’t apparent agent or otherwise.

Inherent authority: agent normally have power & 3rd party think its so.

COST: cheapest cost monitor should; here, simple for buyers to ask in writing whether seller had authority, especially since they had doubts.

CORPORATION: with the corp—agent—buyer situation, the LEAST cost avoider is corporation generally.

HYPO: UC—Agent (partialy disclosed)—Buy land; agent buys wrong land; here, INHERENT AUTHORITY, no apparent b/c no objective m

eeson (trustee can’t deal w/ trust property in individual capacity)

FACTS: 15 days btwn death decedent & new year, trustee failed to show loss. Trustee MUST pay back all profit.

REASONING: no ability for financial gain AT ALL under §203.

Interlocutory fiduciary duty- NO PROFITS! (guardian probably sued)

Reason #2: trustee is agent; monitor can be beneficiaries, but they may be minors and grantor may be dead. This is why there is a HIGHER duty!

Duty of loyalty: non-utility results! Tarnowski, $ goes to man even though overcompensated. Trust- $ can’t stay with trustee, even where “honest.”

III: The Problem of Joint Ownership: the Law of Partnership

A. Introduction to Partnership: Simplest form of jointly owned business


1. All liable as principles AND agents.

2. Both can command and bind.

3. All general members joint & severable liable.

4. Exists for limited duration; subject dissolution by either(absent contrary agree)

Controlling authority: Uniform Partnership Act & Revised Uniform Partnership Act.

UPA transition: partners as loose ass’n co-owners TO bus. entity where partner invest.

REASON FOR PARTNERSHIP: often b/c capital. Also reduces risk: lender less likely to just collect on goods. Benefit to lender: if it works out, they both make lots of $.

Downfall partnership: lose control & profits. also, partners can bind; disagreements

a. Meinhard v. Salmon (Cardozo) most famous US case on organizational law! (DUTY OF LOYALTY) (joint venturers, like co-partners, owe duty of the finest loyalty)

KEY PHRASE: “A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.”

FACTS: Salmon secretly signs new lease at end. Heightened scrutiny because Salmon managing; robbed Meinhard opportunity. Relationship of undivided loyalty; must be up front. Highest fiduciary duty.

HELD: Salmon is a joint venture; duty to tell Meinhard b/c part of partner.

What Salmon should have done: tell Meinhard, perhaps opportunity to move on project. Opportunity belongs to joint venture.

Other options:

(1) (Cardozo): benefit is venture’s, share 50/50. disincentive looking 4 new

(2) (Both parties can bid) Gerry benefits here, NOT Kaldor-Hicks efficient

(3) (Salmon keeps things identified): Better for Salmon, he does good to attract new capital & get new corporate opportunity.

a. Incentivizes undermining each other; M may devote less resource

Meinhard issue- Salmon spend more Meinharts $ 4 more risks +reward.

PRINCIPLE: One party may not take for self renewal of the lease.

Salmon more than a co-venturer; he was a managing co-venturer.

HELD: Share split, Salmon getting enough extra to stay as manager.

DISSENT: (1) thought joint venture, and (2) purchase was more reversion than a renewal. Also, joint venture is SHORT, not in perpetuity!

JUDGE: quotes Salmon: D loses. quote “punctilio,” D will lose big!