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Business Associations
University of Iowa School of Law
Yockey, Joseph W.

Business Association

Yockey Fall 2015

Why business association?


The course: Outline

AGENCY (5 classes)
PARTNERSHIPS (5 classes)
CORPORATIONS (13 classes)

LLC (1 class)

4 Themes in Business Associations (Think of people)

Risk of loss

What happens in an adverse outcome (if the business fails) at any stage


What do I get out of it

Control (complicated)

Who calls the shots?
Who has the highest risk?


Open-ended expiration?

How do you deal with the above elements?

Applicable Laws

Private Law & Order (Contracts): hashing out in the contracts
Public regulations: (Gov’t regulations; such as taxes)

Actual Example: Finding the Right Kind of Business Association

Take into account the four elements 1) Risk of Loss 2) Return 3) Control 4) Duration

Sole Proprietor

Rob the solo practitioner

Risk of Loss: Rob
Return: Rob
Control: Rob
Duration: Rob

You do face all the four thing above in engaging

What happens if you cannot meet the rent? Foreclosure

Who bears the liability? Rob

GOAL#1: how and when can parties minimize personal liability and shift risk of loss to the entity?

Shift the risk to an inanimate entity (non-human)

Hire Employees (Principal and Agency Relationship)

Risk of Loss

Transaction costs (Costs of doing a deal)
GOAL#2: lower transaction costs (the costs of doing a deal, time, money, etc)

Agency Costs

An agent does something in her own self-interests and to the detriment of the principal
GOAL#3: lower agency costs (costs when an agent does something in her own self interest and to the detriment of the principal)
How to deal with it?

Salary-based incentive structure
Hire another employee as a supervisor (disadvantage: possibility that he also not working)

General Partnership

Bringing in a partner “Laura”

Risk of Loss: Tied (interests are tied because they share the risk)
Control: Supervisor

Partnership (almost automatically) brings agency cost down


Becoming an incorporated with shareholders

Investment from shareholders (becomes owners)
Rob gives up his control

Risk of Loss: Shareholder do not have liability
Return: Market Price
Control: Shareholder has none

Who monitors the corporations?

Board of Directors
Hires officers to make decisions

What can shareholders do to reduce agency costs?


Business Association Law

Where do lawyers come in the process?

Adding Value

Minimize personal liability
Transaction cost “Engineers”
Lower agency costs
Bring people together
Compliance / litigation

How do lawyers add value?

Example of buying a suit

Off the rack: cheaper, convenient, easier to replace but may not fit well and cheaper
Customs: perfect fit but expensive and takes longer

Buy off the rack and go see a tailor: what lawyers do (Lawyers are the tailors!)

Role of State Law

Gives us our standard forms of Business Associations and default rules of internal governance
“Hypothetical Bargain” (Off the rack)
Lawyers already have set of tools, then they go tailor these laws to fit the situations of clients
Example: Delaware’s Corporate Codes
If a client does not like the default rules provided by a statute, then use different sources

Make contract with others in the group

Social Impact of Corporations

Corporate Law’s Role in Society?

Financial Crisis
BP Oil Spill
Recent events, crises, and scandals

Corporate gridlock

What is the corporate law’s relevance and society?
The importance of corporate culture
The importance of norms of ethics, compliance, risk-management, and responsibility
Who speaks for the corporation?
Should Corporations be viewed as tools for social change?
Who decides whether corporations are “good”?
How should changes in Corporate Law or behavior be effected?

Topic I – Agency

Minimizing Agency Cost

Definition of Agency
Legal implications of agency

Business Attorney: minimizing Risk of Loss
Risk of Loss: Transaction Cost, Agency Cost, and Personal Liability

Agency Defined

Gorton v. Doty

Football game & Car accident case
Triangle – principal, agents, third party
Legal Standard

Restatement § 1.01: Agency is

nt to so act. How?

Does everything and did not resist – enough to infer consent

Restatement § 14: when does a creditor become a principal?

When it assumes de facto control over the conduct of the debtor
9 factors re: control (pp.10-11)
Looking at factors 3/4/9 seems normal debtor-creditor relationship

creditor has veto power (to protect their investment; common routine practice)

However, looking at other factors gave more than enough


This was a close case; what did the court see as the deciding factor (control)?

Manifestation from Cargill to the farmers that you are ok
Cargill’s employees were actually present on the premise and did aggressive control (proved control) – operatives came in


How can a Principal like Cargill protect themselves in the future?

Account for risk of agency liability up front (increase the interest premium)

more risk means more interest premium
factor into amount of interest

Passive or negative authority

Just maintain veto power only; don’t do more
Preventing some from doing someone
Ex: no more independent loan
Active authority

Ask for financial reports more frequently, strict monitoring (exit if necessary)

Insist on up-to-the-minute financial reports, with exit/penalty rights if they are not forthcoming

Law as Business Cost

McDonald’s (franchisor) & franchisees (McD controls a lot like parental controls of the franchisee)

Agency relationship issues
Here, McDonald’s is assuming liability

Acceptable business cost of the vicarious liability
To preserve and control the accessibility and predictability
McDonald’s lawyers’ role is to lay out all of these costs of the liabilities
The executives of McDonald’s bears the risk

Controlling the food, etc.