EO READING NOTES
I. Introduction to the Law of Enterprise Organization pp. 1-12
A. Themes
1. Most civil law facilitates economic relations.
2. EO concerns the laws of agency, partnership, and corporations
3. EO law has both contractual and property elements.
a. Contractual: EO law offers standard forms to govern relations, which, like all contracts, are entered into voluntarily and can be customized or fine-tuned.
b. Property: they alter the legal rights of third parties in addition to the rights of the parties in the enterprise relationships.
B. Efficiency and the Social Significance of EO
1. Corporations are principal economic actors in the modern world
2. The importance of capital to the creation of wealth is borne out by the failure of Marxism; in contrast, Anglo-American corporation law has recognized incentives, ownership, control structures, and legal protection of capital
3. Corporations share a basic legal form in almost all economies
4. Since organizational law is about the creation of wealth, efficiency in wealth production, i.e. the minimization of waste or maximization of output, should be at the heart of organizational law.
5. What is meant by efficiency?
a. Pareto efficiency: a given distribution of resources is efficient only when no reallocation of resources can make at least one person better off without making at least one other person worse off. Such a distribution is “Pareto-optimal.”
i. says nothing about legitimacy of original distribution
ii. not helpful to courts or legislatures, whose decisions inevitably make someone worse off—concept not helpful in evaluating/criticizing law of EO.
b. Kaldor-Hicks Efficiency: incorporates problem of externalities into the definition of efficiency. A rule is efficient if at least one party would gain from it after all those who suffered a loss were fully compensated.
i. essentially, if the move is Kaldor-Hicks efficient the affected parties experience a net gain in wealth
ii. sometimes terms “wealth maximization”
iii. Problems
1. says nothing about legitimacy of original wealth distribution
2. Ignores actual distributional consequences of a rule
3. It is hard to measure all of the effects of a given rule, either negative or positive, so how can you compare the costs and benefits
iv. despite some problems, used often by lawyers and policy makers
5. Fairness and Efficiency
a. Inevitably, judges must make choices due to ambiguities in the law or the cases before them. Even though authors suggest efficiency should be the criterion judges use to evaluate their decisions, judges rarely do this.
b. Concept of efficiency is not a settled judicial standard
i. incomplete markets make it difficult to determine what is cost and what is benefit
ii. informational asymmetry creates uncertainty
c. Instead of efficiency, judges use concept of fairness
6. Development of the Modern Theory of the Firm
a. Adam Smith identified problem of large firms – they require hired managers, who may work less diligently than the owners of the firms b/c their incentives are lesser. However, his theory that firms would be little used for that reason was incorrect. Why?
b. Coase came up w/a good reason in 1937: there are transaction costs in the market of negotiation; firms might permit transactions that are complex and oft repeated to be accomplished more cheaply than on the market.
7. Agency theory
a. addresses how the actions of the agent affect the interest of the principal
b. reliance on agents causes specific form of transaction costs
i. agents maximize their own interests rather than those of their principals
ii. to the extent that the agent’s incentives are different from the principal’s incentives, an agency cost will arise.
c. sources of agency costs
i. monitoring—costs expended to ensure agent loyalty
ii. bonding—costs agents expend to illustrate their reliability
iii. residual—costs arising from differences of interest
II. Ac
freedom too greatly
b. Law should enforce.
i. if A has special expertise, untimely termination may prevent P from accomplishing important work b/c A may be very difficult to replace
ii. A and P entered into agreement freely; not enforcing the agreement with specific performance does not honor the intent behind the agreement.
D. Parties Conception Does Not Control
1. Even when parties have not explicitly agreed to agency relationship, such a relationship may be implied
2. Important example: when creditors assume a lot of control in a debtor-creditor relationship, an agency relationship may be implied. JENSON FARMS CO. v. CARGILL, INC. (Minn. 1981):
a. Facts: Cargill entered into a series of security agreements w/Warren, a grain and seed company. However, agreements were far more than financing: C was W’s grain agent for the Commodity Credit Corporation and C had first refusal to purchase W’s grain. Relationship became more entangled w/ea. agreement: W had to provide financial statements to C, C had to approve substantial repairs/improvements by W and W’s sale or purchase of stock, etc. Later, W acted as agent to C in obtaining growers for a new wheat variety and for sunflower seeds. C admitted its main motivation was to secure a grain supplier for its business.
b. Procedure: When W went out of business, farmers to whom W owed money sued W and C jointly, and C denied it was liable as a principal on W’s Ks. Пs won at trial and C appealed.
c. Issue: Whether C was liable as a principal on W’s Ks w/Пs.
d. Holding: C was liable.
e. Reasoning: C’s relationship w/W far exceeded that of a financier. C was active participant in W’s affairs. Court cites a number of factors on pp. 18
f. Rule: Where a creditor assumes control of a number of a debtor’s affairs, acts paternalistically in its relations with the debtor, the creditor may become a principal in relation to the debtor and become liable for the debtor’s responsibilities.
