The Public Corporation – Pritchard, Fall 2011
WHY A FIRM? (pg. 1-13)
Introduction to the Law of Enterprise Organization
· Agency relationship can be thought of as the simplest form of business organization
o Can be terminated at any time by either principal or agent
o Problems arise from fiduciary duty of loyalty in this context
· Somewhat more stable: general partnership (jointly owned business firm)
· Corporate form
o Most stable, complex an socially important form of business organization
· Accepting classical liberal perspective that corporation law succeeds to the extent that it enables individuals to increase their utility, implicitly agree that economic efficiency is the principal standard by which this law should be evaluated
· Efficiency
o Pareto Efficiency: A given distribution of resources is efficient when (and only when) resources are distributed in such a way that no reallocation of resources can make at least 1 person better off without making at least 1 other person worse off
§ Poorly suited to evaluating or criticizing the law of enterprise organization
o Kaldor-Hicks Efficiency: An act / rule is efficient (leads to overall improvement in social welfare) if at least one party would gain from it after all those who suffered a loss as a result of the transaction or policy were compensated – i.e. positive net gain
§ Efficient if total wealth of affected parties increases (“wealth maximization”) – allows us to consider externalities
§ Equivalent to saying that a transaction is efficient if the aggregate monetary gains to winner exceed aggregate monetary losses to the losers
§ Has become a standard tool for evaluating enterprise law
· Fairness and Efficiency
o Traditional corporation law addresses ‘fairness’ and refers to fairness to shareholders
§ Shareholders are the residual claimants to the corporation’s income and assets, protection of their interest through a fairness norm is generally consistent w/ increasing total corporate wealth and w/ moving toward K-H efficient state
§ Want to protect investors from exposure to risk, w/ more protection there will be greater investments, more gain for corp
· Firm Theory:
o Coase: suggested that firms existed because it is sometimes more efficient to organize complex tasks in a hierarchical organization then on a market (i.e. having costly buy/sell transactions on an independent basis) – firms permit complex and reiterated transactions to be accomplished more cheaply than market alone allows
§ Other coined: firm is a set of transactions cost-reducing relationships
o Costs
§ Agency cost: The extent to which the incentives of the agent differ from the incentives of the principal himself or any cost associated with the exercise of discretion over the principal’s property by an agent
· Includes salaries/benefits as well as risk/reward divergence
· Assumes everyone is rational, informed and will maximize utility
· Divergence costs: divergence of agents’ behavior from principals’ interests
§ Monitoring costs: costs of watching over agents (i.e. investigations)
§ Bonding costs: costs that agent expend to ensure owners of their reliability
§ Residual costs: costs that arise from differences of interest that remain after monitoring and bonding costs are incurred
§ Incentive costs: costs of agent incentives (stock options, commission scheme)
o NOTE: Principal bears all of these costs
· Agency problems
o (1) Conflict b/w manager and investor/owner interests
o (2) Ability of managers to control returns such that it discriminates against minority owners
o (3) B/w the firm and all other parties w/ whom it transacts, i.e. creditors
· Corporate form reduces the transaction costs of complex economic contracting but does so at the risk of creating agency problems à aim is to reduce agency costs of all kinds
WHO ACTS FOR THE CORPORATION? (pg. 15-34)
Acting Through Others: The Law of Agency
· Principal-Agent Relationship: one person extends the range of their own activity by engaging another to act on their behalf, subject to their control
o Creates legal relationships b/w strangers (principals and third parties)
· Problems arising out of agency relationships
o (1) Formation and termination (how are the relationships formed and dissolved?)
o (2) Principal’s relationship with third parties (what are the principal’s responsibilities w/t/r the agent’s actions?)
o (3) Duties the agent owes the principal
· FORMATION
o Definition (R3A §1.01): Agency is the fiduciary relationship that arises when a Principal manifests assent to an Agent that the Agent shall act on the Principal’s behalf and subject to Principal’s control, and the Agent manifests assent or otherwise consent so to act
§ Consensual relationship – agent holds power to affect legal relationships of principal w/in scope of employment – principal can define/limit scope of authority granted
§ No written agreement required
§ No compensation required
o Special Agents: Agency is limited to a single act or transaction
o General Agents: Agency contemplates a series of transactions
o Disclosed vs. Undisclosed vs. Partially Disclosed Principals
§ Degree to which the third party knows he is contract w/ a principal or his agent
§ Disclosed/undisclosed, third party does/doesn’t know agent is actually acting on behalf of someone else
· Agents can bind principals to agreements outside the scope of their actual authority – third party should no be punished for being unaware the that agent was not authorized to enter into such agreement
§ Partially disclosed, third party knows agent is acting on behalf of principal but is unaware of principal’s identity
o The right to control the agent can vary dramatically depending on circumstances, degree to which principal controls the agent
§ Significant control: Agent = Employee
· Principal has the right to control the manner and means of how the agent goes about his task
§ Little control: Agent = Independent contractor
· No control over minute details
· Be careful w/ this term – could be that agent has a lot of discretion or that he is actually independent and not, in fact, an agent
o What must Plaintiff prove to show agency relationship? (R3A §1.01)
§ Consent from principal and agent
§ Benefit for principal
§ Control of agent by principal
· TERMINATION
o Either principal or agent can terminate at any time
§ Principal may revoke or the agent may renounce
o No specific performance enforcement
§ Not efficient to make two people who don’t want to work together to work together
§ Limited to monetary damages
· CONCEPTION
o When parties’ conception does not control:
An agent may bind the principal even when the agent lacks any form of authority – has the power to bind but not the authority ß agency cost
§ Principal may be able to recover from agent in these cases
o Important factor for determining existence of an agency relationship: control
§ Ex: pure debtor-creditor relationship almost never creates principal-agency liability, more control must be asserted
o What can the principal do to avoid future liability by way of agent’s inherent authority?
§ Do nothing/maintain same level of control (costs might worth efficiency benefits)
§ Can purchase insurance
§ Exercise less control (make it clear they are not a principal for such agent)
§ Exercise more control (try to prevent harm from occurring again)
o Like apparent authority, purpose is to protect third parties
§ Easiest to understand in context of undisclosed principal transaction – too one-sided in favor of principal (principal can enforce, but third party cannot)
o R2A §8A Explicit recognition of inherent authority doctrine
o R3A: Other doctrines in R2A encompass these justifications – importance of interpretation, apparent authority, estoppel, restitution
o R3A §2.06: Doctrine of inherent power gives a general agent the power to bind an undisclosed principal to an unauthorized contract as long as a general agent would ordinarily have the power to enter such a K and the third party does not know that matters stand differently
o Note Inherent v. Apparent: inherent seems to be more about whether agent relationship exists at all, as compared to apparent that is more about determining the scope of authority when it is already clearly an agent
o NOT derived from actual/apparent authority, but rather arises from the relationship itself
· Gallant Ins. Co. v. Isaac (Ind. App. 2000) ß EX: no actual/apparent, but inherent authority
o Facts: Independent insurance Agent served for Gallant Insurance. Gallant issued insurance to Insured through its Agent. Insured contacted Agent to switch insurance to another car and raise the amount of insurance, and Agent said it would do so immediately, even though Gallant later claimed it had no authority to do so. Car was wrecked over the weekend when Gallant claims policy wasn’t in force
o Holding: No actual or apparent authority exists, but there was inherent authority. Renewal of insurance by Agent was an act which “usually accompanies or is incidental” to such transactions – Agent “acted within the usual and ordinary scope of authority” – Insured could have believed Agent had authority
§ By acting as an agent and holding a specific title as an agent, certain authority vests in the agent that may not have been intended to be granted by the principal, but is granted nonetheless
