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The Public Corporation
University of Michigan School of Law
Pritchard, Adam C.

Corp Law
Purpose of Corp Law regulation
·         The following views have been proposed as the objectives/purpose of corp law regulation:
§  Under the Nexus of Contracts view, the corp law should achieve fairness of law by imposing obligations that the parties themselves would have bargained for had they negotiated the terms of their corp relationship
§  Protect investors from exposure to risk – with more protection, there will be greater investments making a greater gain through corps
§  The objective is to make an optimally efficient Tx, viewed either under Pareto Efficiency (everyone gains from the Tx) or Kaldor-Hicks Efficiency (there is a net gain from the Tx even if not everyone gains). 
§  Corp law aims to find a balance between Tx costs and agency costs to create the most efficient corp structure: agents reduce Tx costs by creating efficiency gains by working together; however, they pose the threat of creating agency costs by having unaligned interests. 
·         Coase proposed that the purpose of the corp was to cut down on marketplace Tx costs and thereby create more efficiency that could be achieved by one person alone, therefore corp law should be aimed at achieving efficiency and cutting down on Tx costs
·         Since corps use agents to achieve greater efficiency, corp regulations should aim to create the lowest possible agency costs
·         Nexus of contracts: the managers (those who call the shots), SHs (those who bear the risks), creditors (third parties) and employees (those who do the work) are bound to each other under a contractual type relationship
o    Under this view, corp law should be created to reflect the terms of the contract that the parties would have made themselves, had they negotiated them
o    This view strives for fairness in the default terms of the contract (which would be imposed by the state corp laws) but allows for parties to contract-out of those default terms and make their own customized rules in most situations
§  Some laws are mandatory, others are default rules
·         Efficiency is the simultaneous maximization of outputs, with a minimization of waste, for a given set of inputs
o    Pareto Efficiency – the aim is to distribute resources to achieve the “pareto optimal” – resources are distributed in a way that not reallocation of resources can make at least one person better off without making at least one person worse off. 
§  However, this view on efficiency does not take into account whether the original distribution of resources was fair
§  It is no longer the prevailing view of when something should be deemed efficient
o    Kaldor-Hicks Efficiency – an act is efficient if there is a net gain: the party has gained enough to be able to compensate all of the parties who have suffered losses from the exchange (essentially the ability for the gains to outweigh the negative externalities)
§  This principle does not require that the harmed parties actually be compensated, just that the exchange created enough gains to make compensation possible
·         Rule of wealth maximization – the gains exceed the losses
o    Tx Costs – the costs implicit in a Tx which derive from the process required to enter into a Tx, though not actually adding to or involved with the substance of the Tx (EX – information gathering: looking for the best deal). 
§  Externalities are Tx costs which are borne by third parties not privy to the Tx.    
·         Coase hypothesized that the purpose of corps was to cut down on marketplace Tx costs.  Individuals in a market will spend time and money gathering information in order to make a decision, a corp pools these resources and previously gained knowledge in order to make effective decisions in an efficient manner.
o    This is why firms become so big: there are economies of scale in market Txs, making it more and more efficient the bigger a firm gets
§  Corp law aims to find a balance between Tx costs and agency costs: agents reduce Tx costs; however, they pose the threat of creating agency costs. 
Agency Law
·         The Principal-Agent Relationship allows for greater efficiency because the principal does not need to do all of the information gathering on his own, he can assign these tasks to his agents
o    In an agency relationship the agent is given power over the principal’s property
o    In corps, the SHs are the principals, and they might not be able to directly observe/control the actions of its agents (Ds and Os of the corp)
Creation of Agency Relationship
·         RST 1.01-1.03: The elements that a plaintiff must prove to assert that an agency relationship existed are:
1.       Manifestation of Consent
§  Principal’s
§  Agent’s
2.       Benefit (we have not read a case which requires this and neither does the Restatements, but Pritchard has it on his slides) – Derived from RST 8.01
3.       Subjecting the Agent to the Principal’s Control
§  The amount of control that the putative principal exercises over the putative agent is the most important factor for determining whether an agency relationship exists
·         E.g. A purely debtor-creditor will almost never create principal-agent liability – more control must be asserted
·         An agency relationship is formed when a principal manifests assent to the agent that the agent shall act on the principal’s behalf and s.t.  his control, and the agent manifests assent to do so. 
o    No formalities (written agreement, certain words etc.) are required to create an agency relationship 
o    No compensation is required, an agency relationship and obligations can be imposed even when an agent renders services for free
o    It is a consensual relationship with the scope determined by the principal (the only things the agent can do are set forth by what the principal wants to achieve) – the agent cannot, by his actions alone, expand the scope of the relationship, this would not reflect the purpose of an agency relationship
§  Since it is a consensual relationship, it can be revoked at any time by either party.  However, since the relationship is governed by contract law, a termination of the relationship can be s.t.  breach of contract claims for damages. 
o    Determining whether there is an agency relationship is an objective inquiry – it is understood from the perspective of a reasonable party (including third parties and parties s.t.  the relationship) – they must have a reasonable belief that the relationship exists. 
o    The subjective intent of the parties (whether they actually intended to create an agency relationship) does not matter for imposing agency duties/obligations
·         Agency relationships differ according to their:
o    TYPE – RST 3
§  Special Agents – single purpose for limited duration
§  General Agents – series of acts or Txs with more discretionary power
§  Disclosed Principals – third-parties understand that the agent is acting on behalf of a particular principal
§  Partially Disclosed Principals – third-parties understand that the agent is acting on behalf of a principal, but the identity of the principal is unknown
§  Undisclosed Principals – third-parties are under the impression that the agent is acting on his own behalf, and is unaware of the principal’s identity and that an agency relationship exists
·         Agents may bind undisclosed principals through actions which are directly contradictory to the agent’s actual express authority, if the agent would be able to enter in to such a contract on his own (if he were acting as his own principal).  This rule applies because third-parties should not be at the mercy of principals – since the third-party did not know that it was actually dealing with an agent rather than a person acting on his own behalf, they would not be able to investigate and ensure that the agent was acting within his actual authority, thus the principal should be bound in order to not create a disincentive and unfairness/injustice for third-parties by allowing the principal to shirk his responsibilities haphazardly.  This derives from the agent’s inherent authority.   
§  RST 8.01 Servants or Employees – the principal has the right to control the manner and means of how the agent goes about his task
§  Independent Contractors – the principal does not have control over minute details of the task.  [Pritchard says that this term is used in two different ways]:
1.       The person is an agent that is given broader discretion than an employee, but is still technically an agent
2.       The person is truly independent from the principal, thus no agency relationship exists
Extent of Liability of Principal for Agent’s Actions
Jensen Farms Co. v Cargill Inc (company financed and oversaw grain elevator operations)
o    An agency relationship (and thus duties) can be created through parties’ implicit actions, which can be determined through circumstantial evidence that the relationship exists
§  All aspects of the relationship must be considered when determining whether the agency relationship exists
o    The agent must reasonably understand, from the principal’s actions, that the agency relationship exists, and that he has been authorized to act on the principal’s behalf
o    The scope of the agents authority is as follows:
§  RST 2.02 Actual Authority –
·         Express Actual Authority – authority to partake in specific activities which are specifically identified by the principal
·         Implied/Incidental Actual Authority – authority that encompasses activities which are necessary to the completion of the principal’s objectives which are not expressly granted
§  RST 2.03 Apparent Authority – the amount of authority that a third-party has reasonably determined to have been granted to an agent, through the principal’s conduct. The principal does not need to directly manifest the agent’s authority to the third-party. See Jennings v. Pittsburg Mercantile, p. 11, supra.
·         Two Scenarios
1.       An agent appears to have authority, but no actual authority exists
2.       An agent exceeds the scope of his actual authority (more common) 
·         Apparent authority can persist even after the actual authority / agency relationship has been terminated – therefore, the principal must take action to notify third-parties that this person is no longer an agent.
§  RST (2d) 8A Inherent/Implicit Authority – the third-party’s belief that an agent has authority to bind the principal because of the position/station that the agent holds in the corp; purpose – to protect

of authority – RST §8.09(1)
3.       Comply with lawful instructions – RST §8.09(2)
4.       Behave reasonably, don’t hurt principal – RST §8.10
5.       Provide information – RST §8.11
6.       The fiduciary duty requires that the agent only use the principal’s property for advancing the aim of the relationship – cannot use the property for self-interest RST 8.05
§  RULE: The principal does not need to prove that any harm was suffered if the agent engages in self-dealing
·         The principal is able to recover the benefits that the agent gained from the agent, as well as rescind any of the contracts made by the agent, and recover damages from the agent which were suffered due to the self-dealing. 
o    Overcompensation of principal?
o    RST 8.06 Principal Consent: Principal may consent to any of the above and thus expunge agent’s breach of duty.
Tarnowski v Resop (selling jukeboxes without full disclosure and making secret profits)
o    RULE: Agents cannot personally gain off of the principal’s Txs, thus all profits are owed to the principal.  The agent would also be responsible for any damages suffered as a result of the self-dealing. 
o    RST 8.04 The agent cannot compete with the principal for Txs
§  Unless principal consents (8.06)
o    RST 8.05 The agent must keep certain information confidential
In Re Gleeson (trust-relationship – trustee leases the farm to himself, even if beneficial, he is liable)
o    RST (Trusts) 203: A trustee cannot personally benefit off of the trust property (even if it would be the best course of action for the trust beneficiaries)
§  It does not matter if the Tx was made in G.F. or that the beneficiaries suffered no harm – it is a simply matter of whether the trustee benefitted
o    Profits off of a trust relationship may be non-consentable (unlike in agency) b/c trustees usually hold a position of power over their beneficiary, e.g. incompetent beneficiaries
§  A trustee can excuse himself from the position of trustee if he wishes to profit off of the trust property
Agency Costs
·         Agency Costs arise when the interests of the agent contravene the interests of the principal
1.       Monitoring Costs – the costs required to provide the principal with assurance of the agent’s loyalty
§  Incentive Costs – the costs of aligning the incentives of the agent to those of the principal (e.g. stock options)
·         By paying managers to align their incentives, the investors do not get as big of a return, but they help ensure that the returns are as big as possible
§  Important because of the passive SH phenomenon
2.       Bonding Costs – the costs that agents create in proving to their principals that they are loyal (acting in the principal’s best interest)
3.       Residual Costs – costs arising out of the difference of interest that remain even after the monitoring and bonding costs have been applied (because such efforts would not completely eliminate the difference in the principal’s and agent’s interests) 
·         The corp/investors can respond (must be proactive) to high agency costs by
o    Removing shirking managers
o    Recovering damages from misbehaving managers
·         In a corp, the Agency Costs manifest themselves in the following forms:
o    DO self dealing (insufficiently aligned incentives)
o    Conflicts between the majority and minority SHs
o    Conflicts between SHs and third-party stakeholders (creditors)
Partnerships and Other Forms of Biz
·         REV. UNIFORM PARTNERSHIP ACT (RUPA) 403: a partnership has these characteristics:
o    Dedicated pool of partnership assets
§  Thus, may own property and take on obligations
§  Tenancy in partnership is the special designation for property held by the partnership
o    Class of beneficial owners (the partners)
o    Clearly defined class of agents (the partners)
§  Optional: LLP
·         Each partner can bind the partnership if acting in the usual course of biz
·         The reason for the creation of a partnership is the greater access to capital
o    Less Incentive Cost than Corp: Ownership interests and liability interests are both held by the partners in a partnership, therefore their interests are aligned
§  Partnership interests do not necessarily have to be equal