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

THE PUBLIC CORPORATION
PRITCHARD
FALL 2012
 
 
 
I)                 Introduction to Enterprise Organizations
1.      Purpose of Corporations and Corporate Law
a. Law: Enables the creation of wealth by facilitating of voluntary economic relationships/
b. Corporations: Economic actors that create wealth and raise utility. Good law is “efficient” law, meaning that it maximizes the size of the economic pie. Enterprise law can enhance efficiency in three ways:
1.      Providing standard platforms for business entities as well as agency contracts and creditor protections.
2.      Permitting business actors modify third-party property rights in circumstances where contract law alone will not suffice (i.e. dividing assets to serve as collateral for different creditors).
3.      Provides variety of rules and standards – called “fiduciary duties” – that are intended to either prevent or remedy self-interested opportunism by parties within enterprises.
c. Economics of a Firm
1.      Efficiency
a.      Pareto: An act is efficient only if the pie increases AND every constituent’s piece of the pie is also increased. Concerned with distribution of wealth.
b.      Kaldor-Hicks: An act is efficient when it increases the size of the value pie (i.e. the net economic welfare of society). KH is a purer measure of efficiency, unconcerned with distribution. Protecting the interests of shareholders is generally consistent with increasing corporate wealth and maximizing KH efficiency.
2.      Transaction Cost Economics
a.      Owners of various resources will contract to reduce costs and share efficiency gains.
b.      A firm is a nexus of contracts with:
                                                                                            i.      Managers
                                                                                          ii.      Shareholders (rent capital to the firm)
                                                                                        iii.      Creditors
                                                                                        iv.      Employees
c.       Every decision the firm makes is whether to contract for something or bring it in-house. Answers are always changing b/c markets are always changing.
2.      Agency Costs
a. When they occur: When an agent makes uneconomic decisions for the firm that may be in his personal interest, but not the corporation’s.
b. Sources
1.      Divergence: Costs due to divergence of agents’ behavior from principals’ interests
2.      Monitoring: Costs that owners expend watching over agents (to insure their loyalty)
3.      Incentive: Costs of agent incentives (e.g. stock options)
c. Transaction costs
1.      Collective action: for practical reasons, principals must delegate responsibility to a core set of decision-makers
a.      Upside
                                                                                            i.      Frees up shareholders to do things beside monitor their investments
                                                                                          ii.      Shareholders can also protect themselves through diversification
b.      Downside
                                                                                            i.      Agents may act in their own self-interest
d. Agency costs and law: Corporate law and the corporate form act to reduce transaction costs through collective action and to reduce agency cost.
1.      It seeks to address 3 problems
a.      Facilitating relationships among shareholders
b.      Facilitating relationships between shareholder and managers
c.       Facilitating Ks between shareholders and other stakeholders – especially creditors
2.      Role of corporate lawyers
a.      Provide legal advice
                                                                                            i.      Off-the-rack rules for organizations
                                                                                          ii.      Rules customized to the client’s unique business/ownership situation
                                                                                        iii.      Helping clients comply with the law
b.      Provide business advice   
                                                                                            i.      Understand intersection of legal & business problems, help clients foresee potential pitfalls
                                                                                          ii.      Facilitate the business and craft solutions, instead of just saying no
                                                                                        iii.      Lawyer’s credibility is enhanced if he understands the business
c.       Provide ethical advice
e. Investors’ Response to Agency Costs
1.      Monitor managers
a.      Downside: over-monitoring will curtail their discretion too much
b.      Shareholders don’t oversee managers, the board does
2.      Provide incentives to maximize profits
a.      Downside: bonuses take away from profits and dividends
b.      Also a short-term horizon problem (with options)
3.      Remove shirking managers
a.      Managers are accountable to the board
b.      Downside: Who will take over for the incumbent?
                                                                                            i.      Short-term: you lose key employees
                                                                                          ii.      New CEO also has to spend time getting up to scratch
4.      Recover damages from misbehaving managers
a.      Not as important as the other three, BUT the board implements those
b.      Damages are largely entrusted to lawyers
II)              Agency
1.      Statutes:
a. R3rd Agency (p. 20)
1.      1.01 Agency Defined
2.      1.02 Parties’ Labeling Not Controlling
3.      1.03 Manifestation
4.      2.01 Actual Authority
5.      2.02 Scope of Authority
6.      2.03 Apparent Authority
7.      2.05 Estoppel to Deny Agency Relationship
8.      2.06 Liability of Undisclosed Principal (Inherent Authority)
2.      Definition and Required Elements: Agency is a fiduciary relationship with three elements
a. Manifestation of mutual assent
b. Agent acts on the principal’s behalf (power to bind) AND
c. Agent is subject to the principal’s control
3.      Termination: Either party may terminate the relationship at any time for any reason.
a. Agency will never continue over the objection of one of the parties
b. May be liable for contractual damages.
4.      Examples – Agency relationships are fundamental building blocks of market economies
a. Sole proprietor with one employee
b. General Motors and its CEO
1.      Perks (corporate jet, fancy office, etc.)
2.      The quiet life: coasting, not making risky, positive NPV investment decisions
5.      Authority: Agent’s Power to Bind
a. R3d § 1.02: Characterizing a relationship as an agency does not control à the courts look at the objective elements of an agreement to determine the nature of a relationship.  
1.      § 2.01: It is necessary for the agent to reasonably understand from the manifestations of the principal that he has been authorized to act on the principal’s behalf.
2.      Jenson Farms Co. v. Cargill: Plaintiffs sued Cargill to recover for Warren’s default on its grain purchases. They met burden of establishing:
a.      Consent
                                                                                            i.      Cargill assented to Warren acting on its behalf by procuring grain from Warren and financing its operations.
                                                                                          ii.      Warren entered Ks with farmers to grow seeds for Cargill
b.      Benefit
                                                                                            i.      90% of Warren’s grain went to Cargill
c.       Control
                                                                                            i.      Directed Warren to act on its behalf and interfered in its operations (reviewed expenses, recommended actions).
                                                                                          ii.      Also placed its name on some Warren forms (bad lawyering!)
3.      Control
a.      Recognize tradeoff b/t control and risk of liability
b.      Difference b/t positive powers for lender & negative restrictions for borrower is meaningful
b. Types of Authority
1.      Actual Authority
a.      Express § 2.01
                                                                                            i.      P expressly manifests consent to A by spoken or written words or other conduct (1.03) AND reasonable person in A’s position would infer assent from P’s conduct.
b.      Implied § 2.02(1)
                                                                                            i.      “Acts necessary or incidental to achieving the principal’s objectives, as the agent reasonably understands the principal’s manifestations and objectives”
                                                                                          ii.      Can be implied by context (industry custom, prior practice, course of dealing)
2.      Apparent Authority – § 2.03
a.      Definition: A third party reasonably believes the actor has the authority to act on behalf of the P and that belief is traceable to the P’s manifestations
                                                                                            i.      P tells 3P that A can act on P’s behalf.  But apparent authority needed b/c A exceeded scope of actual authority.
                                                                                          ii.      Manifestation – § 1.02 : Person manifests consent through words or other conduct if he has notice that another will infer consent or intention from the words or conduct.
b.      White v. Thomas: White instructed to buy house for Simpson, claimed POA, purchased 217 acres for more than authorized, then sold 45 to recoup $. White ratified purchase, but not sale. Court said no AA, b/c ability to enter a K for sale is not necessary to carry out the ability to K for purchase. Thomas can’t rely solely on agent’s claims of authority, must verify.
3.      Inherent (Implicit) Authority –
a.      Definition: Agent’s power to bind a principal to an unauthorized contract when a general agent would normally have the power to enter such a contract and the third party does not know that matters stand differently in this case.
                                                                                            i.      Not conferred on agents by principals, but imposed on principals by the law.
                                                                                          ii.      Theory exists for the protection of persons harmed by or dealing with a principal’s servant or agent. Imposes liability for unauthorized acts. Enterprises get the benefit of agents’ work, so it’s only fair to make them accountable for their excesses sometimes.
b.      R 3d § 2.06 – Undisclosed Principal: “An undisclosed principal is subject to liability to a third party:
                                                                                            i.      Who is justifiably induced to make a detrimental change in position
                                                                                          ii.      By an agent acting on the principal's behalf and w

                                                                             i.      Indicia of lack of control: Operator (Barone) held title to the station and set its hours, K terminable by either side w/30 days’ notice, Sunoco made recommendations but Barone was free to ignore them.
c.       Policy Considerations
                                                                                            i.      When Liability Should Attach – Possibilities
1.      Appearance of responsibility: Sun Oil logo made customers think this
2.      Large residual interest: Whoever receives financial benefit from station
3.      Deep pockets: Supplier w/deep pockets and a connection to the accident
4.      Risk prevention: Control or right to control harmful activity
                                                                                          ii.      Costs of Respondeat Superior Liability
1.      Could give entrepreneur less incentive to exercise oversight (if he’s going to be held liable regardless)
2.      Alternative: require station operators to get indemnity insurance for accidents.
d. Scope of Employment – R3rd 7.07(2)
1.      Employee acts within scope of employment when:
a.      Performing work assigned by the employer OR
b.      Engaging in a course of conduct subject to the employer’s control
2.      Employee does not act within scope of employment when:
a.      Act occurs within an independent course of conduct not intended by the employee to serve any purpose of the employer.
 
III)          Fiduciary Duties of Agents
1.      The Duties
a. Core Fiduciary Principle: Duty of Loyalty (R3d A 8.01): An agent has a fiduciary duty to act loyally for the principal’s benefit in all matters connected with the agency relationship. Encompasses selflessness and protectiveness.
1.      Duty not to acquire a material benefit (R3d A 8.02): From a 3rd party in connection with a transaction conducted or other actions taken on behalf of the principal or otherwise through the agent’s use of the agent’s position.
a.      Agent is entitled to reasonable compensation but no other profits, unless P consents.
2.      Duty to not be adverse (R3d A 8.03): Must not deal with the principal as or on behalf of an adverse party in a transaction connected with the agency relationship.
 
3.      Duty not to compete (R3d A 8.04):
a.      Can’t compete with the principal or assist competitors in doing so
b.      BUT may take action to prepare to compete following termination of agency relationship
4.      Duty not to use property/confidences (R3d A 8.05)
a.      Can’t use the principal’s property for agent or 3rd party purposes
b.      Can’t use or communicate the principal’s confidential information for agent or 3rd party purposes.
b. Core Fiduciary Principle: Duty of Care (R3d A 8.08) A must act with standard care, competence, and diligence of those in similar circumstances (i.e. occupation and locale). Must use any special skill (i.e. skill of ordinary lawyer in area).
c. Corollary Duties
1.      Duty to abide by contracts (R3d A 8.07): An agent has a duty to act in accordance with the express and implied terms of any contract between the agent and the principal.
2.      Duty to act within scope of authority (duty of obedience) (R3d A 8.09(1)): to take action only within the scope of the agent’s actual authority.
a.      Simpson could’ve sued White for indemnification if he lost.
3.      Duty to comply with instructions (R3d A 8.09(2)): Must comply w/all lawful instructions from P.
4.      Duty of good conduct (R3d A 8.10): Duty to act reasonably and to refrain from conduct that is likely to damage the principal’s enterprise.
5.      Duty to provide information (duty of candor) (R3d A 8.11): A must use reasonable effort to provide the P with facts A knows, has reason to know, or should know when:
a.      A knows or should know P would wish to have the facts or such disclosure is material to the A’s duties to the P; and
b.      The facts can be disclosed w/o violating a superior duty owed by the A to another person.
2.      Principal’s Consent – R3d A 8.06
a. Single Principal: Conduct by an A that would otherwise be a breach of the duty of loyalty or subsidiary duties does not constitute a breach if the P consents, provided that:
1.      In obtaining consent A:
a.      Acts in good faith
b.      Discloses all material facts A knows, has reason to know, or should know would affect the P’s judgment
c.       Otherwise deals fairly with the P; and
2.      The P’s consent concerns either a specific act or acts in transactions of a specified type that could reasonably occur during the course of the relationship.