1. Economic and Legal Aspects of the Firm
A. Some Basic Concepts and Terminology
1. Why do people form Corporations?
a. Make money
b. Sole Proprietorship: 1 person works on their own
c. “Team”: people getting together to use their skills and different aspects of their skills
d. Risk v. Return: more risk = possibility of MORE return
2. 4 main themes to the Course:
a. (1) Ordering of Relationships: who controls the firm
· Directors, Managers, Shareholders, Employees, 3rd party stakeholders
b. (2) Trust
· Limiting Opportunism: “Self-interest seeking with guile: individuals who act opportunistically seek to further their own ends by taking advantage of the information deficits of those with whom they deal.” (p 7)
· Look for secrecy, or misstatement/omissions of “material” information
· Law provides a fluid set of FORMAL rules to govern the relationship and limit the possibilities of opportunism; some rules can be contracted around but others may NOT be
· If the officer’s decisions benefit him, not the shareholders and uses shareholders’ money – he is limiting opportunism
c. (3) Internal Public Ordering
· Contractual agreement/internal governance Rules:
® Corporate by-laws, partnership agreements, NLERS (non-legally enforceable rules and standards)
· State and Federal statutes: default rules that come into play if you can’t privately order amongst yourself
® Agency relationship and agency principles
· Common Law Rules: fiduciary duty, fair dealing, care
· Litigation: this is the least cost-efficient means of creating and enforcing corporate law rules
d. (4) Importance of Lawyers (“Breaking up is hard to do”)
· If there is no agreement in place as to what happens when the corporation breaks up, then the state statues govern
· Discrete Rule: Tailored rule individually aimed at what the parties want
· Good Faith Rule: you can’t anticipate everything, but parties will use some standard for consequences that are unanticipated as of now
B. Organizing the Firm: Selecting a Value-Maximizing Governance Structure
1. Organizational Forms/Forms of Proprietorships:
a. Sole Proprietorship: 1 individual, NO partners, business, invested capital from anyone else; 1 person is fully liable for the actions of the organization
b. Partnership: 2+ people come together (either through contractual agreement, or without – in which case there are state imposed rules)
· General Partners: joint and severally liable
® Ex: Sprint-Nextel, 2 people owning property
® IMPT aspect is the shared liability (twice as many pockets to go after for P’s lawyer)
c. Corporations: range in size from large publicly traded companies to small, closely-held businesses
· Ex: Starbucks, Dell, Sony, etc
d. Hybrid Entities: blend partnership and corporate rules (ex: Limited Partnership (LP), Limited Liability Companies (LLC) and Limited Liability Partnerships (LLP), Limited Liability Limited Partnership (LLLP))
C. The Firm and the Law of Agency
1. Introduction
2. Agency Law and Choice of Sole Proprietorship Form
a. Principal-Agent Relationship
· Agency: the most basic unit, vehicle for people to employ other people
® Ex: Prof paid student $5/day to get everyone coffee, then student is Prof’s agent
· Rstmt 2d Agency §15 (p 529): An agency relation exists only if there has been a manifestation by the principal to the agent that the agent may act on his account, and consent by the agent so to act.
® An agent is a fiduciary with respect to matters within the scope of his agency.
® Fiduciary duty: certain standard imposed by law; requires agent to be honest, trustworthy, loyal and not to violate that loyalty
· Rstmt 2d Agency §387 (p 534): Unless otherwise agreed, an agent is subject to his duty to his principal to act solely for the benefit of the principal in all matters connected with his agency.
® Unless otherwise agreed: individuals can contract otherwise, i.e. the principal and agent may have a contract that does NOT delineate that the agent’s duty is not act solely on behalf of the principal
b. Agents owe many duties to Principals, Principals don’t owe many duties to Agent
· Agent has default rules to follow + contracted rules
· Rules have been established that govern employers
c. Dealing with 3rd Parties: Types of Agency Authority
· Rstmt 2d Agency §1 (p 527): Agency is the fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act.
· Rstmt 2d Agency §7 (p 527): ACTUAL authority is created by the Principal’s consent to give the Agent the power to affect the legal relations of the Principal by acts done in accordance with the principal’s manifestations of consent.
® Authority is the power of the agent to affect; i.e. stockbroker executes order to buy/sell stock
· Rstmt 2d Agency §27 (p 529): APPARENT authority is created by the Principal’s words/conduct to a 3rd Party which, reasonably interpreted, causes the 3rd person to believe that the Principal consents to have the act done on his behalf by the Agent purporting to act for him.
® Reasonable perception of what is going on; i.e. stockbroker is acting as a stockbroker and is the agent, then the principal will also be bound
· Rstmt 2d Agency §8A (p 529): INHERENT agency power is the power of a
amental rule that reflects reality, you can’t stop memory, but you can stop lists, will set a rule that is convenient for the parties to follow
4. Limits on Firm’s Right to Discharge an Employee at Will
a. Foley v. Interactive Data Corp.(CA SCT, 1988) (p 23):
· IMPT: Duty of Candor – what the employee should give to the employer as part of the agent duty
® CT shifts the burden, overcomes the presumption that there is at-will employment
® CT held there is NO covenant of good faith and fair dealing; CT wants to give discretion to employers to fire employees
· FACTS: Foley informed someone when he found out boss had embezzled previously; Foley was fired; Foley brings action that he was fired b/c he was a whistleblower (i.e. breach of public policy); as an employee, Foley has a DUTY of CANDOR to his employer
· ISSUE 1: Foley’s firing was in opposition to public policy
® CT HELD: no – if the Employee that Foley was actually currently embezzling then Foley being fired would be breach of public policy; but they will not reach that issue b/c here Foley was just “telling” on another employee for being bad in the past; Corporations can order their own rights
§ But, isn’t past criminal conduct relevant to current circumstances…?
· ISSUE 2: At-Will Doctrine
® FACTS: Foley says his employment was NOT at will, b/c of termination policy, oral assurances of employment during 7 years, Foley had a non-compete with the employer
® CT HELD: not at-will; Foley has proven that there was an implied-in-fact contract, and its breach, entitles Foley the right to prove those allegations, and therefore the CT will let the issue go to jury
· ISSUE 3: Breach of the implied covenant of good faith and fair dealing
® FACTS: “back up” cause of action; punitive damages for tort = MORE $$; would persuade the Employer to settle b/c the jury will find lots of punitive damages for the poor sad whistleblower
® CT HELD: NO tort of good-faith and fair dealing; distinguishes b/t tort (societal interest) and contract (private ordering of individual’s agreement); look at the parties’ intent in the contracts; and thus the court is limiting litigation by holding NO tort here; CT wants to protect employers
