Overview
Theory of the firm (by Jensen and Meckling): A separation of interests problem, the people who run the firm are not the same people who own it (officers vs. shareholders).
Three aspects:
Shareholder / officer dichotomy
Agents acting in their own interests and not necessarily for the shareholders
Creates Agency Costs
Cost of obtaining faithful and effective performance by one’s agent
Mitigating agency costs (to decrease agency costs)
Legal: fiduciary duties, stockholder suits, etc.
Economic:
Audits
competition factor (and product and labor markets having to be competitive)
market for corporate control (if run ineffectively will be taken over)
stock option and executive compensation (make officers care about shareholders by making them shareholders)
Principal / Agency Relationship
Definition: A relationship whereby :
Mutual consent (formal or informal; express or implied)
One person or entity (agent)
Undertakes to act on behalf of another person or entity (principal)
Subject to principal’s control’
Issue: whether or not agent has authority to make decisions
Actual, apparent, or implied authority?
Actual: board authorizes agent to do something
Apparent: Some third person reasonably believes the “agent” has authority
Implied: Because of the agent’s office she has certain authority to do certain things (CEO can do certain things)
o Forms of organization:
· Proprietorship: operating a business without any formal legal organization (no written agreement)
§ Ex. Selling stuff on ebay – personal liability for something going wrong
· Partnership: two or more persons agree to carry on a business for profit (no written agreement necessary)
§ Downside: You are personally liable for debts of the partnership
· Limited Partnership: 2 types of partner
§ Limited partner: only liable for amount of investment
§ General partner: liable for all debts
· Corporation:
§ S-Corp. :
· Has pass-through taxation (only taxed at individual level, not at individual level)
· Downside: Must meet certain reqs (< 75 shareholders, can’t have corporate shareholders, can’t have non-resident alient as shareholder)
§ C-Corp. :
· 2 levels of taxation
· all big corps in US are C-corps
Partnerships
Definition: 323A.01012(8) – An association of two or more persons to carry on as co-owners of a business for profit
Advantages:
Taxes – taxed under subchapter K, informational return for whole firm, but otherwise individual return.
Flexibility – Not large/complicated corporate structure
Restrictions on certain businesses – ?
Inadvertance – you can become a partnership without any agreement at all (inadvertant partnership)
Poor or no legal advice
Everyone must share profits
· Agreement
· Governing document:
§ Partnership Agreement rules – Uniform Partnership Act of 1994 – Sect. 323A.0103(a), (b) – default rules for when specifics are not laid out in agreement.
§ If written agreement (there typically is): Good because it forces people to avoid future disagreements, provable in court, and focuses intention on difficult areas.
· Law Firm Partnerships (pg. 35)
§ Different tiers of partnership (equity partner > income partner)
§ Pyramid scheme for firms – problem: must keep growing and can’t let base flatten out
· Division of Profits/ Losses
· Default rule: Equal sharing among partners – usually specify otherwise
· What happens when a partnership loses money:
· Richert v. Handley
§ Facts: Partnership where Richer
ed by a partner, the partnership is liable for the loss
· Partnership Duties
· No duty to furnish services, except that which is mentioned in partnership agreement – otherwise partner can be removed at any time
· Duty of care: Refrain from gross negligence/ reckless conduct
§ Even legal malpractice usually isn’t violation of duty of care, unless reckless
· Business judgment rule – analogous to corporations – pretty extraordinary when duty of care actually violated
· Duty of loyalty: Put partner’s interests ahead of your own
· Statute – (b)(1) – Account for benefits
§ If some opportunity comes your way in the course of business, you give it to the firm instead of taking it personally
· Statute – (b)(2) – refrain from doing something adverse
§ Ex. Can’t work for Dorsey and represent someone suing Dorsey
· Statute – (b)(3) – refrain from competing
§ Can’t compete with partnership at same time as working for it – must have full disclosure and fair dealing overall
· Meinhard v. Salmon
§ 2 co-adventurers (a joint venture is a partnership with a specific purpose) leased a property for $200,000. One partners was a managing partner who leased more space on the property without the other partner’s consent, and pursued it without his co-partner.
§ Court: No, breach of duty of loyalty, because Salmon deprived Meinhard of the chance to compete for the new lease.
§ Rule: Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. (Should’ve told your partner)
· Partnership Dissolution
· Remember: Any default rules trumped by something specified in the agreement
· In general: the dissociation of a partner causes dissolution – statute lists events (death of a partner, disbarred, etc.)
