Business Organizations – Professor Lambert
Spring 2012
I. Introduction – The Nature of the Firm; the Corporate Lawyer as “Transaction Cost Engineer”
a. The American system of economics
i. Our system is capitalist in nature. This means that incentives are profit-driven, with allocation of resources occurring without central control. The “hand” is invisible as opposed to visible. Resources are just allocated, without direction.
ii. The obvious contrast to this system is socialism. The classic example is the Soviet five-year plans, where the Board of Central Planning determined future economic production (a central planning authority allocated resources)
iii. Capitalism is better because it generates more wealth, is more efficient (meaning that wealth enhancement occurs, as opposed to cost reduction), and has a clear motivational benefit
b. Hayek’s “The Use of Knowledge in Society”
i. Hayek’s point is that central planning doesn’t work because planners are not privy to the time, value and place specific information needed to ensure proper price setting.
1. Hayek wasn’t really proven right until following the collapse of the Berlin Wall, and recognition of East German economic decay. Massive surpluses/shortages reinforced Hayek’s point that central planners improperly allocate resources, resulting in surpluses and shortages of goods.
ii. Hayek’s solution was decentralization of the decision-making process and use of the price system to determine prices of goods. Demand and supply would establish whether more or less of a good is required.
iii. Shortages would result in increased prices, producers producing more, consumers substituting away, setting a new equilibrium price.
iv. Surpluses would result in prices going down, producers substituting away, consumers coming forward, setting a new equilibrium price.
v. Price conveys to producers in the most efficient manner exactly what they need to know
c. Coase’s “The Nature of the Firm”
i. Coase wants to describe the defining characteristics of a business organization. Economically, what makes a firm a firm is the supersession of the price mechanism. A firm is a group of individuals that allocate resources by managerial fiat in order to maximize wealth and minimize costs. In other words, a firm is a socialist economy floating in a sea of market capitalism.
ii. Downsides of the Firm
1. Hiring runs the risk of allocative inefficiency. This could be solved by hiring daily from the unemployment line, but that raises transactional costs.
2. Another downside is agency costs. Bosses make mistakes and cost the firm money.
iii. The Legal Definition of the Firm
1. A nexus of contracts. Legally, a firm is a series of interrelated contracts put together in order to facilitate the economic functions of the firm.
d. How the transactional attorney adds value to the firm
i. First, by serving as a transaction cost engineer. Second, by tailoring preestablished types of contracts nexuses for the firm based on their model.
II. Agency
a. Who is an agent?
i. Rest. Agency § 1:
1. 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.
a. The one for whom action is to be taken is the principal.
b. The one who is to act is the agent.
2. The four-prong test for agency relationships:
a. Agency is (a) manifestation of assent by the principal (b) that the agent will act (c) subject to the principal’s control, and (d) the agent consents so to act.
i. Note the asymmetry in the assent. The principal has to manifest consent to the agent, but the agent’s consent does not need to be manifested to the principal.
ii. The second requirement means that the principal agrees that the agent will act as the face of the principal (quintessentially, think lawyer-client)
b. The third requirement, that the agent act subject to the principal’s control – the principal needs only control the ends of the relationship, not necessarily the means of the relationship.
c. Agency relationships are frequently inferred from relationships called something else by the parties. Also note that agency relationships require mutual assent, NOT mutual contract.
3. A principal bound by an agent’s acts can never be more liable than the agent.
a. Gorton v Doty – The evidence sufficiently supports the finding that the relationship of principal and agent existed between Doty and Garst.
i. We can infer that Garst was at least negligent because Doty was held liable, and
ii. The court may be trying to achieve a policy goal, getting the owners of automobiles to buy insurance to cover not only themselves but any drivers of their vehicles – it seems like Doty just loaned her car, but the court strains to find a principal-agent relationship
ii. Buyer-Supplier/Creditor-Debtor Relationships
1. The overarching test for when a buyer-supplier relationship becomes a principal-agent relationship is whether it is agreed that the supplier is to act primarily for the benefit of the buyer and not himself
a. In determining where a buyer-supplier relationship becomes a principal-agent relationship, look to the three factors at Rest. Agency § 14(k) Factors indicating that the one who is to acquire the property and transfer it to the other is selling to, and not acting as agent for, the other are:
i. That he is to receive a fixed price for the property, irrespective of the price paid by him.
1. Is the buyer charged a retail or cost-plus price? If buyers charge cost-plus prices they look like agents.
ii. That he acts in his own name and receives the title to the property which he thereafter is to transfer.
1. Buyers who act in their supplier’s names look like agents.
iii. That he has an independent business in buying and selling similar property.
1. Buyers without independent business look like agents.
2. The overarching test for whether a creditor-debtor relationship becomes a principal-agent relationship is whether the creditor has taken de facto control over the debtor
a. Why is control given so much emphasis?
i. If principals are not held accountable when they control their agents, they are given a powerful incentive to force their agents to take as many risks as possible, and make as much money as possible, without fear of costs. Emphasizing control forces principals to internalize the costs of the business activity.
3. A. Gay Jensen Farms Co v Cargill, Inc
a. Cargill was a principal over Warren and is therefore liable. Cargill consented to be a principal once Warren agreed to implement the changes and policies that Cargill suggested. Cargill’s subsequent interference in Warren’s internal operations further established the relationship.
iii. The Master-Servant/Employer-Independent Contractor Relationship (subsets of the Principal-Agent Relationship)
1. A master-servant relationship is a relationship in which the principal controls not only the ends of the relationship but also the agent’s means of accomplishing it. A master-servant relationship establishes vicarious tort liability for the principal
a. If the principal doesn’t have control over the physical conduct of the relationship (means), but rather only the ends, then the relationship is an employer-independent contractor relationship.
2. Examples of a master-servant relationship:
a. Starbucks (master) controls the ends (selling coffee) of its baristas (servants), as well as the means (what to wear, how to brew, etc.)
i. Contrast this with the relationship between an investor and their stockbroker. This is an employer-independent contractor relationship. The same is true for lawyer-client relationships.
b. The line between master-servant and employer-independent contractor is established by the right to control the physical conduct of the agent.
3. Not all independent contractors are agents.
a. A subset of the employer-independent contractor relationship are non principal-agent relationship. For example, hiring a contractor to renovate your kitchen is not a principal-agent relationship because the contractor is not acting as the face of the principal.
i. While this is the factor courts typically gloss over, in cases involving contractors courts will avoid finding agency relationships when the contractor does not act as the face of the employer
b. However, establishing a credit account for your contractor to make purchases, giving him authority to enter into contracts on your behalf, would transform the non-agent independent contractor into an agent of the principal.
c. The distinctions between non-agent and agent independent contractors are drawn on a transaction-by-transaction basis. Therefore a single employer-independent contractor relationship can be both an agency relationship and a non-agency relationship depending on which transaction is occurring.
4. Restatement of Agency § 220(2)(a)-(j) Factors to Consider in Distinguishing Master Servant from Employer-Independent Contractor – The dispositive question is whether the employer exerts day-to-day control over the contractor
a. the extent of control which, by the agreement, the master may exercise over the details of the work;
b. whether or not the one employed is engaged in a distinct occupation or business;
c. the kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the employer or by a specialist without supervision;
d. the skill required in the particular occupation;
e. whether the employer or the workman supplies the instrumentalities, tools, and the place of work for the person doing the work; (note: Lambert thinks this is an easy test, which is why it is used)
i. An agent who brings his own tools looks more like an independent contractor than a servant
f. the length of time for which the person is employed;
g. the method of payment, whether by the time or by the job;
i. If the job isn’t paid for until the end, it looks more like an independent contractor than a servant
h. whether or not the work is a part of the regular business of the employer;
i. If the work is part of the regular business, and the employer hires more help, this looks more like a servant than an independent contractor
i. whether or not the parties believe they are creating the relation of master and servant; and
i. This factor is only to be used in close cases as a tiebreaker. By itself it is less relevant than the other factors.
j. whether the principal is or is not in business.
5. Ultimately a policy argument should be made, using the a-j factors, to argue for or against making the employer liable for the agent’s torts.
iv. Franchises
1. A franchise is a large company that owns a bunch of intellectual property (a business method, and a lot of trademarks). Small business owners set up outlets, license the intellectual property, and set up their franchises. They are the franchisees, and the company is the franchisor.
2. When looking for a m
tiple forms of authority [Dweck v Nasser]
ii. The Pecking Order of Looking for Authority – When looking to establish the Agent’s Authority:
1. First look for actual express authority, then actual implied authority, and then apparent authority. These all occur pre-contract
2. Next, look for ratification. If the principal hasn’t ratified, look for facts to establish agency by estoppel. Remember that estoppel is an equitable doctrine and is thus disfavored.
3. Lastly, if you haven’t located any other manner of authority, look for the “catch-all” of inherent authority
iii. Types of Authority
1. Actual Express Authority is the most obvious kind of authority
a. The principal told the agent, “Enter into this contract on my behalf.”
2. Actual Implied Authority exists where the principal intends for the agent to have the power to enter into contracts on his behalf, but didn’t necessarily express that authority; the authority is implicit;
a. The touchstone for actual implied authority is the agent’s reasonable understanding – did he reasonably understand that he had the authority to enter into contracts on the principal’s behalf?
b. Mill Street Church of Christ v Hogan
i. Note that for there to be actual authority (either express or implied), the authority must have been conferred prior to execution of the contract. If authority is granted post-contract, this is insufficient to establish actual authority – however it may establish ratification
3. Apparent Authority is unintended by the principal. However, the principal creates an impression in a third party that gives that party the reasonable impression that the agent is capable of entering into contracts
a. Note that the third party’s reasonable belief HAS to be based on the manifestations made by the principal, not the agent – Restatement of Agency § 2.03
b. The law allows aparent authority to arise based on indirect manifestations that are subsequently made to third parties [Dweck v Nasser]
c. Having an attorney of record make appearances on your behalf probably establishes apparent authority in opposing parties [Dweck v Nasser]
4. Inherent Authority is the power of an agent which is derived not from authority, but solely from the agency relation, and exists for the protection of persons harmed by or dealing with a servant or other agent
a. This is a catchall that has bedeviled courts.
b. The doctrine of undisclosed principal limits liability to situations in which a principal has set up an agent to look like he is acting for himself, when in fact he is working for a principal who has kept himself hidden from third parties (Rest. 2d, Watteau v Fenwick)
i. The Rest. 3rd has rejected inherent authority, and replaced it with “Liability of Undisclosed Principal (Rest. Agency § 2.06). This attempts but fails to account for situations like Watteau v Fenwick, because it limits inherent authority to situations where a principal sets up an agent to look like the agent is acting for himself, when the agent is in fact working for a principal
ii. Conservative courts still invoke inherent authority, limiting it to undisclosed principal situations
c. An efficiency argument for finding inherent authority in undisclosed principals
i. While third parties should educate themselves about who they do business with, the investigation should be reasonable – a person who appears to be a man of means and is not obviously an agent shouldn’t require credit checks for small-scale transactions
5. Ratification is different than other theories of authority because it comes into effect after the contract has been entered into.
a. Ratification requires either an express affirmance by the principal in favor of the contract, or a situation where the principal has accepted the benefits of the contract and the ONLY explanation for that acceptance is a desire to ratify the contract at issue.
i. Botticello v Stefanovicz – where alternate explanations for accepting the benefits of the contract are apparent, a ratification theory will fail
b. Also, in order for ratification to occur by acceptance of the benefits, it must be possible to reject those benefits. If it is impossible not to accept, ratification is not possible by acceptance of benefits.
i. Ratification can occur through silence or inaction – the law doesn’t allow the principal a put option on a contract already entered into.
c. Ratification cannot occur following a “material adverse change” to the object of the contract. Because ratification is a way for a principal to receive benefits from an unauthorized contract, it is inappropriate where it would prejudice the third party who entered the contract with the agent
