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Business Associations
University of North Carolina School of Law
Hazen, Thomas Lee

Business Associations – Hazen – Fall 2012

School: University of North Carolina

Text: Corporations and Other Business Organizations: Cases and Materials (Standard 3d ed. 2009)

Types of Business Organizations

1) Sole Proprietorship:

Pros: Control, Simple, Less Expensive, Taxes

Cons: Unlimited liability, no separation between ownership/control, transferability

2) Partnership: business owned by two or more persons

Pros: control, simplicity, lower cost, taxes, flexibility

Cons: unlimited liability, non-transferable, joint/several liability for debt of the partnership

3) Corporation: Assc of individuals, statutorily governed separate legal entity. AoC must be filed w/Sec of State for the incorporation state, SH have no authority conduct C business.

Pros: limited liability (SH liable to extent of their investment), separate ownership/control, taxation (corp pays tax if reinvest profit, not SH), ownership interest is freely transferable, centralized management, perpetual life.

Cons: double taxation, managerial self-interest, Federal Securities laws

4) Limited Partnership: Limited partners + 1 or more general partner

Pros: limited liability for limited partners separates control and ownership, limited filing requirements, Federal Securities laws, unlimited liability for GP.

Cons: GP subject to unlimited liability, LPs cannot sell or transfer interest

5) LLC: Corp entity that can be run as partnership, with “pass through” tax treatment

Pros: LL, separation of control/interest, taxation may be passed through to members/avoid double taxation

Cons: interest may be transferred but subject to terms of operating agreement

6) LLP:

– Limited liability, taxed as partnership, must file with Secretary of State (RUPA 1001)

Pros: LL, taxation may be passed through to members/avoid double taxation

Cons: Partner may be subject to unlimited liability for his own acts, ownership interest not easily transferred

7) Joint Stock Company: Corp with unlimited liability

8) Partnership Association: supplanted by LLC

9) Business Trust: Mass. Form of limited liability organization. Trustees manage the business and beneficiaries share in profits/appreciation of assets. Organized through deed or declaration of trust.

I. Agency Law

– Restatement 1(1): Agency is a fiduciary relationship that results from manifestation of consent by one person (principal) to another (agent) that the agent shall act on his behalf and subject his control, and consent by the other to so act.

o Fiduciary relationship.

o Principal (P) is liable for the acts of the agents (A), if the acts are within the scope of the agency relationship.

o EEs are agents

o Acts of an A bind P

– Types of agent authority

o Actual: If P’s words would lead a RP to believe that he had authorized the agent to act.

§ Express: P tells A exactly what to do

§ Implied: reasonably necessary to carry out express authority given to A

o Apparent: P’s words/conduct cause RP to believe that P has authorized A to act. P gives 3P reason to believe that actual authority exists.

§ Question of fact

§ A cannot create his own apparent authority.

o Scope of duties: P becomes 100% liable for A’s actions if A is within the scope of his authority. If A is outside scope, P is not liable.

o Creation of Authority: only P can create A’s authority. If A holds out to the world, and 3P reasonably relies on the authority, there is still no authority unless P has consented to authority. 3P can sue for breach of warranty of authority, agency by estoppel.

o Related Doctrines

§ Ratification: P’s after the fact approval of A’s actions, may be either express or implied, binds the principal, relates back to time of unauthorized acts. Where P affirms the acts expressly or acts in a manner showing affirmation or acquiescence.

§ Acquiescence: Similar to ratification

o P can terminate agency relationship at any time because the agency can impose unlimited liability. Can terminate even if would breach an employment contract. P will be liable for those damages, but the relationship will still terminate.

– A can bind P through actual, apparent, ratification, estoppel, and respondeat superior

– P is liable for the acts of A when A acts with a) authority and b) within the scope of the authority.

– While A, A cannot deal with P as an adverse party. A must act for sole benefit of P.

Third party may be bound to the P even when the agency relationship or identity of P is not disclosed. Third party will not be bound where A misrepresents relationship, or if 3P wouldn’t have dealt with P if P’s identity had been known.

3 classes of principal

Disclosed: at the time of the transaction made by the A with the 3P, the latter knows that the person he is dealing with is acting as A and also knows the P identity.

Partially disclosed: at the time of the transaction, the 3P knows that the person he is dealing with is acting as A but does not know P’s identity

Undisclosed: The person acting as A represents they are acting on their own behalf and does not disclose the existence of the agency relationship. This is usually because the P is wealthy and believes that money can be saved on the proposed deal if their involvement is hidden.

Who is liable in the following contexts of principal disclosure?

o Undisclosed: both principal and agent are liable

o Partially disclosed: both principal and agent are liable

o Disclosed: only principal is liable, assuming that the agent had the authority and acted within his scope. If only apparent authority, then both are liable.

Agency duties: Unless otherwise agreed…

1. A must act solely for the benefit of P

2. Must give all profits to the P, except for tips in a restaurant.

· This includes duty not to compete and not to appropriate opportunities that belong to P.

3. Must have confidentiality of information–cannot disclose secret formula

4. A may not treat P as adverse party (any contractual agreements are by nature adverse, because the better terms for A are worse for P)

Agency–General Rules about Apparent Authority

– President has authority to do ordinary things

– Vice-presidents generally do not have such authority

– Chairman of the board could either be nominal or very powerful

– Corp. Secretary can fix the seal; no authority to transact business or sign deeds

– Corp. Treasurer has no apparent authority

In order to ensure that you have the proper authority to do a business deal and to “cover your ass”, you should:

1. Go to the Board and get a resolution for the multi-million dollar deal

2. Get opinion of the corporation’s counsel

3. Ask for resolution/opinion as part of the deal

4. Check the corporate statute / articles of corporation / bylaws / board minutes which will serve to check on the authority of the corporation.

DEL § 142–clothing officers with actual and apparent authority

MPC §8.40–clothing officers with actual and apparent authority

MPC §8.41–duties of officers

Gay Jenson Farms v. Cargill, Inc (Minn. 1981) (Identifying the Agency Relationship) – de facto, implied from conduct.

Cargill continued to loan $ to Warren, a grain elevator, $ with several requirements on the loan. Did Cargill manifest consent for Warren to act on its behalf/Did Warren consent? Does the loan make an agency relationship? Through its control and influence, Cargill became a principal of Warren’s.

5. Cargill exercised control over Warren, dealt in the day-to-day operation of Warren, had right to micromanage Warren’s business. Cargill had right to demand audits.

6. Warren acted on behalf of Cargill, loan was for benefit of Cargill as 80-90% of Warren’s business was with Cargill, Cargill allowed Warren to look like it was acting on Cargill’s behalf (stationary, order forms, etc.)

7. Cargill allowed Warren to “hold out” use its name. If Warren had not used Cargill’s forms, more likely that Cargill would have gotten off.

What are the aspects of the loan in this case that led the court to lean toward P/A relationship rather than just a loan? The court looked at the substance of the relationship.

• Control—“subject to the control of the P” so if there is no control of the A, there is no A

• Right of entry demonstrated control here. Management decisions over how Warren spent its money was also a form of control. How much officers got paid was subject to the control by P. Investment decisions also demonstrated control.

• Cargill also had the right to demand audits to look at the books.

• Bills to customers were sent on Cargill Stationary. Use of the logo demonstrates more of a P/A relationship.

Butler v. McDonald’s Corporation (2000) (Apparent Agency & Vicarious Liability)

Franchise situation where the Franchisor (McD’s) was found to be responsible as the P of the franchisee, it’s A. Court found that b/c of the extent of the control D had over the franchise (manner of cooking, management, etc…), and b/c of the efforts to make everything uniform, D was in fact the P of the franchise. The public was led to believe that D was the owner of the store, not exclusively the franchisee.

Held. The court found this P/A relationship in spite of documents that specifically said there was no agency relationship created.

II. Partnership Law

RUPA – greater stability for partnerships, dissociation instead of dissolution, recognizes limited liability partnerships, can convert GP into LP, nature & transfer of property interest.

Governed by Uniform Partnership Law – partnership recognized both at CL & in statute.

Partnership = association of 2+ to carry on as co-owners of a business for profit. (Martin v. Peyton: determine partnership through profit sharing, control etc.)

Default method of doing business

Each partner joint/several liable

Creation is by express or implied agreement.

Acts out of the ordinary course of business will not bind the partnership unless it so agrees.

UPA§7 = rules for determining the existence of a partnership

Can determine partnership through:

– Intent of parties

– Language of agreement, if any

– Conduct of the parties towards third parties

– Treatment of the returns of the business

o Sharing profits in a business is prima facie (rebuttable presumption) evidence of a partnership except where those profits are received as debt service, wages, rent, or annuity.

If partnership is found:

– Each partner is jointly and severally liable for the debts of the partnership

– Each partner has the power to create obligations and liabilities for the partnership.

o If partnership assets are not sufficient for debt, partners are personally liable.

– Each partner has the ability to participate in the control and management of the business. Each partner gets ONE vote, regardless of capital investment. (Can establish by agreement alternative voting standards).

– Profits are shared equally. When dissolved, assets are divided equally. Can change through agreement.

– Partnerships are not taxed on their income. The tax responsibility is “passed through” to the partners to include on their personal tax returns.

– Partners owe fiduciary duties to each other and the partnership.

Fiduciary Obligations of Partners – the punctilio of an honor most sensitive

– Partnership Duty of Loyalty

o To account to the partnership for profits, property, or benefits from the conduct (or winding up) of partnership business or use of the partnership property.

o To refrain from acting as or on behalf of a party with an adverse interest to the partnership

o To refrain from competing with the partnership in the subject matter of the business

o To perform all duties to the partnership consistent with the obligation of good faith and fair dealing.

– Partnership opportunities (Meinhard v. Salmon)

If the opportunity is just information about the potential to profit in an enterprise out

governance)

Implied partnership between husband/wife in a dairy farm. Husband provided capital, wife provided labor.

There are informal relationships that are not partnerships (like here marriage) by definition but evidence indicates that relationship was partnership in legal sense (de facto partnership) (question of fact). Should have drafted partnership agreement

Jury could infer (taking light most favorable to π) that there was a partnership from financing, registration, etc. Although registration certificates do not give title they are evidence of ownership, so they were co-owners of cattle. Basically, partnerships can be formed orally or implied by conduct of the partners.

o P is default business mechanism. Most that exists come from this type (inadvertent). If not something else and you are in business, then you have a partnership.

Meinhard v. Salmon (NY 1928) (Fiduciary Obligations)

P contributed money to D who managed the joint enterprise for the two men for a period of 20 years. Near the end of their lease, the D was approached by a third party for an option in a new business venture with the same property that the P was a part of, and D tried to take advantage of it by himself, without telling P.

o Court found that partners have a duty of FOREMOST LOYALTY, and a fiduciary duty to the partner. Failure to include P was a breach of loyalty by D.

o Partners are held to something stricter than the morals of the market place; not honesty alone but the punctilio of an honor the most sensitive is the standard of behavior—this tradition is unbending and inveterate

a) Joint venture partners have the highest obligation of loyalty to their partners. This includes an obligation not to usurp opportunities that are incidents of the joint venture. The duty is even higher of a managing co-adventurer.

b) There was a close nexus between the joint venture and the opportunity that was brought to the manager of the joint venture, since the opportunity was essentially an extension and enlargement of the subject matter of the existing venture.

c) Since D was to control the project, he should receive 51 shares of the corporation that holds the lease on the new project, and P should have 49 shares.

Summers v. Dooley (Idaho 1971) (Partner’s Authority & Governance)

Summers (P) and Dooley (D) entered into a partnership operating a trash collection business. Both worked in the business, each providing and paying for a substitute when he could not work. P asked D to hire a third person and D refused; P hired him anyway, paying him with his own funds. When D found out, he objected. P sued for reimbursement from partnership funds for monies he paid the third person. The trial court found for D; P appeals.

Rule: In a two person equal partnership one partner, over objection of the other partner, cannot take action that will bind the partnership.

National Biscuit v. Stroud (NC 1959) (Partner’s Authority & Governance)

P baker sold D bread, but after D’s partner had not authorized the purchase of any more bread. D partner, however, bound the partnership by agreeing to order more bread without consent of D’s partner.

– Rule: Equal voices in running the partnership

– Majority vote rules for ordinary course of business

– Each partner may bind the partnership. Acts of any equal partner within the scope of the partnership binds all partners

– A majority of partners can make a decision and inform creditors and will thereafter not be bound by acts of minority partners in contravention of the majority decision. But here there could be no majority decision, as they are equal co-partners.

– Court said that a partnership needs a device in place to resolve issues of “deadlock”.

– Had D dissolved the partnership and given P notice prior to the order by Freeman, then D would not have been personally liable for the partnership debt to P.

Page v. Page (Dissolution & Dissociation)

Plaintiff and Defendant were brothers who ran a linen supply business. After years of losses, Plaintiff wanted to dissolve the business just as it became profitable.

Rule: Unless specified, a partnership may be dissolved at will by any partner providing the partner is exercising good faith.

o UPA allows for dissolution at will unless stipulated in agreement. A partner’s good faith obligation to operate in good faith overrides their freedom to dissolve partnership.

o Some cases do hold that the partnership shall continue for a term necessary to repay debt, but only if there is evidence showing this intention. There is no such evidence here.

o If P is acting in bad faith in seeking dissolution, then he may be violating his fiduciary duty as a partner. Dissolution must be in good faith. State law provides for damages in that case. A separate action could determine this issue. But a partner at will is not bound to remain in a partnership just because it is profitable.