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Business Associations
University of North Carolina School of Law
Coyle, John F.

Professor John Coyle

Business Associations

Spring 2017

UNC School of Law

Introduction

Concept of Limited Liability

Limited liability is not the same as zero liability. Rather, limited liability means that if you invest money in a certain type of business (corporation) you can only lose the amount of money that you invested.

Use to be that a Corporation was the only way you could get limited liability, but now there are other ways to get non-corporate forms of limited liability.
In a partnership, you do not have limited liability. You are liable to lose more than your investment.

Litigator v. Transactional Lawyer

Transactional lawyer: does not want any surprises—want the result to be the result you think will come. Wants to draft narrowly and not push the limits of the law. Should be like an engineer building a bridge in that the transactional lawyer will want a margin of error.
Litigator: wants to stretch law to their benefit and push the law to the edge.
NOTE: Ask what they could have done differently — how could they have drafted to get the result they wanted (what term in the documents or contractual provisions would have guaranteed the result desired?)

Race to the Top (or “Race to the Bottom”):

Race between states to give corporations freedom to run business in an imaginative way without having to worry as much about accountability to shareholders. Other states limit management’s ability to act without worrying about accountability to shareholders.

One of the first choices that a business has to make is whether the business wants to be a corporation, LLC, partnership, LLP, business trust, or limited partnership.

Agency Law

Definition of Agency

Agency is the fiduciary relationship that results from the manifestation of consent by one person (principal) to another (agent) that the agent can act on the principal’s behalf and subject to the principal’s control, and consent by the agent to so act.

Manifestation of consent à does not require the formalities of a K. Mutual consent can be short of the requirements of an enforceable contract.
Both the principal and agent have to consent.
IN SHORT: relationship that lets one person, the agent, act on behalf of and bind another, the principal (Common Law, NOT statutory)

Identifying the Agency Relationship

Three Elements for Agency to Exist: (1) Manifestation (does not require a contract à words, actions, conduct of parties suffice); (2) Control; (3) Benefit.
De Facto Agency Relationship à the inadvertent creation of an “agency relationship” which is implied by the parties’ conduct. Agency is not always contractual.
Gay Jenson Farms Co. v. Cargill (Minn. 1981):

Facts: Cargill made a loan to Warren Grain (WG). WG owed money to its farmer customers, but WG went bankrupt and the farmers could not collect. Since the farmers can’t be made whole by WG they sue Cargill asserting that Cargill was not just a lender but rather a principal (agency relationship) even though there was no express understanding of agency.
Issue: to the extent that WG’s assets are less than the amount owed, can the creditors go against Cargill for the deficit?

If this is a loan: NO, cannot sue a lender for financing something that causes damage/loss (Financier = limited liability)
If Cargill was acting as Principal: YES; Principal responsible for actions of Agent (Principal/Agent = unlimited liability)

What factors made this loan look more like an agency than simply a loan?

NOTE: A loan is a form of limited liability. You can invest in anything and make a loan. When you lend money to someone, you can lose it if they don’t pay you back. The lender is not liable beyond the amount of the loan amount though. For instance, if the loan money is used to buy a car, the lender is not liable for any negligence caused by the car

Different from a typical loan because of the control Cargill had over WG.

(1) Recommendations on running business (day-to-day control); (2) Right of first refusal; (3) Limits on business activities (some limitations are consistent with being a lender though); (4) Cargill opened bank account for Warren and had access to funds; (5) WG needed permission to spend money; (6) Right of entry and right to inspect books/audit (micromanaging).

Different from a typical loan because the lender (Cargill) was getting the primary benefit of WG’s business.

WG’s business activities were designed to benefit Cargill (i.e., captive dealer: whole purpose to provide seeds to Cargill, NOT just middle man)*. Cargill wanted grain so that it could perform its own business. It was not just a mere loan to an industry.
*Principle of Agency: Agent is acting solely for the benefit of the principal.

Holding Out: there was a holding out of WG as an agent of Cargill. This aspect tips the balance if it was a close case based on the other factors above.

Cargill allowed the world to believe that WG was working on its behalf by allowing WG to use Cargill letterhead (apparent authority).
Using Cargill name in dealing with others
NOTE: *no one thing that makes this an agency. Cumulative effect of the factors makes this an agency relationship rather than a typical loan.

Holding: Cargill is a principal of WG, and therefore, liable for the acts of its agent WG.

What could have Cargill done differently à (1) Not allow WG to use stationary; (2) Eliminate benefit issue by having WG produce grain for other companies; (3) Control is not as big of an issue because lenders typically have a good amount of control over use of proceeds.

Fiduciary Obligations

Two Duties: (1) Duty of care and (2) Duty of loyalty.

Duty of Care: negligence
Duty of Loyalty: Unless otherwise agreed, the agent:

Must act solely for the benefit of the principal. [Duty of Undivided Loyalty]

An employee is almost certainly likely to be an agent. Unless otherwise agreed, only act on employer’s behalf.

May not deal with the principal as an adverse party. [Conflict of Interest]

Any type of contractual relationship in which the agent is getting a benefit is self-dealing. If benefit is going from principal to agent, need principal’s consent and creates disclosure issues.

Employee negotiating his salary is self-dealing.
If an agent wants to sell car to principal, conflict of interest. Agent wants highest price, principal wants lowest price. So unless otherwise agreed, there is a conflict of interest.

Is under a duty to give any profit to the principal that was made by the agent while working for the principal. Profits belong to the principal, but it doesn’t work both ways, there’s no sharing of losses.

Common sense: Unless you are strictly prohibited from doing so, reasonable personal business is not given to principal. But the rule is clear that any profit has to go to principal during agency relationship.
An agent who uses confidential information of the principal to profit from it, has to place profits in a constructive trust for the principal.
Sub Rule – Use of Confidential Information

Insider trading based on nonpublic information
*Breach of fiduciary duty, that information was not yours to profit from, it was your employer’s

NOTE: You can clearly create contractual limitations to the duty of loyalty, but otherwise you cannot completely contract out of the duty of loyalty.

Authority of Agents

Authority & Liability à If agency actions are within scope of authority, the principal is liable. However if agent’s actions are not within scope of authority, the principal is not liable.
Two types of authority: (1) Actual Authority; (2) Apparent Authority; and Inherent Authority

Actual Authority: depends on dealings between the principal and agent: mutual assent, understanding, K’s, employee handbook, training, discussions, expectations etc.

Express authority: granted in writing (contract) or other verbal communication about the scope of authority. I.e. employment contract or job description.
Implied authority: can imply authority from the context and circumstances. Can imply from conduct or course of dealings. I.e. if bank is 20 miles away and the job description is that the employee makes deposits, then it is implied that she will have the authority to drive to bank.

Apparent Authority: An agent cannot create their own apparent authority, but the principal may acquiesce as to give appearance that agent has the authority (i.e., even if contract says agent does not have authority to do something, but has been doing it for past three months, he is acting with apparent authority). The Principal’s action or inaction creates appearance of authority. Third party has reason to believe that actual authority exists because of the Principal’s actions. Runs from the principal to the third party.

Apparent Authority is a question of fact.
If agent lies about authority à 3rd party does not have a claim against principal (only agent). Agent is liable to principal

Inherent Authority: Principal (not the agent) gives a 3rd party reason to believe the actual authority exists (nature of job title).

Mix of implied and apparent authority

Principal gives agent a title which communicated implied authority. Because of agent’s title, the principal holds out to 3rd parties the agent’s apparent authority.

Ratification: when agent acts without authority, principal can ratify the act (express or implied, such as taking benefits of contract)
Adoption: when principal adopts agent’s action as his/her own

Vicarious Liability: if you have principal-agent relationship, the principal is liable for the acts of the agent.

Butler v. McDonalds:

Issue: whether franchise arrangement created an agency relationship.

If McDonalds is the principal, then it is liable for the spider crack in the door which causes the injury at the franchise.

The more involved in day-to-day operations and control, the more likely to be seen as agency relationship

Control is one of the major factors in turning a relationship into an agency relationship. Da

expiration of the lease would have been a breach of the agreement.

Duty of Loyalty: Salmon and Meinhard were not just parties to a contract; they were partners. As partners, they owe each other fiduciary obligations. “A Trustee is held to something stricter than the moral of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.” Cardozo.

Partners have to treat each other more honestly and fairly than people in the ordinary business world because that is the nature of the partnership relationship. Partners are agents of the partnership, agency is a fiduciary relationship.
Timing: The partnership was not over when Salmon was negotiating for the renewed lease. Salmon was acting on behalf of himself and not on behalf of the partnership when he was negotiated a renewed lease term.
Secret negotiations: Salmon at least owed a duty of disclosure so long as he was negotiating during the term of the partnership. If he had waited until the end of the lease, there would be no problem.
Holding: Applying fiduciary duty, Salmon cannot negotiate for his own personal benefit while partnership is still in effect and Salmon is still fiduciary.

Authority and Governance

Partner’s Authority: Each partner is an agent of the partnership and has the authority to bind the partnership and other co-partners when acting in the “ordinary course of business.”

Acts that are NOT within in the “ordinary course of business” must be specifically authorized by a majority of the partners.
A partner has “apparent authority” unless 3rd party knows that he has no authority.

Equal Management and Control (UPA § 18): unless otherwise stated in the partnership agreement:

Every partner has an equal right to participate in management of partnership business.
Any disagreements about ordinary course of business must be decided by a majority vote (each partner has equal vote regardless of amount of capital contribution, e.g., contributing 90% of capital does not equal 90% of control).
For extraordinary matters à outside the ordinary course of business or amendments to partnership agreement require unanimous approval.

Equal Share in Profits/Losses: unless otherwise stated in partnership agreement:

Each partner shares equally in profits and losses regardless of the amount of capital contribution. (UPA § 18)
Ex) Unless otherwise agreed, If A puts in 90% and B puts in 10% — they split equally profits or losses. They each get back their initial investment, then they split profits or losses equally.
* Partnership interests are not readily transferable.

Summers v. Dooley:

Issue: P&D are 50/50 partners. Summers decided he wanted some time off and wanted to hire someone to replace him. Dooley objected, so Summers hired someone out of his own pocket. Then he requested 50% reimbursement for Dooley’s share. Did Summers have the authority to hire an employee?
Holding: Court says no authority to hire replacement unless you physically can’t do the work. Hiring an employee is not within the usual course of this business. Accordingly, there was no authority for a partner to hire an employee absent a majority vote.

A majority is more than half. So in a 50/50 business, majority means unanimity.

National Biscuit Co. v. Stroud:

Facts: again, 50/50 partners. Stroud decided he didn’t want to authorize Freeman to purchase bread and not only told Freeman but told the bread supplier (plaintiff). Freeman continued purchasing bread. Plaintiff continued delivering bread. Plaintiff now suing partnership for the bread sold once Stroud made clear he didn’t want any more.
Outcome: Agent can bind partnership in the ordinary course of business. So the important question is what’s the ordinary course of business? The partner wanting to act outside normal course of business must overcome the majority requirement. Here, trying to stop buying bread was a change the ordinary course of business.
RULE: agent can bind partnership in ordinary course of business, and it takes a majority to change an ordinary course of business. In extraordinary cases, may take unanimous decision.