Corporations – Jill Fisch – Fall 2011
I.) INTRODUCTORY PRINCIPLES
o Corporate Law: The allocation of rights and power within a corporation; the internal body of law
§ Addresses the creation of economic wealth through the facilitation of voluntary, ongoing collective action
§ Flexible- expectation that market discipline will weed out what is not working
§ Principle aim- reduce agency costs of all sorts
o Securities Law: Regulates capital markets that corporations use to obtain funding
o Firm: A form of business relation that has a temporal dimension, a social identity, and a separate pool of dedicated assets
A.) Efficiency and Other Concepts
· Efficiency is the primary objective of business law (fairness objectives, like protecting the environment, are dealt with through other bodies of law)
o Economic Efficiency: The extent to which the law enables individuals to increase their utility
§ Pareto Efficiency: (improve 1 person without hurting anyone else)
· A given distribution of resources is efficient when, and only when, resources are distributed in such a way that no reallocation of resources can make at least one person better off without making at least one person worse off.
o Voluntary exchange is a prerequisite
o Weakness: there is a societal imbalance in the distribution of resources, and it is virtually impossible for courts/legislatures to make important decisions that do not make someone worse off
§ Kaldor-Hicks Efficiency: (Business law model) *Increases aggregate well-being* Fairness model
· An act/rule is efficient (leads to overall improvement in social welfare) if at least one party would gain from it after all those who suffered a loss as a result of the transaction or policy were fully compensated (but those who suffer do not actually have to be compensated).
o Wealth-maximization model that takes externalities into account. Potential improvement (not actual payment) is required.
o Weakness: doesn’t speak to legitimacy of initial distribution of wealth; ignores the actual distributional consequences of policies and difficulty of accurately measuring external effects.
· Theories of the Firm
o Coase Theorem: A firm exists because, in a world of positive transaction costs, it is sometimes more efficient to organize complex tasks within a hierarchical organization; firm permits transactions (especially complex and reiterated ones) to be accomplished more cheaply.
o Types of Firms:
§ Sole Proprietorship- single owner firm
§ Partnership- an association of two or more persons to carry on as co-owners of a business for profit
§ Corporation- a special business form created by state law, requiring cooperation of the state
B.) Agency and Partnership Law
· Agency Cost Theory: Focuses on how actions of the agent affect interests of the principal. Corporate law is largely about addressing agency costs (in U.S. between managers and shareholders).
§ Economic actors are rational, informed, utility maximizers (of their own interests)
§ Managers offer to investors a share of the utility that arises from centralizing information and expertise in a single enterprise.
o Agency Cost: A cost associated with the exercise of discretion over the principal’s property by an agent that arises when the incentives of the agent differ from the incentives of the principal.
§ Example: having a photocopy machine within the firm (firm transaction) vs. going to Kinkos for copies (market transaction).
§ Three Sources:
1. Monitoring Costs- costs that owners expend to ensure agent loyalty
2. Bonding Costs- costs that agents expend to ensure owners of their (A’s) reliability (credentials, such as a JD- costs are borne by the P in the form of a higher salary for A)
3. Residual Costs- costs that arise from differences of interest that remain after monitoring and bonding costs are incurred (ex: employee spends $6000 on a shower curtain at firm’s expense- not acting in P’s best interest)
· The Law of Agency
o Agency: the fiduciary relationship that arises when one person (a ‘principle’) manifests assent to another person (an ‘agent’) that the agent shall act on the principal’s behalf and be subject to the principal’s control, and the agent manifests assent or otherwise consents so to act. Rst. 3rd of Agency § 1.01.
§ Not simply a contractual relationship, agent also agrees to act carefully and loyally to the principal
§ Key Elements: (Rst. 3rd of Agency §1.01)
· (1) Consent (not consent to agency relationship- simply a voluntary relationship with the attributes of agency)
o Tends not to be the most important element
· (2) Benefit
o Think about uniting risk and reward
· (3) Control
§ Parties’ conception does not control- agency relationship may be implied even when the parties have not explicitly agreed to an agency relationship
§ Special + General Agents: special agents complete a single transaction, whereas a general agency relationship contemplates a series of transactions
§ Disclosed + Undisclosed Principles: when third parties understand that the agent is acting on behalf of a particular principle, the principal is “disclosed.” When third parties understand they are dealing with an agent but do not know the identity of the principal, the principal is “partially disclosed.” When third parties are unaware of a principal and believe that the agent herself is a principle, the principle is “undisclosed.”
o Hanson v. Kynast (S.C. Ohio 1986) – No secondary liability because student athlete not in an agency relationship with University
§ Facts: D Kynast hits P Hanson in lax game and paralyzes him. Hanson sues Kynast and Ashland Universityarguing that Kynast was acting as the agent of Ashland, and so university was liable under respondeat superior.
§ Issue: Whether Kynast was acting as the agent of Ashland such that the University could be held liable for Kynast’s wrongful acts?
§ Holding: No, Kynast was not acting as the agent of Ashland.
· In order to establish a claim under the doctrine of Respondeat Superior, it must be demonstrated (1) that a principal-agent relationship existed, and (2) that the tortious conduct was committed by the agent while in the scope of his agency. Element (1) is not established.
· Principal-agent relationship exists when one party exercises the right of control over the actions of another and those actions are directed towards the attainment of an objective which the former seeks.
o Consent: Ashland made no promises to induce Kynast to attend the university. The student was the buyer of an education rather than an agent of the university.
o Benefit: School is not making money from lacrosse, and the student can walk away at any time. Kynast played lacrosse voluntarily and for his own enjoyment.
o Control: (1) Kynast was not “performing in the course of the principal’s business”- he was not teaching students; (2) Kynast was not being compensated by university; (3) the university did not supply the tools/place of work in the normal course of the relationship
§ Concurrence: (Holmes)- Agency relationship 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.” Where no contractual relationship exists, no principal-agency relationship exists.
· This is true even where student receives scholarship or is recruited by university; the university charges an attendance fee; the university purchases equipment/uniforms, etc.
· Respondeat Superior unites risk associated with agency relationship with gains, and gives master more incentive to train better
o Jenson Farms Co. v. Cargill, Inc. (Minn. 1981) – An implied agency relationship can be created when a creditor has significant control over a debtor – explicit agreement unnecessary
§ Facts: D Cargill lent extensive credit to D Warren, a grain elevator, which was overextended. Cargill got excessively entangled in Warren’s business. Cargill exercised significant control over Warren (ex. Warren could not make capital improvements or repairs in excess of $5,000 without Cargill’s consent; Warren could not become liable as a guarantor on another’s indebtedness or encumber its assets without Cargill’s permission; consent by Cargill was required before Warren would be allowed to declare a dividend or sell or purchase stock). Warren quickly fell into debt under Cargill’s management. Ps (farmers) brought action against Cargill and Warren, alleging that Cargill was jointly liable for Warren’s indebtedness as it had acted as a principal for the grain elevator.
§ Issue: Whether Cargill, by its course of dealing with Warren, became liable as a principal on Ks made by Warren with Ps.
§ Holding: Yes, all three elements of an agency relationship are found in this case.
· Key Facts:
o Cargill kept Warren in business for its own benefit
o Cargill made key economic decisions for Warren
o Aggressive financing – Cargill was supplying so much of Warren’s capital that it looked like equity/ownership (vs. debt).
· Consent: By directing Warren to implement its recommendations, Cargill manifested its consent that Warren would be its agent.
· Benefit: Warren procured grain for Cargill as part of its operations which were financed by Cargill.
· Control: Cargill was an active participant in Warren’s operations rather than simply a financer. It was a paternalistic relationship, and Cargill exercised operational control over Warren (verified that Warren was entering into specific transactions).
o The reason for Cargill’s financing of Warren was not to make $ as a lender but rather to establish a source of market grain for its business.
o (The fact that Cargill was a big customer, alone, would not establish an agency relationship, nor the fact that Cargill had ultimate authority to approve new transactions.)
§ Notes: This is very different from a standard loan; Analyze it from Cargill’s perspective- not only does Cargill get a return on the loan, but it also gets virtually all of the grain at a low price from a reliable source. This looks like a within the firm transaction.
§ POLICY: We’re trying to use agency principles to tie together risk and rewards. Cargill will reap the benefit of dealing with Warren, so it should bear the costs. From a social welfare perspective, this will create the appropriate level of investment in operations.
· Limiting Principles of Agency Relationship
o Liability in Contract (scope of authority)
· Actual Authority: An agent acts with actual authority when, at the time of taking action that has legal consequences for the principal, the agent reasonably believes in accordance with principal’s manifestations to the agent, that the principal wishes the agent to so act. (Rst. 3rd 2.01; 2.02)
· Express Authority- communication was explicit
· Implied/Incidental Authority- the authority to do those implementary steps that are ordinarily done in connection with facilitating the authorized act.
· Apparent Authority: Authority that a reasonable third party would infer from the actions or statements of the principal. This provides an equitable remedy to prevent fraud/unfairness to a third party who reasonably relies on the principal’s actions or statements in dealing with the agent. (Rst. 3rd 2.03)
· White v. Thomas (Ark. App. 1991) – Agent at auction does not have apparent authority to sell back land that she purchased because buyer didn’t reasonably believe agent had authority to sell
o Facts: White instructed Simpson to attend a land auction and bid up to $250,000 on a farm. Simpson was awarded the land for $327,000 and attempts to sell 45 acres back. Simpson said that she had power of attorney for White, and a blank check from White to pay for the purchase. Third party sued White for specific performance of the K to convey the land.
o Issue: Whether the scope of Simpson’s actions fell within the scope of her apparent authority.
o Holding: Simpson lacked apparent authority to sell the land. There is no evidence that White knowingly permitted Simpson to enter into a K to sell, and purchasing and s
Mary Gleeson dies. Colbrook is executor and trustee of her will, for the benefit of her children. Colbrook leases the land to himself for the year right after she died and the following year leases to someone else for the same price he was paying. Children sue to recover profits earned by petitioner who held over as a tenant and leased land to others.
o Holding: Petitioner should have paid all profits earned to the trust by virtue of his being a co-tenant of trust property. Any profits gained from the trust must be given to the trust: a trustee cannot deal in his individual capacity with the trust property
§ It was irrelevant that it was in the interest of the trust that petitioner continue to hold over for the year.
§ Fiduciary duty in trust is higher than in agency law
o Remedies: Rst. Of Agency § 407(1)
§ If an agent has received a benefit as a result of violating his duty of loyalty, the principal is entitled to recover from him what he has so received, its value, or its proceeds, and also the amount of damage thereby caused, except that if the violation consists of the wrongful disposal of the principal’s property, the principal cannot recover its value and also what the agent received in exchange therefore.
· Commentary: P is entitled to be indemnified by the agent for any loss which has been caused to his interests by the improper transaction.
· PARNTERSHIP LAW
o Partnership- “an association of two or more persons to carry on as co-owners of a business for profit.” UPA §6l RUPA § 201, 202. A partnership is an independent legal entity (can sue and be sued)
o Default Rules:
§ Each partner shares power to bind the business and acts as an agent for the partnership (unless an agreement provides to the contrary)
· Partners have a fiduciary duty to each other with respect to the enterprise
§ Every partner is subject to unlimited personal liability for the debts and obligations of the partnership.
· Either joint and severally liable (RUPA) or joint, but not severally liable (UPA).
· But partners can be indemnified by the partnership. RUPA requires a third party to win a judgment against the partnership and exhaust partnership funds before collecting from an individual partner.
§ Each partner has equal management/voting rights, and partners share profits and losses
· Partners have an interest in the partnership, not in particular partnership assets
o A partner cannot transfer his partnership interest in such a way as to make the transferee a member of the partnership, except with the consent of all remaining partners. UPA §8; RUPA §401(i).
o A partner can, however, assign his interest in the partnership that entitles the assignee to receive, in accordance with his contract, the profit to which the assigning partner would otherwise be entitled. UPA §27.
· HYPO: Klein & Coffee- Pamela can either seek loans from Abe and Bill who will be subject to a higher risk of loss (their claim is secondary to a more senior investor) OR she can allow Abe and Bill to share in the risks of the business (share of profits instead of fixed return rate). Under option 2, all three would have a residual/equity interest in the business.
· Pam doesn’t have to pay Abe and Bill if business fails but would have to pay back loan.
· No obligation to cash out partners on a schedule, loan has obligations, so reduced liquidity pressure
· Have to share upside potential of business. With loan could just pay back everything and then keep all rest
§ Shared control
§ Reduction of agency costs
· Abe and Bills interests are in line with Pam…if she hired employees there are agency costs
o Bottom line: To share in ownership is to give up control in exchange for greater flexibility in terms of financing.
§ Asset partitioning- separation of firms’ assets from assets of firm’s owners (compare sole-proprietorship). Partnership qua firm, rather than the individual partners, exercise true ownership rights over the partnership property.
· Partnership property is owned by the partners as “tenants in partnership.” UPA § 25(1).
o Individual partners have no power to dispose of partnership property;
o A partner cannot possess or assign rights in partnership property; a partner’s heirs cannot inherit it; and a partner’s creditors cannot attach or execute upon it
· RUPA § 501, 502- entity ownership
o While partners do not own the partnership’s assets, they retain a transferrable interest in the profits arising from the use of partnership property and the right to receive partnership assets – “right to cash flow”
§ RUPA § 504 and UPA § 28 permit individual creditors of partners to obtain a “charging order”- a lien on the partner’s transferable interest that is subject to foreclosure unless it is redeemed by repayment of debt.