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Business Associations/Corporations
University of Pennsylvania School of Law
Rock, Edward B.

Rock – Corporations – Fall 2008



Sole Proprietorships

Business organizations owned by a single individual
Unlimited liability: As a matter of law, sole proprietorships have no separate identity from their owners.
Labeled as a Business Org: Sole proprietor does not conduct business by himself; he goes through Agents

o The basis of an Agency relationship is contractual – You hire someone to be your agent.
o Restatement of Agency: R2d Agency §1 – Definition of Agency
· Agency is a legal concept which depends upon the existence of required factual elements:
1. Manifestation by P that A shall act for him
2. A’s acceptance of the undertaking
3. Understanding that the P is in control of the undertaking
· Courts use an objective theory of intent.
o The Second Restatement has three concepts of Agency:
· Actual, Apparent, and Inherent Authority
o The Third Restatement has only two:
· Actual and Apparent Authority
· Instead they expand the notion of actual authority to include acts that a principal should reasonably expect an agent to take on his behalf
o The thought was that Agency provides for the agent to create a relationship between a third party and the principal
o Consider the abstract concept of the firm – includes investors, managers, employees – and excludes customers, and suppliers.
· The employees are hired through contract – But the relationships between the employees and the managers is a hierarchical one. And the relationship between the investors and the managers is one of fiduciary duty, not contract.

Authority and Liability

General v. Special Agent

General Agent: Authorized to conduct a series of transactions involving a continuity of service
Special Agent: Authorized to conduct only a single transaction

o Types of Principals
· Disclosed Principals: At time of transaction, T knows A is acting on behalf of the P and knows P’s identity
· Partially Disclosed Principals: At time of transaction, T knows A is acting on behalf of a P, but does not know P’s identity
· Undisclosed Principal: Agent deals with T purporting to be acting on his own behalf
o In Tort Law – You had Master – Servant Relationship
· Master: P who controls or has the right to control the physical conduct of an A
· Servant: A whose physical conduct in performance of services for P is subject to control of the P
· Respondeat Superior: Master liable for torts of servant if servant’s physical conduct in performance of services for master is subject to master’s control and tort is committed while servant is acting w/in the scope of employment
1. Inherent Agency Power (R2d Agency §8A): In transactions usual in the business conducted by A, if A causes a problem to T even if she was forbidden to do so by P, T can recover from P for injuries.
o Types of Authority and Resulting Liability
1. Actual Authority (R2d Agency §26): P’s words or conduct would lead a reasonable person in A’s position to believe that P had authorized him to so act. Can be express or implied.
§ Incidental Authority — Implied Actual Authority: Authority to do incidental acts reasonably necessary to accomplish an actually authorized transaction, or that usually accompanies it.
§ Liability: If A is acting with actual authority, principal is ALWAYS bound.
2. Apparent Authority (agency by estoppel) (R2d Agency §27): A has apparent authority to act in a given way on P’s behalf if P’s words/conduct would cause a reasonable 3rd party to believe that P had so authorized A.
§ The third party’s belief has to be traceable to the manifestations by the principal (3rd Rest.)
§ Power of Position
· A type of apparent authority: i.e., Bank Teller, CFO, Building Manager
· Would a reasonable person in T’s position believe that A has apparent authority?
· If it was clear to the A that she couldn’t do it, the P can collect damages from the A.
§ Liability
· Disclosed, Partially Disclosed Principals: P Bound
· Undisclosed Principal: P Not Bound; Can’t have apparent authority.
3. Inherent Authority: Power derived solely from the agency relationship and existing for the protection of persons harmed by or dealing with a servant or other A.
§ Test for Inherent Authority = Reasonable Foreseeability(“Would reasonable person in P’s position have foreseen that, despite his instructions, there was significant likelihood that A would act as he did?”)
§ Liability
· Disclosed, Partially Disclosed Principals: R2d §161: Liable, even if P had forbidden A to do the act IF:
· Act usually accompanies or is incidental to transactions that A is authorized to conduct AND
· T reasonably believes A is authorized to do the act.
· Undisclosed Principals: R2d Agency §194: Liable, even if P has forbidden A to do the act IF usual or necessary in such transactions
§ New restatement (3rd) eliminates inherent authority and replaces it with notion of respondeat superior.
o Ratification:
· P bound if A purported to act on P’s behalf and principal, w/ knowledge of material facts either: (R2d §82)
1. Express ratification (R2d §83): Affirms A’s conduct by manifesting intention to treat A’s conduct as authority OR
2. Implied Ratification (R2d §83): Engages in conduct that is justifiable only if he has such an intention.
· Ratification must occur before (R2d §§84-90)
1. T has withdrawn
2. Agreement has otherwise been terminated
3. Situation has materially changed so it is inequitable to bind T and T elects not to be bound.
o Acquiescence: If A performs a series of acts of a similar nature, failure of the P to object to them is indication that he consents to performance of similar acts in the future. Actual authority which results in apparent authority.
o Morris Oil Co. v. Rainbow Oilfield Trucking, Inc. (Objective Theory of Intent for whether agency exists / Liability For Undisclosed Ps / Ratification) Rainbow takes on the day-to-day operations from Dawn. Agreement states R is not D’s agent and that R is not allowed to incur any debt in liability of D other than in the ordinary course of business. R makes deal w/ Morris whereby Morris does some of R’s work and bills under R’s name. R is $25K in debt to Morris when it goes out of business.
§ Court rules there was an agency relationship here.
· Morris does not know R is working for D: there can be NO apparent authority
· Objective Theory of intent — In K, it was clearly stated that R is not an agent of D.
· Authority by estoppel: D made Morris to rely on D’s representation that the amount would be paid by D.
§ A for undisclosed P subjects P to liability for acts done on his account if they are usual or necessary in such transaction, even if A is forbidden by P to do the acts (See R2d Agency §194)
§ Transaction considered ratified if P retains the benefits. Here, P retained the money.
o Termination of Authority (R2d Agency §118): P can terminate authority at any time, even if P and A are in a K that says agency is irrevocable. If P revokes authority when it wasn’t supposed to, it is liable for wrongful termination.
o Liability of 3rd person to P
· General Rule: If A and T enter into a contract under which the A’s P is liable to T, the T is liable to the P.
· Exception: T not liable to undisclosed P if he wouldn’t have dealt with the P had he known who the P was.
o Liability of Agent to 3rd person
· If the Principal is bound:
1. Disclosed Principal: A not bound to T.
2. Partially Disclosed Principal: A and P Bound
3. Undisclosed Principal: A bound, even if P bound
· Majority: A or P discharged if T gets judgment against the other
· Minority: Neither discharged until A or P satisfies judgment.
· If Principal NOT bound: A ALWAYS liable to T.
o Liability of Agent to Principal
· If A has apparent authority, but not actual authority: A liable to Principal
· If A acting with inherent authority, but not actual authority – Law unclear – If A is acting within the scope o

returns are derived.
§ (3) – “A person who receives a share of the profits of a business is presumed to be a partner in the business, unless the profits were received in payment:
· (iv) – “of interest or other charge on a loan, EVEN IF the amount of payment varies with the profits of the business, including a direct or indirect present of future ownership of the collateral, or rights to income, proceeds, or increase in value derived from the collateral.”
o Not like corporation (You don’t have to formally corporate) – One can fall into a partnership
o Formalities of Formation: 4 Element Test(You can fall into partnership by default)
1. Agreement to share profits and proceed as partners
2. Agreement to share losses
3. Mutual right of control of management of business
4. Community of interest in the venture/commonly held property
o Partners are not employees (important for tax and other legal purposes)
· Ex. 10 year tax exemption given to 30th Street region for all taxes except employment taxes – Dechert moved there, so that the partners did not have to pay any taxes
o Case Law
· HILCO Property Services, Inc. v. United States (Objective test for partnership): Conduct of parties and circumstances surrounding their relationship and transactions control the factual question of whether a partnership existed if parties didn’t document their intent in writing.Four Factor Test (above)
§ See also Arnold v. Eckerman (Objective test for partnership, even if original documents say no partnership): Parties enter into agreement that is like partnership, but agreement says it is not a partnership.
· Court says primary criteria is parties’ intent to enter into a relationship which constitutes a partnership, not the intent to form a partnership. Factors:
· A right to a voice in the management of partnership business
· Sharing of profits of partnership business.
· Corresponding risk of loss and liability to partnership creditors.
· Martin v. Peyton (Where a transaction bears all aspects of a loan, no partnership):
§ Peyton loaned certain securities to KN&K (a brokerage firm) and considered themselves trustees, not partners of firm. As compensation, P was given 40% of the firm’s profits and was given an option to join the firm. Peyton did have the right to inspect the books and to veto highly speculative projects.
§ Peyton took increasing control due to worries that KN&K would continue to slide. Martin was owed money by KN&K, and decided to go after Peyton et. al, alleging that they are partners of the firm. Peyton had a veto power, but this is a form of negative control, whereas he can block, but not initiate.
§ Holding: Each provision of the agreement was part of normal debtor-creditor precautions—no partnership.
· You need both a share in the profit and a share in the management, a veto is common and not sufficient to constitute management/control required for partnership
· Rule: Test for whether a relationship constitutes a partnership hinge on whether there is management/control
§ So what type of Liability does Peyton hold as a mere creditor? Rock would argue there is a type of limited liability – You can lose, but all you can lose is the amount that you have invested.