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Business Associations/Corporations
University of Pennsylvania School of Law
Bratton, William Wilson


I. Financial Statements

– Accounting. Accounting involves the collection, summarization, and reporting of financial data by a business, as well as the computation of profit and other measures of a business’ financial health

– Fundamental Accounting Equation. The fundamental equation is simply the mathematical equivalent of the balance sheet. The equation is written as:

Assets = Liabilities + Owners’ Equity

– Double-Entry Bookkeeping. To keep the fundamental equation balanced, there will be two entries for every transaction to be accounted for. They may be in the same column or in either column. These entries are referred to as “debits” and “credits”; these terms signify only where the entries are placed.

o Debits. Debit means the left-side entry.

o Credits. Credit means the right-side entry.

– The Balance Sheet. The balance sheet shows, at any point in time, what assets the business now has and where the money came from to acquire them (snapshot).

o Assets. Assets are the entries on a balance sheet showing the items of property owned, including cash, inventory, equipment, real estate, accounts receivable, and goodwill – items that could turn into cash.

§ Current: cash, marketable securities, accounts receivable (amounts due from customers – can assume that they will pay), inventories

§ Not Current: fixed assets, prepayments and deferred charges, intangible assets (patents, trademarks, and franchises are fine, BUT goodwill, capitalized organizational cost, capitalized research, development costs are red flags – unlikely realistic)

§ Cost. Since it is easiest to measure assets by the price at which they were obtained, they are measured at cost. Consequently, actual net worth may be much higher or lower than the figure for owner’s equity recorded on the balance sheet.

Assets = liabilities + equities

o Liabilities. Liabilities are the money owed by the business to outsiders; accounts payable, note payable.

§ Current: accounts payable (owed to suppliers based on deliveries made on credit; distinguished from short term liabilities), notes payable, accrued expenses payable

§ Long-term. Due more than one year from date of the balance sheet – mortgages, debentures, etc.

o Equity. The money that comes from inside the business. Common stock, retained earning (earnings – dividends). The balancing factor b/w assets and liabilities

§ Consists of: (1) permanent non-debt capitalization of the business AND (2) Retained earnings – accumulated income of the business minus any distribution to owners

Equity = assets – liabilities

o Goodwill (in balance sheet). Amount paid for companies acquired in past at greater price than book value.

– The Income Statement. The income statement is a statement for a period of time, giving a summary of earnings between balance sheet dates (as opposed to a particulate date, as with the balance sheet).

Income = Revenue – Expenses (variable and fixed)

o Statements of Earnings Retained. Connects the bottom line on balance sheet – difference due to profit payout to equity holders

o Net Income & the Balance Sheet. Any net income is an increase in the owner’s stake in the business (i.e. equity).

Net Worth = total assets – liabilities

II. Agency

A. Authority

1. Terminology

– Building Blocks of Corporate Law.

o Tort; Contract; Agency. A corporation is a thought structure – the legal entity is a thought structure/reification that can do things. It makes contracts and is a party to contracts. The human must go forward and act on the structures behalf à the corporation acts through its agents.

– Agency

o Restatement (Third) relationship arising when one person (principal) manifests assent to another (agent) that the agent act on the principal’s behalf and subject to the principal’s control.

o Jensen & Meckling a contract under which 1 + persons engage another to perform some service on their behalf which involves delegating some decision-making authority.

o Difference

§ Restatement (Lawyer): focuses on the subject of control – worries about liability of third parties

§ Jensen & Meckling (Economist): focuses on delegation – gives broad zone of authority

§ Economic definition minimizes control, whereas the legal definition maximizes it – the economic interpretation allows for risk that agent could do something outside wishes of principal

o Two key concepts in agency law. (1) authority; (2) fiduciary duty

– Contract vs. agency.

o K = manifestation of assent + consideration

o Many of the terms of the agency will be in the contract (ex: employment agreement)

§ Ambulatory Interpretation: an agent must be authorized at the moment the action is taken, not necessarily as of the time the contract is entered into. The agent needs the assent of the principal at the time he acts

· Terms of contract are fixed at time of contract

· Interpretation of terms of contract is dynamic – principal can dictate over time

o Agency can exist without an explicit contract (“gratuitous agency” ) though usually does come w/contract – need to distinguish between them.

o Even if the contract has a term of years, termination of agency relationship is “at will” – if K terminated early, agent can sue for breach of K but cannot sue to continue agency relationship

– Agents. An agent is a person who by mutual assent acts on behalf and subject to the control of another, i.e. the principal.

o General agents are authorized to conduct a series of transactions involving continuity of service.

o Special agents are authorized to conduct only a single transaction, or only a series of transactions not involving continuity of service.

– Principal. A principal is a person on whose behalf and subject to whose control an agent acts. Three classes—

o Disclosed principal results when the third party has notice that the agent is acting for a principal and has notice of the principal’s identity.

§ Agent is not bound to Third Party; Principal is bound to Third Party

o Partially disclosed principal results when the third party has notice that the agent is acting for a principal but does not have notice of the principal’s identity.

§ Agent is bound to Third Party; Principal is bound to Third Party

o Undisclosed principal results when the third party has no notice that the agent is acting for a principal.

§ Agent is bound to Third Party; Principal is bound to Third Party

2. Liability

– Liability of Principal to Third Person. A principal becomes liable to a third person as a result of an act or transaction by another, A, on the principal’s behalf, if A had actual, apparent, or inherent authority to act on the principal’s behalf in the way that he did, or was an agent by estoppel, or if the principal ratified the act or transaction.

o Actual Authority. Actual authority may be expressly conferred on agent or reasonably implied by custom, usage, or the conduct of the principal to the agent – agent has actual authority if principal’s words or conduct would lead a reasonable person in agent’s position to act to believe principal wishes agent to so act

§ Express Actual Authority. Usually comes about by an explicit grant of authority to the agent to act on behalf of the corporation (i.e., through bylaws or a resolution adopted by the board of directors.

§ Implied Actual Authority. There is almost always a zone of implication from an express grant of authority. May come from particular action by board – where an act is implicitly necessary to carry out an authorized transaction or board has implicitly granted actual authority to agent to act in certain way – see “Incidental Authority”

· Incidental Authority. Common type of actual authority – the authority to do incidental acts reasonably necessary to accomplish an actually authorized transaction.

§ Example 1. P, intending to give a note to X that says, “I authorize you to contract in my name for the purchase of 100 shares of ABC stock,” accidently gives it to A. When A finds the note, he contracts with T in P’s name for the purchase of the shares. A has actual authority.

§ Example 2. P directs A to sell goods by auction at a time and place at which, as P and A know, a statute requires an auctioneer’s license. A’s actual authority includes actual authority to employ a licensed auctioneer.

§ Example 3. P authorizes A to sell and convey land. At the time and place, it is the custom to make such sales with a warranty of title. A has implied actual authority to execute and deliver a proper deed to the purchaser and include in the deed the usual covenants as to title.

§ Bound? Agent has effectuated a contract between Principal and Third Party à Principal is bound to Third Party, Third Party is bound to Principal; If principal is disclosed, Agent is not liable to Third Party

o Apparent Authority. Principal gives 3rd party reason to think it assents – word or conduct of P leading a reasonable third party to believe that A has authority à If agent has apparent authority to engage in transaction, agent binds the corporation

§ Power of position. When P appoints A to a position, such as that of manager or treasurer, which carries with it generally recognized duties.

· To those who know of the appointment, there is apparent authority to do things ordinarily entrusted to one occupying such a position, regardless of unknown limits (Rest. 2d §27 Comment a)

· President: has authority to bind corporation to ordinary business transactions (hire or fire officer-level people/ enter into ordinary contracts) but has no authority to do extraordinary actions (lifetime employment contracts/real estate leases/sell all of corporation’s assets/issue and distribute stock/settle litigation).

· Chairman of the Board: can sometimes also be CEO or other times be honorary position – no guarantee on any authority to bind.

· Vice President and Treasurer: no authority

· Secretary: has inherent authority to certify records of the corporation, including resolutions, with binding results on corp.

§ Agency by Estoppel. When a principal negligently or intentionally causes a third party to believe that his agent has authority, and the party detrimentally relies thereon, the principal is estopped from denying the agent’s authority. However, the principal may not enforce authority ag

he escrow account it had established.

§ Bratton: This case employs faulty legal reasoning, because the contract is interpreted to authorize R to make the contracts when it explicitly says R cannot make such contracts.

– Liability of Third Person to Principal. If an agent and a third person enters into a contract, and the agent’s principal is liable to the third person under the contract, then the third person is liable to the principal.

o Undisclosed Principal Exception. The third person is not liable if the agent or principal knew that the third person would not have dealt with the principal if he had known the principal’s identity.

– Liability of Agent to Third Person. Depends on (1) whether the principal is bound under the contract and (2) whether the principal was disclosed, undisclosed, or partially disclosed.

Principal is Bound

(agent has actual, apparent, or inherent authority, or principal ratified the act.)

Principal is Not Bound

(i.e. agent did not have authority)

Disclosed Principal

Agent is not bound to third person.

Agent is bound.

Undisclosed Principal

Agent is bound.[1]

Agent is bound.

Partially Disclosed Principal

Agent is bound.

Agent is bound.

o Liability on the Contract or Breach of Warranty of Authority? Courts split. The difference seems to be the former gives expectation damages while the latter gives reliance damages. But, the Restatement opts for expectation damages anyway, mooting the point.

– Liability of Agent to Principal. If an agent takes an action that he has no actual authority to perform, but the principal is nevertheless bound because the agent had apparent authority, the agent is liable to the principal for any resulting damages to the principal.

– Liability of Principal to Agent. If an agent has acted within his actual authority, the principal is under a duty to indemnify the agent for payments the agent made that were authorized or made necessary in executing the principal’s affairs.

B. Fiduciary Duty

– Agency Costs. Jensen & Meckling identify agency costs as the sum of monitoring expenditures by the principal, bonding expenditures by the agent, and residual loss (reduction in welfare experienced by principal due to divergence between agent’s decisions and those decisions which would maximize principal’s welfare).

o It seems J&M would think fiduciary duties are unnecessary. But are fiduciary duties cheaper? Unclear. Probably a difference of ex post versus ex ante.

o Economic justification: w/out fiduciary duty, such requirement would merely be contracted, i.e. we save contractual costs via fiduciary duties à they are utility maximizers

– Fiduciary Duties. Agents are fiduciaries to their principals – Agents must disclose “al facts affecting the desirability of the transaction” and be fair. Restatement (Second) Agency §§ 387 – 389 defines this duty.

o Generally, agent must disclose and be fair! Can be alerted by contract.

o § 387 (General Principles). Unless otherwise agreed, an agent is subject to a duty to his principal to act solely for the benefit of the principal in all matters connected with his agency.

o § 388 (Duty to Account for Profits Arising out of Employment). Unless otherwise agreed, an agent who makes a profit in connection with transactions conducted by him on behalf of the principal is under a duty to give such profit to the principal.

o § 389 (Acting as Adverse Party with Principal’s Consent). Unless otherwise agreed, an agent is subject to a duty not to deal with his principal as an adverse party in a transaction connected with his agency without the principal’s knowledge

[1] Majority rule is that once a judgment is obtained against the principal, then the agent is released from liability (and vice versa). Minority rule is that only satisfaction of judgment discharges the agent or principal.