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

Corporations

Professor Bratton

Fall 2017

I. Background

Corporations is party applied contract law, partly applied tort law, and partly applied agency law.
For purposes of the exam, UPA is the basis of this course

Harmon Problem

Assume that William Harman, age 65, and his son Robert Harman, age 33, owned and operated the Amalgamated Software Products Co., which was once highly successful but has been declining in business in recent years due to outdated technology. Robert has been acting as general manager and has been eager to expand the business, while his father (a man of large wealth) has preferred to keep churning out the same old product. Robert entered into negotiations with Mary B. Lindsay, a brilliant programmer with a radical idea for a low-cost upgrading of the Harman proprietary software that will restore its competitive position. The Harmans and Lindsay then negotiated with Jane Pierrepont Smith, a successful venture capitalist, and the four agreed to join forces. Their respective contributions to the new enterprise were to be: the Harmans, their existing business; Lindsay, her services; and Smith $10,000,000.

The Harmans, Lindsay, and Smith have agreed to value the Amalgamated Software stock at $20 million ($10,000,000 for each of the Harmans) and to value Lindsay’s promise of services at $10,000,000. They have requested you to “draw up the papers” for the new business.

(1) How will the enterprise be treated under law if the participants do not formally select a particular form of business organization?

UPA 6 and 7.
R. Harman has kicked in money and is managing the business – he’ll be a partner
Smith could be a partner, or he could be a creditor (since he just went away after signing over some money)
Lindsay could be a partner, could be an employee, could be both
W. Harman may not be a partner as his contribution might come under 7(4)(e)
So this could be a sole proprietorship for R. Harman w/ a lendor, employee, and installment seller or it’s a partnership w/ R. Harman, W. Harman, and maybe Smith and Lindsay

(2) HHLS sit down in your office. Smith wants her $10M to be a loan. She also wants upside potential and some management control and your opinion that she has limited liability.

Question is how to structure the deal to give a capital participant the benefits of an equity participation, w/o in substance giving the risk of unlimited liability

Call it a loan but structure it w/ so many equity components that you risk the court calling it equity.

(2) What additional information will you seek from the parties in recommending an appropriate form of organization? What alternatives to incorporation will you weigh? Consider the sole proprietorship, the partnership, the limited partnership, and the limited liability company. What problems will you anticipate? Consider specifically the following questions:

(a) How deeply involved may an individual be in a partnership without being deemed a partner?
(b) How can partners limit the dangers of unlimited liability?
(c) What formalities are necessary to commit a partnership to a contract?
(d) How active may a limited partner be in the management of a limited partnership without being deemed a general partner?
(e) How does a limited liability company improve on a limited partnership from the point of view of the Harmans, Lindsay, and Smith?
(f) What are the financial and tax effects of the choice of each of the available business forms?

(3) Do you face any problems in representing all four entrepreneurs?

II. Agency Relationships

Background

Three concepts from agency law that figure prominently into agency law:

Authority: no contract binding the principal unless the agent acts w/ authority

Agent makes contracts on behalf of the principal, that bind the principal

Vicarious Liability: principal being liable for the agent’s torts
Fiduciary Duty

Who Is An Agent?

Zuckerberg: Zuckerberg is an agent of Facebook, the principal and legal entity (a thought construct).
Martin Lipton: may be acting an agent for his client and may be acting as an agent for his firm.

Wachtell is the only big firm remaining that is a true partnership (not a limited partnership).
When a lawyer is giving advice, as opposed to acting on behalf, the lawyer is technically not an agent.

Lawyer is still a fiduciary when giving this advice.

Mickey Mouse: Disney employee doesn’t make contracts. If you don’t make contracts, but are an employee, are you an employee who isn’t an agent? (?)He isn’t an agent but is treated as one(?)

Analytically you can argue he isn’t an agent but “we aren’t going there”

Law Review Journal Editors: are agents of the university as they make contracts with third parties on behalf of the journals.

Universities don’t want their divisions (e.g. Penn Law, Journals) to have independent deritical existencies.

Distinguish the Contract from the Agency It Creates

CEOs compensation is determined by interpretation of the contract.
CEOs authority is determined at the time of the action, according to the principal’s will.

This is an ambulatory interpretation: the agent must be authorized at the moment the action is taken – the consent to contract for the principal must be ongoing.

Jensen and Meckling – Micro-economic View of Agency

Principal and Agent modeled as utility maximizers à “agency costs”

(1) P expects A to self-deal and so, builds incentive correctives into the contract and expends resources to monitor A
(2) A knows P knows A will self-deal, so A incurs costs (“bonding costs”) to assure P that A won’t self-deal

Contracting, monitoring, and bonding don’t reduce agency costs to zero – they can’t be reduced to zero
Does this approach leave room for fiduciary duties, or does it assume that fiduciary duties are unnecessary?

No. Maybe fiduciary duties make perfect sense b/c they save parties of the cost of contracting for them.

What do R 2d §§ 387, 388, 389 mean when they say “unless otherwise agreed”?

I.e., these are all default rules that can be contracted around. But by introducing them, you allow the parties to not have to contract around them.

Definitions

RS(3): relationship arising when one person (principal) manifests assent to another (agent) that the agent act on principal’s behalf and subject to principal’s control

Manifest assent – law of offer and acceptance
RS(3) should’ve included “involves delegating some decision-making authority”
Lawyers are worried about vicarious liability, which follows from control – only liable for the tort when you control that person.

Jensen & Meckling: contract under which one or more persons engage another to perform some service on their behalf which involves delegating some decision-making authority to the agent

Economists wrong to say “contract”
Economist is worried about moral hazard – slacking off and self-dealing.

An agency is not, by-definition, created pursuant to a contract.

When is there an agency but not a contract? When the agent is asking for free (no consideration à no contract). This is relatively rare. There is usually a contract (for employment) creating the agency

Termination: termination o

If attorney is authorized, as between the client and the attorney, the client bears the burden of specificity in the grant of authority

A counter-intuitive implication

REASONING:

(1) Is release actually authorized by client? Depends on whether giving release falls w/in the literal terms of “pursue ‘any and all claims which client may have…’”

Seems to BB it does.
Does that mean that it was authorized? Or do we determine it in relation to what the client expects from attorney?

(2) Court: “… in the absence of express restrictions [in the contract] the authority may be considered plenary by the court and opposing parties. The authority may be considered plenary unless it is limited by the client and that limitation is communicated to opposing parties.”

Lawyer isn’t a general agent here so no apparent authority by power of position. He is special agent acting in respect to specific litigation.
Client can sue the attorney for malpractice. The question is whether the doc is bound by the release.

Morris Oil v. Rainbow Trucking

TAKEAWAY: tendency in the book is to read things broadly to find principal liable; if there is an agency in substance, you can’t negate it with language in the contract
FACTS: Dawn and Rainbow enter a contract. Rainbow to use certificate. Rainbow to pay $1K/mo. Dawn to have “complete control” over operations. All revenues sent to Dawn. Rainbow not an agent and not empowered to incur debts “other than in the ordinary course of business.” Rainbow is “independent contractor” and not an employee. Rainbow did substantial investment for work not in the ordinary course of business. Rainbow goes bankrupt and goes back to TX – disappear, judgment proof. Contractor wants to get paid and Dawn does so, ratifying the contract.
ISSUE: Was this an authorized transaction by an agent?

Is there an agency? If there is an agency in substance, you can’t negate it with language in the contract. So yes, there is an agent.
Is there actual authority? No, a construction cost is not in the ordinary course of business so Rainbow couldn’t incur debts for this purpose.
Is there apparent authority? No because the principal is unknown. But you can argue that Dawn has given Rainbow power of position. Not an argument BB likes
Is there inherent authority? Is the act done “usual and necessary in such transactions.” Who knows. You could argue it is.
What about doing an ambulatory interpretation (RS3) of the contract? Since Dawn just let Rainbow operate, can argue anything Rainbow did allowed in fact.

HOLDING:
BB:

Sounds like an agency b/c of complete control and revenue – why say “complete control” if the intent is to negate agency. But, contract says Rainbow is not an agent, not an employee, and is an independent contractor.
BB’s assumption is that the statute says you can rent out certificate only is you have complete control and if you collect revenues.