Foundations: Agency Law Introduction to law of enterprise organizations

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Corporations Outline Arlen Spring 2004


Agency Law

Introduction to law of enterprise organizations and nature of agency relationship: Attempting to view organizations as complex sets of actors, each with different sets of motivation. Organizations do not have single purpose. Issue: how do you coordinate people with different motivations? Agency costs (of becoming informed) is a big part of the problem, as is opportunity for opportunism  Agents can really misbehave. “moral hazard” problem (hidden actions) and “adverse selection” problem (hidden information); may exploit SH collective action problem.

Law’s response: reduce cost of contracting by providing good default rules, and facilitate contract making. Construct contracts with appropriate incentives that help to reduce agency costs. And prohibit suspect deals via mandatory rules that try to protect vulnerable parties.

Agency relationship

Definition: Fiduciary relationship where an Agent by mutual assent

(1) acts on behalf of a Principal

(2) and is subject to A’s Right of control.

(3) consent by A to so act.

Right of Control: that P exerts need not be direct or exercised in practice. May simply be right to terminate the authority to do the job, and that job is done on P’s behalf.

 The principal always has the right to terminate the agency.

Principal’s Consent: must have manifested consent but it

(1) need not be an express request and

(2) may be inferred from conduct of the parties

  1. Liability in contract

    1. Core questions:

      1. When does an agency relationship arise? (What type is it?)

        1. Actual: P liable, A not liable. Principal’s actions are such that a reasonable person in the position of the agent would believe that the agent was acting on the principal’s behalf and subject to his control. Parties conceptions do not control. If you can’t find evidence of control, look for evidence of risk. Cargill was an actual authority claim, even though it might have seemed like a better apparent authority claim (b/c most of the evidence was of TP perception, and it’s hard to argue that agent Warren thought Cargill was P: Cargill gave farmers assurances; Exercised supervisory authority; Gave individual advice (though W snubbed it – by right? Veto of small expenditures;Right of first refusal, purchase of most of grain (80-90%); Warren is not liable for contracts, Cargill is, because of Warren's expectations; Farmers' expectations are irrelevant here; Cargill-Warren legal statement not determinitive).

        2. Apparent: P liable, can seek indemnification. Idea is that as between the third party and the P, it’s the principle’s fault; but as between the agent and the principle, it’s the agent’s fault. That’s why P can seek indemnification, but TP can initially recover from P. Test: 1) P’s manifestations to a 3rd party are such that (2) a reasonable prudent person in TP position would believe that A was acting on P’s behalf, within scope of his authority, and subject to his control (even if A doesn’t nec. have that authority.) Protects TP R expectations. P must act- A’s actions alone cannot give rise to apparent authority. Some juris require reliance, others do not.

          1. Titles do matter: Lind v Schenley: It was reasonable for Lind to believe that VP had the power one usually has in such a position, that is, he had the power to set/delegate salaries and commissions. (A knew he didn’t have this: so no Actual Authority).

        3. Ex post ratification: P liable, A not liable. Can ratify expressly, or impliedly by conduct. P must exist at the time the agent initially contracted with the 3rd party.

        4. Inherent authority: P liable, can seek indemnification. A need not have a disclosed principle. § 195 – Elements for inherent authority power with an undisclosed P: P entrusts A to manage his business; A is a “general agent” w/actual authority to conduct some types of transactions; the transactions in question were usual or necessary in such a business; A was acting on P’s “account” (i.e., in P’s interests); P is liable even if A acts contrary to express instructions. Nogales involved inherent authority (principle may be liable upon a contract made by a general agent of a kind usually made by such agents, although he may be forbidden to make it and although there had been no manifestation of authority to the person dealing with the agent…). See Menard v Dage.

    2. What kind of agency Relationship is it? 7940765232

      1. Master-Servant

      2. Other types

    3. What are the P’s and A’s rights/obligations towards TPs?

      1. Contract obligations

      2. Tort obligations

    4. Types of relationships:

      1. agency:

        1. General agency: a series of transactions involving a continuity of service.

        2. Special agent: a series of transactions not involving a continuity of service

      2. Contrasting to other types of relationship

        1. Debtor/creditor - Restatement 2nd § 14(O): Creditor becomes a principal when she exerts de facto control over the debtor; Control need not be day to day control, control over what contracts are made is enough.

        2. Buyer/seller - Restatement 2nd § 14(K) : One who Ks to acquire property from a TP and convey it to another is the agent of the other only if it is agreed that he is to act primarily for the benefit of the other and not for himself. Relevant factors include whether he is to receive a fixed price for the property, whether he acts in his own name or receives title in his name, or whether he has an independent business of buying/selling similar property. Test is not necessarily about control but rather what happens with profits

        3. Franchises: Franchisor crosses the line into a P-A relationship when he goes beyond setting standards into controlling day to day operations of the franchisee. Holding self out as one big company allows you to maintain uniformity but may prevent you from escaping liability. Reputation is important  indirect indicia of control. If A operates under P’s name, P has an incentive to maintain sufficient control: make sure A lives up to the P’s reputation. To avoid this problem, use the Best Western method – “independently owned and operated” (see Humble/Hoover)

  2. Liability in tort: (most A can’t pay, so we want liability to rest with P, also to induce P to take precautions)

    1. Definition: A master-servant relationship exists where the servant has agreed to a) work on behalf of the master and b) to be subject to his control (or right to control) over the physical conduct of the servant (This is the manner in which the job is performed; goes beyond the result alone.) If independent contractor, then P is not liable.

    2. Even if a contract specifically states that S is not an employee but an independent contractor and that the master is not to be liable for actions taken by S, it is not enough to terminate a M-S relationship. (see Humble)

      1. Court will look at whether P manifested consent to the MS relationship

      2. P has manifested consent to the right to control A’s conduct.

      3. A master could insert a clause in the contract that would require the S to indemnify.

    3. Restatement § 219 M is liabile for torts of S committed while S acting in the scope of their employment. M is liable for the torts of servants acting outside the scope of their employment if:

      1. M intended the conduct/consequences; or

      2. M himself was negligent or reckless, or

      3. The conduct violated a non-delegable duty of M, or

      4. S purported to act or to speak on behalf of the M

        1. there was reliance upon apparent authority, or

        2. S was aided in the tort by the existence of the agency relationship.

      5. Theory: MS (or respondeat superior) is a type of policy decision on inherent authority.

        1. If have right to control someone, then be responsible for what goes on. Classic example is employer-employee (ie. waitress); but MS goes beyond this. Idea: financial incentives influence the risk taken and thus the chance of tort. Reluctance of courts to extend this to examples like: Managed care: pay structure influences how many patients doctors take on. Forces doctors to see so many patients that something will go wrong.

          1. Solvent agent: P pays anyway: Must either pay A higher salary, or pay plaintiff.

          2. Insolvent Agent*: plaintiffs won’t sue, agent’s won’t pay; P’s off: won’t prevent risks

        2. Problems with vicarious liability

          1. Narrow understanding of control: often courts don’t consider financial control

          2. Incentive to relinquish control where more control is better.

      6. Direct Indicia of MS: Contractual constraints on A’s autonomy such as hours, reports, regulation of business practices. R §220 looks at a variety of factors including: The extent that the P is allowed to determine the details; Whether A has a distinct business; How is the pay organized? Paid per job or by wage?; Tax status; Amount of risk borne by each; If A only has one P (only exists to serve one person), looks like an employee; Long run relationship increases likelihood of finding control; Trade practice – is this the kind of business that’s usually done in a supervised way?; Specialized skill in A that P needs?; Location of work – is it done on a place separate from where the P is?; If P has easy access to/can easily monitor A, Ct may think of P as having control; Who provides supplies? Is A’s job part of P’s regular business? Terms of the relationship. Capacity to control may  right to control.

      7. Indirect Indicia: Financial & Risk Structure: (similar to Cargill) Risk & Profits: Ps who bear the risk and take profits are more likely to demonstrate control.

      8. Humble Oil v. Martin: Humble leased to Schneider (who did hiring & repaired cars on the side), as an independent contractor, but intervened financially, required reports, could terminate lease at will, retained title to unsold products (though this is often red herring), exclusive contract, set hours, paid for ads and utilities; rent was based on amount of gas sold (looks like a commission). Had K saying this was a franchise. Court said this was MS nonetheless; Humble liable.

      9. Distinguishing Independent contractors (§ 219(3)???) Definition: An independent contractor is a person who contracts with another to do something for him but who is not controlled by the other nor subject to the other’s right to control with respect to his physical conduct in the performance of the undertaking. He may or may not be an agent. Specify scope of job, but not how it’s done (ie. builder, lawyer)

        1. Key Issues: Title: usually smoke & mirrors; Who bears risk of losses? Who is entitled to get gain of increased profits? We assume parties will join control with risk & benefit. Financial Structure: Check if financial structure indicates indirect control/leverage over A;

        2. Hoover v. Sun Oil: Sun leased to Barone; employee smoked while filling car. Sun held not liable for injury because, although Sun owned gasoline: P had flexible profit based rent scale and received a commission, the station owner bore most of the risk/retained full profits, controlled day to day operations, held product title, not exclusive products, no reports (wkly visits), 30 day lease notice. Tricky device- shifted title of goods to Barone, but made rent dependent on sales- Sun still bears costs, but is trying to avoid m/s liability.

          1. Financial Structure: Who bears risk for non-sale/gets profits from sale (not nec. title)

            1. Humble Oil: HO got rent, which was based on oil sold; and paid 75% utilities. If mkt demand dropped/increased, HO profit followed. If price of utilities went up/down, HO benefited proportionately.

            2. Sun Oil: Most market risk is with Barone. Rent % agreement: Sun gets high profits if lots of sales. But: rental has min & max: even if Barone does well/miserably, Sun okay. This limited risk enough to find IC in Hoover but not in Humble Risk is important part of calculus

  1. Fiduciary duties: another way of governing agency. Can use ex ante agreements (like monitoring or incentive based contracts). Can use exit rights. Fiduciary duties is the law filling in what agreements/exit right don’t capture.

    1. types of duties:

      1. duty of obedience

      2. duty of care & skill (can contract out of it)

      3. duty of loyalty (duty to act solely for the benefit of P; equivalent: duty not to use your position at firm for your own benefit at firm’s expense) (cannot contract out of duty of loyalty; a fully informed P can agree to a conflict of interest, but you have duty to inform P, get their agreement, and must deal fairly.) Limited to subject matter of agency

    2. Tarnowski v Resop: P engaged D to investigate & negotiate purchase of route of coin operated music machines. P already recovered against sellers. So what is his claim against D? Damages claim: for expenses attorneys fees. Restitution claim: you got $2000 secret profit that you aren’t entitled. Though this restitution might overcompensate P, the claim is that this discourages efficient breach of contract, which we don’t want in principal/agent context. Also, since this was an intentional breach, so less worried about overpenalizing A.

      1. Duty of care breach- to take level of care that reasonable person would (negligence). Core element of this is that he was hired to check out business and didn’t. Clear breach of due care. Also duty of loyalty breach: he got a commission from other guys, so he is on both sides of the deal.

      2. when agent violates duty of loyalty, the deal is voidable even if fair.

    3. trustee duty: special kind of agency relationship: trust is legal entity that trustee manages. Trustee is agent. Manages trust not for benefit of P (whomever set up trust), but for designated beneficiary. A follows direction of P even if beneficiaries are not happy about it. They do not get any say (beneficiaries). Trustee can’t use assets for own benefit unless gets consent of all beneficiaries. Disclosure Requirements: Self-interest; Material facts; To someone who can consent

      1. Several rules available, depending on jurisdiction

        1. Bright line: Trustee can’t deal with trust (no reason to do this). Even if have consent: much closer scrutiny. Idea: Protect them from own consent.

        2. Restitution: If trustee deals w/trust (sans disclosure): then profits go to trust. Constructive trust imposed on all profits derived from trust (ie. farming land). Focus not on damages here: (ie. could they have done better), but on profits

      2. duty of trustee is strict and punishing- don’t need to find evidence of damage and even can find negative damage (i.e. the transaction was good!). Very light burden on plaintiff. Turns hugely on disclosure (disclose to all competent beneficiaries).

      3. Gleeson: someone challenges the trustee’s lease. One of beneficiaries is incompetent and can’t consent w/o guardian. Some jurisdictions have allowances for these transactions without consent, but they have careful scrutiny of fairness. This is a relaxed version of the rule above: idea is to allow some transactions b/c not all trusts are set up to protect money from dumb beneficiaries, some are just for tax and credit purposes (and hence we’re less concerned about dumb beneficiaries that we can trust to consent).

Forms of Business Organization:


  1. Partnership formation, management & authority: General partnership is simplest. Have right to control business and personal liability by owner for debt (contrast w. corporation, where you have legal entity status, w. limited liability. Wall b/t assets of corp and assets of person. General partnership is one that is cheapest to form. We focused on UPA b/c clear, adopted by every state, partnership. Core question: why co-ownership? Can just do P/A! A doesn’t like b/c (1) A may be concerned re; losing job as soon as successful, esp if A is “idea man”. (2)A won’t have control over how business is run.

    1. Formation and rights of third parties

      1. §9: All partners are agent of partnership and hence can create debt and obligation, etc. Parnter can bind partnership if acting w/in authority. Absent agreement to contrary, partner has actual authority and apparent authority defined by Sec 9. This is “ordinary course of business” actual authority. If one P insolvent, all other partners personally liable. Property owned as “tenants in partnership” (§25), and no individual claim to sell it, i.e. partnership sells only if they all agree to sell.

      2. Formation: how do we determine if employee or partner? §6: partnership is association of 2 or more persons trying to carry on as co-owners. Association is intentional language, as opposed to agreement/contract, b/c partnership formation can be informal. §7: what is prima facie evidence of co-ownership? Share of gross receipts is not (gross receipts don’t reflect risk, as in commission). Share of profit is, as its claim to residual. We assume control follows risk.

        1. certain times that it will not: incentive based pay; profit sharing in employer/employee system;

        2. Express indicia: intent (express language of agreement, posture towards third parties, including tax forms)

        3. Descriptive indicia: owner (residual right control + risk)  ultimate control. Capital investment (non-essential). Duration (often fixed in partnership, as opposed to employer relation. Liability to third party (co-owners are joinly liable; employees only liable if they don’t act w. authority). Rights on dissolution (can they share profits, etc.)

        4. Vohland v Sweet: Sweet got 20% share of profits; UPA default is if share of losses = share of profits, then default is you are partner. No evidence here Sweet is haring in losses. He didn’t make capital contribution. Runs day-to-day business (though one gets sense that he doesn’t make ultimate calls). Duration: not indefinite. Sense that Vohland could fire him. Third parties: taxes filed by Sweet as self-employed.

      3. Relationship b/t partners and creditors:

        1. 3 aspects of creditor’s rights:

          1. whom can they pursue?

          2. when can an ex-partner escape partnership debt?

          3. how do partnership creditors fare in competition w.r.t. personal creditors?

        2. Munn v Scalera: Pete & Bob building house, split up; offer to finish it individually. Munns opt for Bob. Bob completes house, but hass debt to pay. Is Pete liable? If P &B still partners, §15: joint and several liability if wrongful act or breach of trust (only for your share of profits). This case, dissolved, so §40 governs: if partnership is bankrupt, then this will dissolve partnership. Upon dissolution, partners have to pay off partnership losses in proportion to their share. If one can’t pay, other has liability. §18(a): your liability is proportional to your share of the profits (default rule). §36(3): if agreement materially changes after you leave partnership, you are off the hook (if you dissolve but other guy wants to keep going, Pete is in a bind b/c can’t pay off existing debt w. assets, and new business may incur new obligations. Default is you’re on the hook, 36(1). (2) lets you off if creditor agrees to let you off hook. (3): if creditor makes material change to obligation between him and continuing party. 36 meant to capture debt restructuring, but used here even though all that changed was who paid, not what they paid.

        3. §18(e): equal right to conduct business. §18(b): indemnification for expense reasonably incurred in ordinary course of business.

    2. Partnership governance

      1. §16: partnership by estoppel (if you represent yourself as a partner, and third party reasonably relies, you cannot deny partnership status for purposes of suit). §§6 and 7 tries to navigate relationship between partners. 18(g): you need unanimous consent to make new partner.

      2. Problem 1: combine 18(e) (equal rights to manage: one person/one vote) and 18(h) (disputes in ordinary course of business resolved by majority vote)– so have S&S v. Columbo - so S&S wins 18(h) most disputes resolved in ordinary course of business (voting can be informal). Voting not by capital contributions, but one partner, one vote (can modify this). If action is in contravention of the partnership agreement, then need unanimous vote. If no partnership agreement, then matters that aren’t in ordinary course of business, you have no authority for and need unanimous consent. For things that there is a secret limitation on (Colombo can’t hire anyone), there may be apparent authority, and so other partners may be liable for his decision to hire Ace.

      3. National Biscuit: If it’s the ordinary course of business, people who want to limit authority still need majority- this is to push partnerships to move forward and avoid hold-ups. There are other juris. who have alternative rule- any guy who wants to do anything needs majority approval if challenged.

      4. You examine authority from the moment that the act was committed not from point (if exists) later on where authority was later limited.

      5. If no written partnership agreement, courts tend to look at ordinary course of business and infer backwards

    3. Fiduciary duties & rights

      1. UPA 22: each partner has a right of formal accountin of partnership affairs

      2. there’s a duty of loyalty (overarching duty to act for the partnership as a whole, not for yourself): that gives rise to lots of subduties: account for profits, not to usurp a business opportunity, not to take partnership confidential info and use it for yourself, not to compete in the subject area of the agency (if partnership sells real estate in ny cant open separate business that sells real estate in NY, but if partnership is re: ny real estate, might be able to sell real estate in CA on the side, as long as partnership contemplates tt partnership is limited to local geographic area)., cant act w/ conflicting interests, and there are rules on self-dealing.

        1. Meinhard v Salmon: If info comes to you as partner, it’s the property of the partnership. “The trouble about his conduct is that he excluded his coadventurer from any chance to compete, from any chance to enjoy the opp for benefit that had come to him by the virtue of his agency alone”. Can tell that opportunity exists, and then dissolve P ship if at will, and compete with Meinhard, or if for a term, wait until the P ship is dissolved and then compete. As in corporate opportunities cases also, now there is shift onto defendant to prove there was no unjust enrichment: its not re: damages where plaintiff has to prove damages - once breach duty of loyalty, you now have to prove you didn’t get anything

  2. Dissolution

    1. UPA 29: Dissolution is automatic, can happen for any one of a number of reasons:

      1. If it’s a partnership at will (not for a particular term (length of time or specific undertaking)), any partner can just say “I dissolve” and that’s it…..or can say “I’m leaving” – withdrawing form the partnership dissolves the partnership (if terminal date comes it automatically dissolves, as it does when partner dies)

      2. Death/bankruptcy of partner automatically dissolves it

      3. Severing of any partner from a partnership automatically causes dissolution

      4. Can be dissolved by court order

        1. a court might Dissolve b/c a partner becomes incapacitated, if he’s breaching fiduciary duties, if it can only be operated at a loss, etc. (see handout)

      5. There are wrongful dissolutions

    2. Dissolution means there’s been a change in the relationship so that one partner is no longer part of the business.

    3. ON dissolution, what happens? Q. is whether will continue the business or liquidate? This is decided at winding up (default term) (dissolution is just a change in the relationship, deciding whether to continue is decided in “winding up” process) winding up phase (look at UPA 37, and 38. When its wound up (sold everything, etc) – its terminated – obligations etc end at termination, not dissolution. During the winding up phase, the partners have to do work for the - scope of agency changes (are to be winding up partnership not to work for it), but still have fiduciary duties. unless otherwise agreed, each partner has right to wind up the business. If you have a wrongful dissolution, any of the rightful partners has right to wind up, and the wrongful partners don’t. If have a rightful dissolution, then, its wound up unless all agree not to. If have a partnership for a term, and one guy decides to leave before the end of the term, he has no right to force a winding up, but any of the other rightful partners could!

    4. Adams v Jarvis: partnership for medical clinic. Agreement that one partner leaving doesn’t dissolve the partnership. but if partnership is dissolved, its liquidated (sold off). Dispute: coming from the fact that we have a partner who’s leaving, trying to force a liquidation of the business. Other partner is saying no, we get to continue on, and you get your rights under the agreement.

    5. Dreifust: UPA default rule: (38(1)) – any one partner has the right to force a sale of the business and to be paid off in cash. Default is liquidation. there are cts tt might do an in kind distribution, but ct says it doesn’t agree, b/c it feels best way to protect you is liquidation, and if you really want an in kind distribution you can agree to it (but we think most pple don’t want this)

    6. Page v Page: Sues for termination, b/c not clear whether it’s partnership at will or for a term. If wrongful termination, then big deal- 37 and 38 would let you liquidate if rightful, but if wrongful, you have damages (i.e. loan withdrawal fees), non-dissolving partner has right to unanimously agree to continue business and doesn’t have to pay back withdrawing partner until business is terminated (just post bond).

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