PART IV
BUSINESS ORGANIZATIONS
CHAPTER 6
SOLE PROPRIETORSHIP, AGENCY AND PARTNERSHIP
LEARNING GOALS
- To consider the legal environment of business organizations.
- To examine the forms of business organizations.
- To outline the areas of law applicable to sole proprietorships.
- To examine the law related to the agency relationship.
- To examine the law of partnership.
CHAPTER COMMENTARY
Chapter 6 examines three distinct classes of business organizations: the sole proprietorship, the agency relationship, and the partnership. The sole proprietorship, due to its apparent simplicity, will be easily understood by most students, but it is important to point out that even this simple form of business will be subject to a great many regulatory rules and laws.
From a business point of view, the agency concept is undoubtedly one of the most important. Apart from the extensive use of agents to carry out specific activities for principals, (such as real estate agents, manufacturer's agents, etc.) the concept represents an essential part of many other business relationships. For example, in a partnership, (which is also covered in the chapter), every partner is the agent of every other partner, and can bind the partnership in contract where the contract falls within the ordinary scope of partnership business. Similarly, in the case of corporations (covered in Chapter 7) the corporation can only act using the concept of agency. Agency, consequently, must be fully understood by students before moving on to the next chapter in the text.
An approach to the topic might be to spend some time on the duties of the agent, with special emphasis on the duty of the agent to act in good faith, and always in the best interests of the principal. This is desirable, since the type of agent that most mature students are familiar with is the real estate agent.
The entire area of third parties and agency should be clearly examined to establish the position of the parties in those situations where an agent acts for a disclosed and an undisclosed principal. Since students sometimes find it difficult to imagine a third party would contract with the agent for an undisclosed principal, the topic should be fully examined.
Termination of the agency relationship is relatively clear, but the effect of failure to notify customers of termination, and the question of apparent authority are worth examining in class.
The partnership relationship employs the law of agency in the determination of some of the rights and liabilities of partners with respect to each other, and to third parties. As the text indicates, the law relating to partnerships is for the most part settled, due to the age and maturity of the relationship. This was recognized almost a century ago in England, and permitted the clear codification of a large part of the law relating to partnerships. The result of this maturity has been limited change in the law since the introduction of the statute.
As with the agency relationship, some emphasis should be placed upon the "good faith" aspect of partnerships, and this should be explained in conjunction with the rule that each partner may bind the partnership in contract in the ordinary course of partnership business. The topic may also be included with a discussion of the conduct of business by a partner in competition with the partnership where no consent to do so is granted.
The liability of partners in general, and in particular the liability of retiring partners, might be discussed along with the registration requirements, and the importance of giving notice of a change in a partnership to third parties.
The example on p. 176 of the text illustrates the court decision in Garner v. Murray and explains the effect of the insolvency of one partner on the liability of the others when the partnership is dissolved. As the case indicates, the loss would not be borne on an equal basis, but distributed according to the ratio of their capital accounts at the time of dissolution. Students could work through Case 5 as an application of the rule in Garner v. Murray to reach a decision on the liability of each individual partner to the others.
REVIEW QUESTIONS
- How does a sole proprietorship differ from other business organizations?
Answer:
A sole proprietorship differs from other business organizations in the sense that it has only one owner who makes all important decisions, receives all profits, and has unlimited liability for any losses. Except for employees, the sole proprietor is the only person involved in the operation of the business.
- What is the role of an agent?
Answer:
An agent is usually used to bind his or her principal in contract with a third party.
- Must an agency agreement always be in writing? If not, why not?
Answer:
A written agency agreement is not necessary unless the relationship cannot be carried out within the space of one year. (note: exceptions here re: long term agreements).
- Outline the various types of agency relationships that may be formed.
Answer:
Agency relationships may be established by: express agreement, by conduct, by operation of law, and by necessity.
- Explain the difference between an express authority and implied authority in an agency relationship. Give examples of each.
Answer:
Implied authority may arise where the principal has expressly withheld certain authority of the agent which agents of that type normally possess. E.g.: leaving goods with a selling agent but denying the agent authority to sell. Since agents of this type normally have authority to sell, if a third party buys the goods, the principal would be bound by the contract. The principal, however, would have a right of action against the agent for breach of the agency agreement.
- Outline the duties of an agent to his or her principal.
Answer:
An agent’s duties are: act in best interests of his/her principal, obey all lawful instructions or directives of principal, keep confidential information given by the principal, report all information to the principal, account for funds received, and maintain the standard of the skill he/she possesses.
- Explain “agency by estoppel”.
Answer:
Agency by estoppel arises where the principal by words or conduct gives a third party the impression that a person is his or her agent. If the third party enters into a contract with the person as agent, the principal is estopped from denying that the agency exists.
- Outline the circumstances where a principal would be entitled to ratify a contract negotiated by agent.
Answer:
A principal may ratify a contract if the principal was capable of making the contract at both the time it was made by the agent and when it was ratified, if it is ratified with a reasonable time.
- Under what circumstances would an agent alone be liable if the agent exceeded his or her authority in the negotiation of a contract?
Answer:
If the agent acted alone without disclosing that he was acting as an agent, the agent alone would be liable.
- Outline the various ways that an agency relationship may be terminated.
Answer:
Agency may be terminated by:
(1) death of agent or principal,
(2) by agreement,
(3) completion of the task,
(4) incapacity,
(5) bankruptcy of the principal,
(6) on notice.
- What essential characteristic distinguishes a partnership from other associations of individuals?
Answer:
A partnership is a relationship which carries on business with a view to profit.
- How is a partnership formed?
Answer:
A partnership may be formed by two or more persons entering into an agreement to carry on business for profit, on the understanding that they would share losses as well, and would participate in its management
- Why is a simple sharing of gross profits not conclusive as a determinant of the existence of a partnership relationship?
Answer:
Sharing of gross profits is often a method of compensating employees. Such sharing does not indicate whether a loss is shared as well.
- How does a partnership differ from co-ownership?
Answer:
Partnership differs from coownership in a number of ways: each is subject to a different statute; a share of coownership may be reality or personality, while a partner's share is always personality; a partner may bind other partners in contract, a coowner may not; a coownership share may be sold or pass to others by will, while a partner may not transfer the interest without the consent of other partners to the admission of the new partner.
- Explain how agency and partnership are related in terms of the operation of a partnership.
Answer:
In a partnership, every person is an agent of the partnership, and may bind it in contract.
- Under what circumstances would a partnership be liable for a tort committed by a partner?
Answer:
The partnership would be liable in tort for the act, provided that the partner committed the tort in the course of partnership business.
- What is the extent of the liability of the partners for the tort of a partner or for contracts entered into by a partner?
Answer:
All general partners have unlimited liability to third parties
- Under what circumstances may a partnership be dissolved?
Answer:
A partnership may be dissolved on the death of a partner, on notice, at the end of the project (if for a profit), at the end of a term, if for a specific term, if for an unlawful purpose, if a partner becomes mentally incompetent, or by the courts for a number of reasons.
- Is it possible for a partner to sell his or her interest to another person? What is the status of the purchaser of the interest if it should be sold?
Answer:
Yes. The person does not become a partner, however, but only acquires the partner's share, which is determined on the dissolution of the partnership. The purchaser may not participate in the business.
- Explain the rights of creditors of a partnership when the partnership is dissolved.
Answer:
The creditors are entitled to payment of these debts from the assets, then any surplus is divided between the partners. If the assets are insufficient to pay the creditors, the partners must pay the creditors from their personal funds.
- Why is registration of a partnership important?
Answer:
Registration is important to inform the public of the identity of the partners and to provide information concerning the business.
- What is a retiring partner obliged to do in order to avoid liability for future debts incurred by a partnership?
Answer:
A retiring partner is obliged to notify all customers and suppliers at the time of his retirement and also notify the publicatlarge through an advertisement in the Provincial Gazette. A dissolution of partnership document should also be filed to correct the registration of the partnership.
23. Explain the nature of a limited partnership.
Answer:
A limited partnership is a special type of partnership that has partners with limited liability, but at least one general partner who has unlimited liability and responsibility for the management of the business.
24. In what ways does a limited partnership (LLP) differ from other partnerships?
Answer:
A limited liability partnership (LLP) differs from other forms of partnership in that an individual partner (instead of the partnership generally) may be liable personally for his or her own negligent acts or omissions.
DISCUSSION QUESTIONS
1. In the Ask A Lawyer case at the beginning of the chapter, Able may adopt one of several forms of business organization. What are they, and what are the advantages and disadvantages of each? Which one in your opinion might be the best for Able and his uncle? Why?
Comment:
Since Able is staring out in his own business, the logical organization would be that a sole proprietorship. See text pp. 158-159 for the advantages and disadvantages of this type of business organization. The Uncle may be hired by Able as his bookkeeper if necessary, and Able may borrow the necessary capital from the Uncle, rather than establish a limited partnership. Case must be taken, however, to ensure that the loan andemployment of the Uncle are separated. The lawyer would probably suggest a proper loan agreement, and an employment contract that would outline the Uncle’s duties as well as his remuneration for his services. Registration of the sole proprietorship would also be an important step if Able intends to operate the business under a name other than his own.
2. Agents provide an useful role in the contract process, but some risks exist. What steps should a principal take in the selection of an agent? What limits should the principal place on the agent’s authority? What steps should the principal take when the agency is terminated?
Comment:
Agents should be selected on the basis of their skills and honesty. A written agency agreement clearly setting out the agent’s duties and responsibilities would be important to avoid the question later. When the agency is terminated, the principal should notify all third parties of the termination of the agent’s authority to represent the principal.
3. Three partners carry on business together, and one now declared personal bankruptcy. What happens to the partners and the partnership? How are the partnership assets divided?
Comment:
Students should note that the personal bankruptcy of a partner terminates the partnership. The remaining partners would be obliged to ‘wind up’ the partnership and pay all of the creditors. Any surplus would be divided amongst all of the partners, but if a loss, the remaining partners would be obliged to cover it according to their capital accounts on dissolution (see Garner v. Murray in text).
4. What is the purpose of a joint venture, and how does it differ from a partnership? From a limited partnership?
Comment:
A joint venture is an agreement between business organizations (usually corporations) to carry out a business project. Each party is responsible for their own part of the project. It is not a partnership and their agreement usually tries to make this point clear. It differs from a limited partnership, because each of the parties is actively performing a part of the venture. A limited partnership involves only an investment by a limited partner.
COMMENTS RE: DISCUSSION CASES
CASE 1
A property owner wished to sell a small apartment building that she owned. She consulted a local real estate agent and listed her property. Because she was about to leave on her lengthy winter vacation, she provided the agent with authority to sell the property on her behalf if the terms of any offer received met the terms set out in the listing agreement. A prospective buyer inspected the property during the period of time that the property was listed for sale, but did not make an offer to purchase.
Before the property owner returned from her vacation, but after the agency agreement had expired, the prospective buyer returned and made an offer to purchase the property that corresponded with the terms of the listing agreement. The agent accepted the offer on behalf of the property owner.
After the purchase agreement was signed, the buyer discovered that the agency agreement had expired. He then began a legal action against the agent.
Explain the nature of the buyer’s action and indicate how the case may be decided. Could the property owner ratify the agreement? What factors would affect the ratification?
Comment:
One cause of the action would be against the agent for breach of warranty of authority to sell the property. The case, however, also concerns the question of the seller's ability to ratify the contract, and this issue should be discussed as well, since the buyer's action would only arise if the principal refused to proceed with the transaction. For the latter, the "rules" for ratification should be reviewed, and the question of whether the principal could satisfy them should be determined. In particular, the question should be asked: Does an action against the agent for breach of warranty of authority constitute repudiation of the agreement, and if so, would it at that point be too late for the principal to ratify
If the case is viewed as a situation where the principal has refused to ratify the agreement, then the question of the agent's authority becomes a key issue. If the agent had the authority to sell the property at the time of first negotiation with the buyer, then the buyer would be aware of the agent's authority. Later, however, the authority would not be present, but the question which might be raised here is: If the authority was for a specified time, was the buyer aware of the expiry date? Was it incumbent upon him to determine if the authority had been extended?
The authority to sell, and the authority to convey are two distinct authorizations under real property law. While an agent may bind a principal in contract under ostensible authority, the expiry of authority to convey the property would terminate the agent's authority to convey, and any conveyance given after the expiry of the authority would not convey the principal's interest. See: Taylor v. Wallbridge (1879), 2 S.C.R. 616 at 678679. If the agent lacks the authority to bind the principal, then an action by a third party for breach of warranty of authority might lie against the agent. See: Wickberg v. Shatsky (1969), 4 D.L.R. (3d) 540.
CASE 2
Lumber Agents Ltd., which frequently acted as an agent for wood processing mills, was contacted by the Finished Flooring Ltd. to find a supply of a particular hardwood for its new product line. Under the terms of the agreement, Lumber Agents Ltd. was entitled to a flat commission rate based upon the quantity of lumber purchased. Lumber Agents Ltd. contacted several small mills and arranged for each to supply a quantity of the type of hardwood required by Finished Flooring Ltd. In each case, Lumber Agents Ltd. charged the mill a fee for arranging the supply contract. In due course, the wood was delivered to Finished Flooring Ltd., and the agreed upon commission was paid to Lumber Agents Ltd., based upon the quantity of hardwood supplied.