Part I: Conceptual View(S) of the Corporation & Its Constituents

Part I: Conceptual View(s) of the Corporation & Its Constituents

Limited Liability: SHs are NOT personally liable for a corporation’s debts/liabilities (may lose value of investment in the company, but that’s usually it)

• Rationale: Corporation is a separate legal “person”

Principal-Agent Problem: problem of motivating a party (the agent) to act on behalf of another (the principal)

Agency Conflict: when an agent has different interests than that of the principal

• Strategies to Prevent: executive compensation, limited-term contract, fiduciary duty lawsuit by SHs, SH voting, specific contractual milestones

Debt v. Equity

Three Agency Conflicts

1. Between Managers & SHs
2. Between Controlling and Minority SHs
3. Between SHs as a class and non-SH constituencies of the firm (creditors/employees)

Two Types of Corporations

1. Publicly Held: thousands of SHs, public market for shares, state corporate law and federal securities regulations (SEC)/exchange rules (NYSE)
2. Closely Held: very few SHs, restricted market for shares, state corporate law (and limited federal regulation)

Conceptual View of the Corporation: Corporation as Contract

• Each corporation files a charter (certificate of incorporation) with the state of incorporation
• Each corporation also drafts a set of bylaws that govern internal affairs of the business
• Charter + Bylaws = Private Constitution

Corporate Law: Providing the Charter You Always Wanted to Write, But Never Had Time To

• Mandatory Rules: parties cannot modify or can only do so at significant cost
• Default Rules: parties can easily modify contractually

Lots of Flexibility in Drafting a Charter, but NOT taken advantage of very often (high transaction costs, network effects compel standardization), firms want the ability to modify their terms as needed in the future

Part II: Agency Law

A. Creation of Agency Relationship

Agency = relationship resulting from

• [M] the manifestation of consentby P to A that;
• [B] A shall act on P’s behalf;
• [CL] subject to P’s right of control; and
• [CT] A’sconsent to so act.

Gordon v. Doty: whether an agency relationship existed between Ms. Doty and Coach Garst (is Doty vicariously liable for the actions of her agent Coach Doty?)

• Manifestation and Consent = met here (but taken from a conversation, NOT a contract!)
• Control: P must have a right of control, need not actually exercise for a P/A relationship to exist
• Behalf: Doty’s? School? Team? Unclear what Doty gets out of the deal here…

Types of Agency Relationship:

1. Principal/Agent
2. Employer-Employee (“Master-Servant”) – Tort/Contract
3. Independent Contractor (“Agent”) – Contract
4. Independent Contractor (“Non-Agent”) – Cannot Bind

Gay Jenson Farms v. Cargill: Acting like a P/A relationship but saying that there is not a P/A relationship is not sufficient to limit the P’s liability.

A creditor become principal when “he assumes de facto control over the conduct of the debtor, whatever the terms of the formal contract with his debtor may be.”

Agency Relationship v. Agency Conflict

1. Legal Principal/Agent Relationship: (viewed mainly from 3d party perspective)
2. A must act “on behalf” of P and
3. Under P’s “control”
4. Economic Principal/Agent Conflict: (viewed from P’s perspective)
5. A has different interests than P, and
6. P does NOT control A

Corporate directors/managers are not “agents” of the SHs under LEGAL, but are under ECONOMIC (so cannot sue SHs for actions of directors!)

B. Liability Under Contract (Authority & Ratification)

Types of Authority

1. Actual Authority: emphasis on A’s reasonable interpretation of P’s communication
2. Actual Express Authority (AEA)
3. Actual Implied Authority (AIA)
4. Apparent Authority (ApA): emphasis on 3d party’s reasonable interpretation of P’s manifestation
5. Manifestation could be made directly to 3d party
6. Manifestation could be made through a reliable intermediary (even the public) to the 3d party
7. In “limited situations,” it could come through A’s communications to the 3d party, must be true that BOTH
8. A actually has been authorized before to act (although authority doesn’t exist at the time of contracting)
9. A accurately describes nature of her agency when she is authorized
10. Ratification (R): no authority of A at the time of execution of contract, but P later assumes liability
11. Inherent Agency Power (IAP): kind of a catch-all for cases that don’t fit the other categories, but where P is nonetheless held liable to 3d party, two primary versions
12. Hidden Principal: A doesn’t inform 3d party about existence of P (3d party thinks she is solely contracting with A), inequitable result if P not liable
13. General Agent: A is acting as a general agent for P, A’s actions were consistent with or incidental to transactions that this type of agent usually allowed to conduct, 3d party has no reason to believe A lacks authority

Mill Street Church v. Hogan:(AIA) Implied authority is actual authority circumstantially proven which [A reasonably believed] P actually intended A to possess and includes such powers as are practically necessary to carry out the duties actually delegated.

Dweck v. Nasser:(AEA, AIA, ApA) Shiboleth had [at least implied and likely apparent] authority to settle the case, such that the settlement was binding on Nasser.

Creating Apparent Authority (ApA):

1. [M] ManifestationfromP to 3d party
2. [RB] Sufficient to create reasonable belief in 3d party that authority existed
3. (some jurisdictions) and which 3d party actually believes/relies to her detriment

Legal definition of “manifesting consent” under ApA can be quite broad (conditional gifts, express statements/communications, assertive actions, job titles/descriptions, failure to correct mistaken assumptions)

Watteau v. Fenwick:(IAP) Three basic elements for IAP Version 1 in “Undisclosed P” case

1. A was a “general agent” for an undisclosed P,
2. The transactions in question were usual or necessary in such a business, and
3. A was acting on P’s “account”(in P’s interests) although contrary to directions of P

IAP Version 2 (Restatement § 161)

Disclosed P is liable for A’s unauthorized acts, even if absent actual/apparent authority, if:

• A is acting as general agent;
• A’s acts usually accompany or are incidental to transactions which this type of agent (based on title/office) would usually be allowed to conduct;
• 3d party has reason to believe that A is authorized and had no notice to the contrary

Restatement 3d eliminates IAP, expands ApA instead (but ApA doesn’t extend to undisclosed Ps, so R.3d added another section to cover undisclosed Ps), still exists in many states

Ratification occurs when:

• A person misrepresents her authority to act on behalf of P (act is unauthorized), but
• Purported P later ratifies (affirms) the unauthorized act

Time 0: Unauthorized action by A, Time 1: Affirmance by P

P’s Affirmation

• Can be express or implied
• P must know or have reason to know all material facts at the time of ratification

Timing of Ratification

• Not effective unless it precedes the occurrence of circumstances that would cause ratification to have adverse and inequitable effects on 3d parties. These circumstances include:
• Communication of withdrawal by 3d party;
• Material change in circumstances that would make it inequitable to bind 3d party; or
• Specific time that determines whether 3d party is deprived of a right or subjected to a liability.
• MAY NOT “wait and see”

Botticello v. Stefanowicz: (R)Ratification is defined as “the affirmance by a person of a prior act which did not bind him but was done or professedly done on his account.”

Agent’s Liability to 3d Parties:

• Tort: If A commits a tort, she is always liable to 3d party. (respondeat superior?)
• Contract:
• If P is not liable under principles of agency, A (or “non-agent”) may be liable to 3d party on one of two bases:
• Common Law Fraud/Deceit: Non-agent willfully/recklessly misrepresents fact of agency; existence of agency is material; 3d party justifiably relies on misrepresentation; and misrepresentation actually induces 3d party to enter contract.
• Warranty of Authority: Non-agent who purports to enter contract of P thereby become subject to an implied warranty of authority, unless A manifests that he does not make such warranty or 3d party knows that A is not so authorized
• If P is liable under principles of agency, A’s exposure is more limited:
• Disclosed P: A is (essentially) not liable
• Undisclosed/Partially-Disclosed P: A is liable as guarantor on contract

Atlantic Salmon v. Curran: A can be liable as guarantor to hidden/partially disclosed P, even if A had actual authority (A should disclose P’s identity to protect himself from liability)

• A can be liable as “guarantor” to hidden/partially disclosed P, even if A had actual authority (AEA or AIA)
• Advice to A  disclose P’s identity (especially if you have actual authority)
• Who is better protected: Agent with AEA but hidden P or Unauthorized A acting for identified P? But 2nd type is liable to P for breach of fiduciary duty

Practical Advice: Contracting through an Agent

• How can A minimize her risk of liability?
• Act with authority
• Disclose identity of P to 3d party
• How can P minimize his risk?
• Give A clear/unambiguous directions
• Avoid communications that could lead to ApA
• What should 3d parties do to minimize their risk? NOTHING!

Contract:

• Focus on the specific event/contract
• Did A have authority (AEA, ApA, etc.) to enter into the transaction/contract on P’s behalf?
• Ignore the general definition of an agency relationship
• Definition may or may not be satisfied
• AEA, AIA  Yes, P-A relationship exists.
• ApA P-A relationship may or may not exist (equitable rule to protect 3d parties)

C. Liability Under Tort

Vicarious Liability: Two Elements

1. Master-Servant (Employer-Employee) Relationship
2. Acting in the scope of their employment

Types of Agency Relationship:

1. Principal/Agent
2. Employer-Employee (“Master-Servant”) – Tort/Contract
3. Independent Contractor (“Agent”) – Contract
4. Independent Contractor (“Non-Agent”) – Cannot Bind

Servant: agent employed by master to perform service in his affairs whose physical conduct in the performance of the service is controlled or is subject to the right to control by the master

Independent Contractor: 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 (may or may not be an agent)

• Control: supervisory rights over the manner in which A completes the job/task
• Factors of Control over Physical Conduct (R.2d § 220): term of the relationship, skill required of A, trade practice of supervision in locality, location of the work, whether P is in business herself, extent of P’s control over work details, whether A has distinct business, P’s and A’s beliefs about relationship, etc.

Humble Oil v. Martin: Does Humble have a legal right to control Schneider’s “physical conduct” on the job?

• Court can look at:
• Direct indicia of control: contractual allocation of P’s control over A’s physical conduct, course of performance
• AND indirect indicia of control: contingent rent, profit/loss sharing, lease rather than title to inventory/equipment
• More control indicators imply greater likelihood that A will be deemed “servant” under common law

• Court focuses on: formal control rights (Humble’s obligation to reimburse Schneider for utility bills, a major operational expense)

Humble could have argued that Schneider was not acting “in the scope” of employer-employee relationship

If a “Master-Servant” relationship exists:

• M is liable for all S’s torts WITHIN SCOPE of his/her employment.
• M is liable for S’s torts OUTSIDE SCOPE if:
• M intended the conduct/consequences, or
• M himself/herself was negligent or reckless, or
• The conduct violated a non-delegable duty of M, or
• S purported to act or to speak on behalf of the principal and there was reliance upon apparent authority, or he was aided in accomplishing the tort by the existence of the agency relation.

Hoover v. Sun Oil

• Similar facts to Humble, except 30-day notice of contract being terminated, non-exclusive products, no time requirements, no reports required, etc.
• Court says no physical control here, relationship is that of a landlord-tenant or independent contractor

Murphy v. Holiday Inn:

• Δ is a franchiser that provides a name, quality assurance, advertising, and system of operation in return for fees from franchisees
• Court decides that defendant did not control the day-to-day operations of the hotel and thus the master-servant relationship does not exist (also, even though the contract expressly denies that the parties are principal-agent, the contract’s terms do not govern if there is such an agency relationship)

Principal-Agent relationship requires minimal control, but Master-Servant relationship requires extensive control

Tort

• Focus on the relationship
• Did P have sufficient control over A that the relationship falls into the M-S category?
• General definition of agency matters!
• Need to have P-A relationship + extra emphasis on control for it to qualify as M-S
• Apparent Agency complicates things!
• Creates tort liability even though P-A or M-S relationship does not exist (designed to protect reasonable expectations of 3d parties)

Miller v. McDonalds Corp.: factual issues as to whether actual or apparent authority relationship existed between franchisor and franchisee precluded summary judgment

• Apparent Authority: something A has
• Apparent Agency: 3d party believes manifestation that A had authority from P  π must show manifestation that creates reliance interest

R.2d § 228: Conduct of a servant is within the scope of employment if, but only if:

1. it is of the kind he is employed to perform;
2. it occurs substantially within the authorized time and space limits, and
3. it is actuated, at least in part, by a purpose to serve the master

Bushey v. United States: Three Tests

1. Traditional “purpose” test (§228)
2. Lower court’s test (Least Risk Cost Avoider/Bearer Policy-Based Test)
3. Judge Friendly’s test (Foreseeable connection to employment)

A’s Duties Towards P:“An A has a fiduciary duty to act loyally for the P’s benefit in all matter connected with the agency relationship.”

• No secret profits for A
• A cannot deal with P as an adverse party
• A may pursue personal opportunities with P’s consent

Part III: Corporate Formation & Limited Liability

A. Formation of the Corporate Entity

Form Over Substance

Corporation = separate legal entity (numerous legal consequences flow from this)

Ownership structure and governance rights chosen by entrepreneur (promoter)

Default = Sole Proprietorship/General Partnership

Corporate Status (v. Sole Proprietorship or General Partnership)

• Limited liability (no, possible indemnity provisions)
• Free transfer (no)
• Indefinite continuity (at will)
• Central Management (decentralized)
• Awkward Flexibility (excellent)
• Formalities Required (Informal formation)
• Separate Entity (Pass-Through Taxation)

Double Taxation (& Avoidance)

• Individual pays taxes on earnings, so instead Individual forms Corp.
• Corp. can issue After-Tax Dividend (double tax!)
• Corp. can pay salary and benefits (Corp. = 0 GI, Individual = taxed on salary only)

Sources of Law

• Background common law rules (fiduciary duties)
• Mostly DEFAULT rules (if you don’t choose, this is what you get)
• Primarily statutory interpretation (DGCL)

Basic Steps to Form a Corporation

1. Promotional Arrangements (financing, business plan, etc.)
2. Decide where to incorporate
3. File certificate (articles) of incorporation in the chosen location
4. Draft bylaws
5. Hold an organization meeting
6. Elect board of directors
7. Adopt bylaws, issue stock, appoint officers

Deciphering the Charter

Certificate of incorporation = charter (publicly available, filed with Secretary of State)

Broad structure

• Required disclosure (DGCL § 102(a))
• Optional information (DGCL § 102(b))

Hierarchy of Corporate Law

Default Rules: Charter/Bylaws/Corporate Status/Judicial Decisions

Mandatory Rules: Corporate Statute/Judicial Decisions

Liability for Pre-Incorporation Activity

Promoter: someone who purports to act as an A of the business prior to its incorporation

General Fact Pattern: promoter enters into contract on behalf of yet-to-be-formed corporation

1. Once the charter is filed, does the corporation become a party to the contract?

Yes, but not automatically. The corporation must “adopt” the contract.

1. Once the charter is filed, is the promoter liable if the corporation breaches the contract?

Yes, all persons that act as or on behalf of a corporation, knowing that the company wasn’t incorporated, is jointly and severally liable for all liabilities. (MCBA § 2.04) Even if the corporation adopts the contract, the promoter is not necessarily released from liability without a release from the other party to the contract.

1. If the charter is not filed, is the promoter liable on the contract?

Yes, absent an agreement to the contrary, the promoter remains liable if the corporation never comes into existence.

1. If the charter is not filed or is defectively filed, can the defectively formed entity (or individuals) enforce the contract?

Yes.

Southern Gulf Marine v. Camcraft: A third party who dealt with the firm as though it were a corporation and relied on the firm, not the individual defendant, for performance is estopped from denying the firm’s corporate existence.

1. In good faith tried to incorporate
2. Had a legal right to do so
3. Acted as a corporation.

1. Thought it was a corporation all along
2. Would earn a windfall if now allowed to argue that the firm was not a corporation

B. Limited Liability (and Exception: Piercing the Corporate Veil)

General Rule: Unless otherwise provided in the articles of incorporation, corporate SHs are not personally liable for the acts or debts of the corporation except that they may become personally liable by reason of their own acts or conduct