Corporations Prof T A Smith USD Law School

Corporations Prof. T. A. Smith USD Law School Fall 2012

Or. . . Business Associations • Agency • Partnerships • LLCs and other unincorporated entities • Corporations

Agency exists where: – (1) one person (the principal) consents that another (the agent) shall act on P’s behalf and subject to P’s control and – (2) A consents so to act • Ubiquitous – Sole proprietor with one employee – General Motors with CEO 3

Agency Defined: Gorton v. Doty Coach Garst • Soda Springs H. S. Cardinals Teacher Doty

Issue? • What was the issue in this case? – Whether an agency relationship existed between Ms. Doty and Coach Garst • Why did it matter? – As principal, Doty would be liable for the actions of her agent, Garst

The PAT Triangle P (1) Agency relationship between P and A (1) (3) A (2) A’s dealings with T (3) Create legal liability of P to T (and vice-versa) T

The PAT Triangle (1) P A (2) (1) Agency relationship between P and A (3) (2) A’s dealings with T (3) Create legal liability of P to T (and viceversa) T

Legal standard? • Agency is a relationship that results from: – The manifestation of consent by P to A that A shall act • on P’s behalf • Subject to P’s control – A’s consent to so act -- Restatement § 1

Legal standard • Agency exists if: – A manifestation of consent by Doty to Garst that Garst shall act • on Doty’s behalf • Subject to Doty’s control – Garst’s consent to so act

Legal standard applied • Agency exists if: 1. A manifestation of consent by Doty to Garst that Garst shall act • on Doty’s behalf • Subject to Doty’s control 2. Garst’s consent to so act • Evidence? 1. Doty made Garst’s driving the car a condition precedent to its use • How on her behalf? – Dissent’s point? • How subject to her control? – Dissent’s point?

What’s Really Going on Here? • On what grounds did defendant move for a mistrial? – Implication by plaintiff that defendant Doty carried insurance • What effect will this decision have on Doty? On other drivers? – Incentive to insure

The agency relationship • Common issues: P A T – Does an agency relationship exist between P & A? – What consequences follow to P from interaction between A and T?

A Gay Jenson Farms v. Cargill Warren • Revolving line of credit • Right of first refusal on grain Farmers Grain elevator contracts

A Gay Jenson Farms v. Cargill Warren Farmers sue Cargill Warren defaults Farmers

A Gay Jenson Farms v. Cargill : Issue? Warren defaults Why does it matter? Farmers

Define an agency relationship • A manifestation of consent by one person (the principal) that another person (the agent) act: Restatement § 1(1) • On the principal's behalf; and • Subject to the principal's control • The agent's consent to so act

Review questions re: formation 1. Can you form an agency relationship without even knowing that you’re doing it? 2. The Cargill court says, that “there must be an agreement, but not necessarily a contract between the parties. ” What does that mean?

Capacity • Capacity to Be a Principal – Test: Does the principal have the capacity to do the act for which the agent was appointed. – Generally any person having capacity to contract can appoint an agent. – E. g. , minors and incompetents cannot appoint an agent if they could not themselves do the act in question. • Capacity to Be an Agent – Anyone can be an agent.

Holding • Cargill argued that its relationship with Warren was purely contractual. – In contrast, the plaintiff farmers argued that the web of contracts between Cargill and Warren had become so strong that their relationship had evolved into an agency relationship comparable to a sole proprietorship. • Holding? – That an agency relationship did exist between the defendants.

Apply the definition • A manifestation of consent by Cargill that Warren act: – On Cargill’s behalf: How? By procuring the grain for Cargill as part of its ordinary operations, which operations were financed by Cargill

Apply the definition • A manifestation of consent by Cargill that Warren act: – On Cargill’s behalf: How? – Subject to Cargill’s control: How?

Apply the definition • A manifestation of consent by Cargill that Warren act: – On Cargill’s behalf: How? – Subject to Cargill’s control: How? • “By directing Warren to implement its operations. ” – Cf. Gorton v. Doty: Control established by a condition precedent. – Control the end result, even if only by prescribing the agent’s responsibilities • By Interfering in Warren’s operations

Apply the definition • A manifestation of consent by Cargill that Warren act: – On Cargill’s behalf: How? – Subject to Cargill’s control: How? • Warren’s consent to so act: How?

Apply the definition • A manifestation of consent by Cargill that Warren act: – On Cargill’s behalf: How? – Subject to Cargill’s control: How? • Warren’s consent to so act: How? – Sort of ignored it.

Controlling Creditor • Restatement § 14 O: When does a creditor become a principal? • Creditor becomes a principal at that point at which it assumes de facto control over the conduct of the debtor • Nine factors re control • See planning question

Supplier • Restatement § 14 K: – One who contracts to acquire property from a third person 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. • Cargill court opines: – “Under the Restatement approach, it must be shown that the supplier has an independent business before it can be concluded that he is not an agent. ” – True?

Planning • Suppose you are Cargill's lawyer. • The chief executive officer (CEO) of the company, after hearing about the decision in the case involving Warren Grain & Seed Co. , asks for your recommendations about how Cargill should change the way it does business to avoid liability in the future. • What would you say? – you are expected to exercise sound business, as well as legal, judgment, but. . . – your role is to offer alternatives, not to make decisions.

Options? • Do nothing

Options? • Do nothing • Reduce Cargill’s Control – How?

Reconsider any factors? • Cargill's constant recommendations to Warren by telephone; • Cargill's determination that Warren needed "strong paternal guidance"; • Cargill's right of first refusal on grain; • Provision of drafts and forms to Warren upon which Cargill's name was imprinted; • Warren's inability to enter into mortgages, to purchase stock or to pay dividends without Cargill's approval; • Cargill's right of entry onto Warren's premises to carry on periodic checks and audits • Cargill's correspondence and criticism regarding Warren's finances, officers salaries and inventory; • Financing of all Warren's purchases of grain and operating expenses; and • Cargill's power to discontinue the financing of Warren's operations

Options? • Do nothing • Reduce Cargill’s Control • Take on additional control – Mc. Donalds

The Principal-Agent “Problem” • The principal must allow agents to make decisions for her or make decisions on the basis of information provided by the agent • Principal is concerned that the agents will not do what she herself would have done. • Agents have preferences of their own. • These are usually private information. • How can the principal ensure that the agents act in her best interest instead of their own?

Introduction to Agency Costs • Can you suggest some examples? – Shirking – Self-dealing – Opportunism – Great variety. . . • In a restaurant business? A law firm? Other?

Oliver Williamson I won a Nobel Prize in economics for my work on transactions costs and theory of the firm! Check out my papers here: http: //groups. haas. berkeley. e du/bpp/oew/papers. htm It’s hard not to look smug when you’ve won a Nobel Prize!

Opportunism, Hold Ups, and Quasirents • Assume Newspaper and Printer A enter into a contract under which Newspaper pays Printer A $5, 000 per day – Printer B would do the job for $7, 000 per day – The $2, 000 difference is called a “quasi-rent”

Hold up Problem • “Hold-up”: – Attempting to appropriate a quasi-rent by refusing to perform or by demanding that a contract be renegotiated – Why don’t book printers try to holdup the publisher?

Opportunism and markets • Competitive markets deter opportunism because non-cheating party can readily find alternatives • But. . . Markets are not always competitive! – In the press example, you no longer have a competitive market; instead, a bilateral monopoly – You can definitely have temporary bi-lateral monopolies!

“Shirking” by agents • “shirking” = Any action by a member of a production team that diverges from the interests of the team as a whole – Includes not only culpable cheating, but also negligence, oversight, incapacity, and even honest mistakes – In other words, shirking is simply the inevitable consequence of bounded rationality and opportunism within agency relationships – Check out http: //en. wikipedia. org/wiki/Bounded_rationality

Shirking by Agents • Why do agents shirk? – The value of the agent’s productive labor goes mainly to the principal as profit – Agent generated revenues – Agent’s compensation = Principal’s profit – The non-pecuniary benefits of shirking are enjoyed by the agent and none of their value is realized by principal – Translation: Agent enjoys benefit of goofing off (it’s fun) but principal gets none of that benefit

Agency Costs Defined as the sum of three sets of costs incurred to prevent shirking: Monitoring expenditures by P + Bonding expenditures by A + Residual loss (shirking that was not prevented)

Monitoring devices? • Cargill's constant recommendations to Warren by telephone; • Cargill's determination that Warren needed "strong paternal guidance"; • Cargill's right of first refusal on grain; • Provision of drafts and forms to Warren upon which Cargill's name was imprinted; • Warren's inability to enter into mortgages, to purchase stock or to pay dividends without Cargill's approval; • Cargill's right of entry onto Warren's premises to carry on periodic checks and audits • Cargill's correspondence and criticism regarding Warren's finances, officers salaries and inventory; • Financing of all Warren's purchases of grain and operating expenses; and • Cargill's power to discontinue the financing of Warren's operations

Bonding devices • Bail bonds – Other bonding devices? – L&W Associate buys house with big mortgage • Hostages – Did Warren give any hostages?

Ulysses and the Sirens Herbert James Draper

Policy • Do you think the court reached the right result? • Is there a policy goal the court might have been trying to implement?