Transcript Business associations 2: External governance (corporate

Business associations
Section 2:
External governance
(corporate compliance)
Prof. Amitai Aviram
[email protected]
University of Illinois College of Law
Copyright © Amitai Aviram. All Rights Reserved
F15D
External governance
Overview of Chapter 2
a. Liability (to T) for A’s contracts
–
–
–
–
–
A’s liability to T for A’s contracts
Actual authority & ratification
Apparent authority
Estoppel
Special rule for undisclosed principals (virtual apparent authority)
b. Liability (to T) for A’s torts
c. Asset partitioning (limited liability)
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Agent’s liability to T
Types of principals [R3A § 1.04(2)]
Principal Type
T has notice that A acts on
behalf of someone else
Disclosed
Unidentified
Undisclosed
• Determined at time that A & T interact
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T has notice of
P’s identity
Agent’s liability to T
Status based on P’s type
• Disclosed principal [R3A §6.01]
– P & T are parties to the contract; by default, A isn’t a party (unless A & T agree
otherwise)
• Unidentified principal [R3A §6.02]
– P & T are parties to the contract; by default, A is a party (unless A & T agree
otherwise)
• Undisclosed principal [R3A §§6.03, 2.06]
– If A acted with actual authority
• A & T are parties to the contract; by default: P is a party (unless excluded by the
contract)
– If A acted without actual authority
• A is liable to T under R3A §6.10 (see next slide)
• P’s liability to T discussed in “special rule for undisclosed P”
• Non-existent principal [R3A §6.04]
– P doesn’t exist (or has no capacity to contract), so P cannot be a party
– By default, A & T are parties, if A knows/had reason to know that P did not
exist/lacked capacity
– If A doesn’t know that P doesn’t exist then no contract exists, but A may be
liable for breach of implied warranty of authority (see next slide)
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Agent’s liability to T
Liability for exceeding authority
• R3A §6.10: If A purports to act as an agent, A gives T an
implied warranty of authority
• Result: if P is not bound to T, A is liable to T for lacking
power to bind P, unless:
– P ratifies the act;
– A gives notice to T that no warranty is given; or
– T knows that A lacks actual authority
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Principal’s liability to T
Sources for P’s liability to T in contracts
• P may be liable to T for a contract that A made with T on P’s behalf,
based on the any of the following sources of liability:
– Actual authority (including via ratification)
– Apparent authority
– Estoppel
– Special rule for undisclosed principals (“virtual apparent authority”)
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External governance
Overview of Chapter 2
a. P’s liability to T in contracts
–
–
–
–
–
A’s liability to T for A’s contracts
Actual authority & ratification
Apparent authority
Estoppel
Special rule for undisclosed principals (virtual apparent authority)
b. P’s liability to T in torts
c. Asset partitioning (limited liability)
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Actual authority
Elements [R3A §§2.01/3.01]
1.
2.
Manifestations by P that are perceived by A
These manifestation cause A to reasonably believe that A is
authorized to act in a certain way on behalf of P
• R3A §2.02(1): A has actual authority for acts that are “necessary or
incidental” to achieving the principal’s objectives
– Practical tip: if you find there’s actual authority for act Z under R3A §2.01, you can
use R3A §2.02(1) to expand actual authority to other acts that are “necessary or
incidental” to act Z
• Hypo: Patty owns an apartment building & hires Andy to manage it
– P tells A to hire someone to fix the elevators
– A invites Tim to the manager’s office of the building, tells T he is Patty’s
apartment manager & hires T to fix the elevators
– A also hires T to clean the apartment building (P said nothing about it)
– T does jobs & bills P $60 for fixing the elevators, $40 for cleaning
– P refuses to pay. T sues P for breach of contract. Discuss T’s suit.
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Actual authority
Express & implied actual authority
• Discussion of hypo
–
T knows A is acting for P, so P is a disclosed principal (R3A §1.02(2)(a)). As a
disclosed principal, Patty is liable if Andy was her agent & acted with authority
(R3A §6.01)
a) Is Andy Patty’s agent? (R3A §1.01)
b) Was the contract between A & T within A’s authority?
1.
2.
3.
Actual authority? (R3A §2.01/3.01, 2.02)
Apparent authority – relevant; will be discussed later
Irrelevant in this case: ratification; rule for undisclosed P; estoppel
• Some case law calls 1st situation (fixing elevators) “express actual
authority” or “express authority”, and 2nd situation (cleaning)
“implied actual authority” or “implied authority”
– This is an unnecessary distinction; both are actual authority
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Ratification
Elements [R3A §4.01-4.08, 8.06]
•
Ratification retroactively creates actual authority
1. Appropriate approver
–
–
–
Identity
Attributability
Capacity
2. Appropriate approval
–
–
–
–
Unambiguous
Informed
Timely
Appropriate scope
•
Each of these elements was explained in detail in Section 1a3
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Ratification
Effect on future authority
• Ratification without notice to T that A was unauthorized may result in
A having apparent authority in future similar acts
– Suppose that Patty told Andy expressly, in front of Tim, that Andy may not hire
Tim. Nonetheless, Andy hires Tim, who fixes the elevator.
– Patty pays Tim (maybe feeling it’s unfair to leave Tim uncompensated). By
paying Tim, did Patty ratify Andy’s act of hiring Tim?
– When the elevators break again, Andy hires Tim for another job. This time Patty
objects, claiming she specifically prohibited hiring Tim.
– Did Andy have apparent authority to hire Tim the second time?
• Similarly, lack of notice to A that the act was unauthorized may result
in implied actual authority
– Assume that Patty is forced to pay Tim for the second job. She sues Andy for
acting without actual authority.
– Did Andy have actual authority to hire Tim the second time?
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External governance
Overview of Chapter 2
a. Liability (to T) for A’s contracts
–
–
–
–
–
A’s liability to T for A’s contracts
Actual authority & ratification
Apparent authority
Estoppel
Special rule for undisclosed principals (virtual apparent authority)
b. Liability (to T) for A’s torts
c. Asset partitioning (limited liability)
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Apparent authority
The problems with having only actual authority
• Problem 1: How little we know…
– Prof. A is an agent of law school P
– Prof. A shows up at the assigned time in the assigned classroom for the BA class
– How do the students (T) know whether P authorized A to teach the BA course?
• Prof. A tells the worried students to rest assured that the Dean authorized him
to teach the BA course – but this is a manifestation from A to T, not from P to A,
so it doesn’t create authority
– Sometimes only P and A know what the actual authority was, and neither may
have an incentive to tell T (P won’t want to be liable, and A might not want to
antagonize P)
– If A lacked authority, T can still sue A for breaching his implied warranty of
authority (R3A §6.10), but A might be judgment-proof (unattractive to sue
because he has no assets/is a sympathetic defendant/can escape judgment)
– T knows it is unlikely to have evidence of actual authority, so allowing this
problem to exist would make T less likely to be willing to deal with agents
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Apparent authority
The problems with having only actual authority
• Problem 2: Heads I win, tails you lose…
– Prosperity, an hedge fund, hires agent Andy, who is judgment-proof
– Prosperity gives Andy actual authority to buy Google stock on its behalf, but
only at a price no higher than 10% of the market value of the stock
– Andy meets with Tim (who wants to sell his Google stock) in Prosperity’s office;
they agree Prosperity will buy Tim’s stock at 1% above current market price
• If Google increased more than 1% in price, Prosperity could ratify the contract
and make a quick profit
– But Google drops 2% & Prosperity points out it is not bound by the deal since the
price was beyond A’s actual authority (101% of market value > 10% of market value)
– Again, Tim can sue Andy for breaching his implied warranty of authority (R3A
§6.10), but Andy is judgment-proof
– P knows it can get a free option by hiring judgment-proof agents, so allowing
this problem to exist will cause dishonest Ps to hire many judgment-proof As,
increasing fraud and eroding trust in the use of agents
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Apparent authority
Elements [R3A §2.03/3.03]
• Apparent authority was created to address both of these problems:
1.
2.
•
Manifestations by P that are perceived by T
These manifestation cause T to reasonably believe that A is authorized to act
in a certain way on behalf of P
Mirrors the elements of actual authority, except apparent authority
examines P’s manifestations to (& reasonable belief of) T (not A)
– Apparent authority binds P to T, but P can sue A if A exceeded actual authority
• Addresses “how little we know” problem, because T can rely on
manifestations she received from P
– E.g., manifestation of allowing Prof. A to be in class during class times causes
students to reasonably believe that A is authorized to teach the course
• Addresses “heads I win, tails you lose” problem, because P cannot
avoid a deal based on unreasonable limits to A’s actual authority
– E.g., manifestation that A is P’s securities agent makes it reasonable for T to
believe that A is authorized to buy at 101% of market value, so P is bound
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Apparent authority
Hypo
• Patty hired Andy to manage her apartment building. She specifically
told him not to hire anyone to clean the building. Nonetheless, Andy
hires Tim to do so.
– It is customary in that region that apartment managers have the power to
hire janitors to clean the buildings they manage
– Is Patty bound by the contract with Tim?
• Is Andy Patty’s agent? Yes
• Does Andy have actual authority?
1.
2.
Manifestations by P that are perceived by A
These manifestation cause A to reasonably believe that
A is authorized to act in a certain way on behalf of P
• Does Andy have apparent authority?
1.
2.
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Manifestations by P that are perceived by T
These manifestation cause T to reasonably believe that
A is authorized to act in a certain way on behalf of P
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Apparent authority
Manifestations by A
•
Manifestations by A don’t create actual or apparent authority, but
can be circumstances in interpreting P’s manifestations
Hypo: Pete & Angela talk with Tessa. Angela tells Tessa that she is
Pete’s agent and has authority to hire Tessa. Pete hears this and says
nothing.
•
–
•
Assume that an agency relationship exists between P&A
Does Angela have apparent authority to hire Tessa?
1. Manifestations by P that are perceived by T
2. These manifestation cause T to reasonably believe that A is authorized
to act in a certain way on behalf of P
•
If Pete later sues Angela for his loss from having to honor the
contract, does he win?
–
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Assume earlier P told A that she isn’t authorized to hire anyone
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Apparent authority
Lind v. Schenley [CA3 1960]
• What was the main issue in Lind?
Parties in Lind
Lind
Promoted to District Manager
Park & Tilford
Lind’s company
Herrfeldt
P&T’s VP & General Sales Manager
Kaufman
N.Y. Sales manager; Lind’s new boss
Role (P/A/T)?
• Issue 1: Agency relationship (R3A §1.01)
• Issue 2: Authority
–
–
Actual authority?
Apparent authority?
1. Manifestations by P that are perceived by T
2. These manifestation cause T to reasonably believe that A is authorized to act in a
certain way on behalf of P
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Apparent authority
Acts of firm’s organs
• If the organ’s act is not authorized by law, the firm is not bound by it
– When the organ is the board of directors, this is a very small category (DGCL
§141 gives BoD plenary authority, so BoD is authorized by law to do any act on
behalf of firm unless case law/statutory law limits BoD authority)
• If the organ’s act is authorized by law, the firm is bound by it
• If act is authorized by law but prohibited by the charter (ultra vires):
firm is bound by A’s act unless SHs or the Attorney General sue to
enjoin it, in which case T is compensated but doesn’t get anticipated
profits of contract [DGCL §124(1)]
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External governance
Overview of Chapter 2
a. Liability (to T) for A’s contracts
–
–
–
–
–
A’s liability to T for A’s contracts
Actual authority & ratification
Apparent authority
Estoppel
Special rule for undisclosed principals (virtual apparent authority)
b. Liability (to T) for A’s torts
c. Asset partitioning (limited liability)
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Estoppel
Why do we need estoppel?
• Hypo: Heads I win, tails you lose…
– Prosperity, an hedge fund, contacts Andy, who is judgment-proof (unattractive
to sue because he has no assets/can escape litigation or judgment)
– Prosperity tells Andy if anyone got an option to buy Google stock below market
price, it will fund the purchase & share the profits; but they explicitly agree that
Prosperity is not allowing Andy to act as its agent
– Andy meets with Tim (who wants to sell his Google stock) in Prosperity’s office;
they agree Prosperity will buy Tim’s stock at 1% above current market price
• If Google increased more than 1% in price, Prosperity could ratify the contract
and make a quick profit (which it would share with Andy)
– But Google drops 2% & Prosperity denies Andy was its agent. Is Prosperity correct?
– Tim lacks proof of the conversation between Prosperity & Andy, so no evidence
of an agency relationship. Can Tim force Prosperity to buy his Google shares
based on apparent authority? How about “virtual apparent authority”?
– Tim can still sue Andy (for breaching his implied warranty of authority (R3A
§6.10), but Andy is judgment-proof
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Estoppel
The rule
• R3A §2.05: In a transaction between an actor (A) and a third
party (T), which the actor purportedly did on behalf of another
person (P), P is liable to T if:
– T “justifiably is induced to make a detrimental change in position
because the transaction is believed to be on [P’s] account”
and either:
• P intentionally or carelessly caused such belief
or
• Having notice of such belief and that it might induce others to
change their positions, P did not take reasonable steps to
notify them of the facts
• Estoppel can only bind P (T is not bound)
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Estoppel
The hypo reconsidered
• Andy meets with Tim in Prosperity’s office and they agree Prosperity
will buy Tim’s stock at 1% above the current market price
• Google drops 2% in price; Prosperity denies Andy was its agent
• Tim lacks proof of the conversation between Prosperity & Andy
• Is Prosperity liable for Andy’s deal with Tim due to estoppel? If so,
what remedy?
– T makes detrimental change in position
• An expenditure of money or labor, incurrence of a loss, or subjection to
legal liability, but not loss of the benefit of a bargain
• Damages in estoppel are limited to the detrimental change in position
– T’s change in position is due to being justifiably induced
– P either
• intentionally or carelessly caused such belief?
• had notice of T’s inducement & didn’t take reasonable steps to notify T
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Estoppel
Hoddeson v. Koos Bros. [N.J. Super. 1957]
• Hoddeson went to the Koos Brothers furniture store
– At the store, she was helped by “a tall man with dark hair frosted at the
temples and clad in a gray suit”
– He accepted her order & received money
• The man was not an employee of Koos Brothers
– When Hoddeson discovered the fraud, she sued the store
– Is the store liable due to apparent authority?
– Is the store liable due to estoppel?
• T makes detrimental change in position
• T’s change in position is due to being justifiably induced
• P either
– intentionally or carelessly caused such belief?
– had notice of T’s inducement & didn’t take reasonable steps to notify T
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Estoppel
‘Best Buy’ prank
– ~ 80 ‘fake employees’
http://www.improveverywhere.com/2006/04/23/best-buy/
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External governance
Overview of Chapter 2
a. Liability (to T) for A’s contracts
–
–
–
–
–
A’s liability to T for A’s contracts
Actual authority & ratification
Apparent authority
Estoppel
Special rule for undisclosed principals (virtual apparent authority)
b. Liability (to T) for A’s torts
c. Asset partitioning (limited liability)
26
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Undisclosed principal
What’s the problem?
1. Tricking T into dealing with P
–
•
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T is entitled not to deal with P, yet P can trick T by dealing
through A, without A disclosing she’s dealing on P’s behalf
Solution – R3A § 6.11(4): If A falsely represents to T that he is
not acting on behalf of a principal, T is not liable if P or A had
notice that T would not have dealt with P
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Undisclosed principal
What’s the problem?
2. Involuntarily asymmetrical relationship (T is bound; P is not)
•
Hypo
–
–
•
P’s option
–
–
•
If Apple shares increase in price, P ratifies & closes the deal
If Apple shares decrease in price, P claims no liability (no actual authority &
apparent authority is not possible)
But A is a party to the contract (since it was with an undisclosed P)
–
–
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P hires A to buy T’s Apple shares; agency agreement says A can’t pay >$1
A signs deal with T to buy shares for $200K (market price), not mentioning
she’s buying on P’s behalf
Given that A is liable, is it a problem that P is not?
Yes: windfall for P vs. windfall for T
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Undisclosed principal
Solution under R2A
• Inherent authority
– A minimum level of authority inherent in an agent regardless of
P’s manifestations
• This concept was eliminated in R3A
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Undisclosed principal
Solutions under R3A
• R3A §2.06(1):
– Undisclosed P liable to T, if T was justifiably induced to make a
detrimental change in position by A’s unauthorized acts, and P had
notice & didn’t take reasonable steps to notify T
– This is estoppel (will be discussed later in this section)
• R3A §2.06(2):
– Undisclosed P “may not rely on instructions given an agent that
[limit A’s] authority to less than the authority [T] would reasonably
believe [A has] under the same circumstances if [P] had been
disclosed.”
– I call this “virtual apparent authority”: acts that would have had
apparent authority if T knew A was an agent are considered part
of the actual authority
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Undisclosed principal
“Virtual apparent authority”
• Reconsider hypo: P hires A to buy T’s Apple shares; agency agreement
says A can’t pay >$1; A signs deal to buy T’s shares for $200K (market
price), not mentioning she’s acting on P’s behalf
– R3A §2.06(2): Undisclosed P “may not rely on instructions given an agent that
[limit A’s] authority to less than the authority [T] would reasonably believe [A
has] under the same circumstances if [P] had been disclosed.”
• If T knew that A was acting on P’s behalf, would T reasonably believe
that A had authority to offer $200K?
– Probably yes – it would be reasonable for T to believe A was authorized to offer
the market price for the house
• Now change the hypo, so that A offers $2M (x10 market price)
– If T knew that A was acting on P’s behalf, would T reasonably believe that A had
authority to offer $1M?
– Maybe not – would at least raise a “red flag” as to agent’s authority (similar to
Lind)
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Liability for A’s contracts
Sources for P’s liability to T in contracts
• Actual authority
1.
2.
P & A have an agency relationship; and
A had actual authority (including via ratification) to undertake the specific act
1.
2.
Manifestations by P that are perceived by T
These manifestation cause T to reasonably believe that A is authorized to act
in a certain way on behalf of P
• Apparent authority
• Estoppel
1.
2.
3.
T makes detrimental change in position
T’s change in position is due to being justifiably induced
P either intentionally or carelessly caused such belief, or had notice of T’s
inducement & didn’t take reasonable steps to notify
• Special rule for undisclosed principals
1.
2.
3.
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P & A have an agency relationship
P is an undisclosed principal
A has “virtual apparent authority” to undertake the specific act
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External governance
Overview of Chapter 2
a. Liability (to T) for A’s contracts
b. Liability (to T) for A’s torts
–
–
–
–
P’s negligence
Actual authority
Apparent authority
Respondeat superior
c. Asset partitioning (limited liability)
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Liability for A’s torts
A’s liability to T in torts
• R3A §7.01: Agency relationship does not absolve agent from liability
for A’s tortuous conduct
• R3A §7.02: A’s breach of a duty to P doesn’t make A liable to T
• P’s liability when A is not liable
– Generally, P can only be liable in torts for A’s behavior if A is also liable in torts
– Exception: P is liable in torts even when A is not, if P would be liable had he
committed A’s acts [R3A §7.04(2)]
• Example: P sends A (a child too young to be liable in torts) to assault T. P will be
liable for the assault even though A is not liable
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Liability for A’s torts
Sources for P’s liability to T in torts
• P is negligent in selecting/supervising/controlling agent [R3A §7.05]
– This is a simple application of general torts principles
• A acted with actual authority or P ratified A’s conduct [R3A §7.04]
– Because agency relationship + actual authority + A’s act = P’s act
• Acts taken by A with apparent authority constitute the tort [R3A §7.08]
– In order to prevent A from limiting liability by artificially restricting actual
authority (and ratifying after the fact only when P likes the outcome)
– But unlike in contracts, apparent authority in torts is only relevant in a small
number of cases (misrepresentation, defamation, conversion of property),
because tort victims often don’t rely on
• Respondeat superior: employee acting within scope of employment
[“SoE”] [R3A §§7.07, 2.04]
– What is the justification for vicarious liability? (explained in Patterson v. Blair)
– Sources sometimes categorized as direct liability (negligence, actual authority) &
vicarious liability (respondeat superior, apparent authority)
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Liability for A’s torts
P’s negligence
• P is liable in torts to T for A’s conduct if the harm was due to P’s
negligence in selecting or controlling agent
– R3A §7.05(1)
• Liable to whom: any T who foreseeably could be harmed by A’s behavior
• For what: hiring/retaining an A who P knew/should have known was unfit for
the job in the sense that employment placed A in position where his unfitness
would create a foreseeable danger to others (MacDonald v. Hinton, [Ill.App.,
2005])
– R3A §7.05(2)
• Liable to whom: T who has a “special relationship” with P. Recognized ‘special
relationships’ (Iseberg v. Gross [Ill., 2007]): common carrier-passenger,
innkeeper-guest, business invitor-invitee & voluntary custodian-protectee.
Draft of Restatement (3rd) of Torts adds employer-employee, school-student &
landlord-tenant.
• For what: foreseeable harm from A’s behavior
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Liability for A’s torts
Actual authority
• P is liable for A’s conduct if it was within A’s actual authority [7.04(1)]
• E.g.: P gave instructions that A believed, and a reasonable agent would also
believe, authorized the tortuous conduct
• Same liability if P ratified A’s conduct
– Since ratification retroactively grants A actual authority
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Liability for A’s torts
Apparent authority: elements
• R3A §7.08: “A principal is subject to vicarious liability for a tort
committed by an agent in dealing or communicating with a third
party on or purportedly on behalf of the principal when actions taken
by the agent with apparent authority constitute the tort or enable
the agent to conceal its commission.”
• Typically relevant torts
– Misrepresentation
– Conversion of property
– Defamation
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Liability for A’s torts
Apparent authority: examples
• Example: misrepresentation
– A is a salesperson at a bookstore specializing in rare books. T inquires about a
particular book, and A misrepresents to him that this is an extremely rare book
that is worth twice the prices the store is selling it for. Relying on this, T buys
the book, which turns out to be common.
– Bookstore is liable to T, if T can show that – based on A’s position as
salesperson (manifestation by P) – he reasonably believed that A was
authorized to make representations about books. In that case, act with
apparent authority constituted the tort (of tortuous misrepresentation).
• Example: conversion of property
– A is a salesperson at a bookstore specializing in rare books. T wishes to buy a
particular, fragile book. A takes the money & persuades T to leave the book
with the bookstore to properly store it. A then disappears with the cash and the
book.
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Liability for A’s torts
Apparent authority: examples
• Example: defamation
– A is a security guard in a store. A falsely accuses shopper T (with whom he has a
private dispute) of shoplifting. Store is liable under §7.08 because T would
reasonably believe that A was authorized by the store to act in the way that
constituted the tort (A’s shoplifting accusation), based on the manifestation
that A is a security guard there.
– Note: outside SoE (personal motivation), so no liability under §7.07
• Example: concealing a tort (misrepresentation)
– A works at a bookstore specializing in rare books. Certain book has mold on it,
reducing its value. A paints over the mold to hide it (but mold still endangers
book, so book’s value still reduced). A sells book to T, not telling T that book has
(painted-over) mold.
– Bookstore liable to T if A has apparent authority to fix books & the “fix”
concealed the misrepresentation of not disclosing book’s mold problem
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Liability for A’s torts
Respondeat superior: employee
•
“An employee is an agent whose principal controls or has the right
to control the manner and means of the agent’s performance of
work” [R3A §7.07(3)(a)]
–
A gratuitous agent may be an employee [R3A §7.07(3)(b)]
Modern term
(R3A)
Traditional term
(R2A)
Non-agent
[service provider]
Independent contractor
(non-agent)
Non-employee
agent
Independent contractor
(agent-type)
Employee
Servant
41
A has power
to act on P’s
behalf
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P
controls
results
P controls
physical
conduct
Respondeat superior
Employee: Brooks v. Grams, Inc. [Ky. App., 2008]
•
Apryl, who works for Gram’s Grocery, asked her husband Ferand to
drive to WalMart to buy sausage for the grocery
–
–
•
Appelate court: Ferand may have been an agent
–
–
•
If Apryl had authority to ‘employ’ Ferand
Or by ratification, if Fitzgerald ratified Apryl’s acts (e.g., by warning
Ferand about the weather)
But Grams’ liability depends on Ferand being Grams’ employee
–
–
42
Ferand causes an accident that kills him & injures Brooks
Brooks sues Grams; trial court finds Ferand was not an agent
R3A §7.07(3)(a): Did P control the manner & means of A’s performance
of work?
Court suggests several criteria to determine whether Ferand was an
employee
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Respondeat superior
Employee: Brooks v. Grams, Inc.
•
a)
b)
Court: Ferand was not an employee [Green=non-emp.; Red=emp.]
•
•
Extent of control which P may exercise over details of the work
Telling Ferand to drive carefully because of weather isn’t much control; specific
attention to control over instrumentality that caused the harm (car & driving)
Is A engaged in a distinct occupation/business?
Neither a distinct occupation of driver, nor same occupation (grocer)
c) Is work usually done under P’s direction, or by a specialist wo/ supervision?
• Task normally would have been done by Fitzpatrick or Apryl
d)
e)
f)
g)
h)
i)
43
•
•
•
•
•
•
Skill required in the particular occupation [less skill = employee]
Only driving skills required
Who supplies the instrumentalities, tools & place of work for A?
Ferand supplied the car, but Apryl supplied the money; specific attention to
supplying instrumentality that caused the harm (car)
Length of time for which A is employed [long = employee]
Short period of time (one trip to WalMart)
Method of payment, whether by the time or by the job [by time = emp.]
No payment at all; Ferand acted gratuitously
Is the work a part of the regular business of P? [yes = employee]
Yes
Do the parties believe they are creating an employment relationship?
No
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Respondeat superior
Defining SoE [R3A §7.07 (2)]
•
“An employee acts within the scope of employment when
performing work assigned by the employer or engaging in a course
of conduct subject to the employer's control.”
–
•
44
But an act may be within SoE even if:
•
It is forbidden or done in a forbidden manner
•
It is consciously criminal or tortuous
“An employee's act is not within the scope of employment when it
occurs within an independent course of conduct not intended by
the employee to serve any purpose of the employer.”
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Respondeat superior
SoE: Patterson v. Blair [Ky. 2005]
• Patterson buys car from car dealer Courtesy Autoplex
– Owes them $3K, but doesn’t pay
– When employees try to repossess car, Patterson threatens to kill them
– Blair (Courtesy’s service manager & son of owner) encounters Patterson on the
road. When Patterson refuses to exit the car, Blair draws a gun & shoots car’s
tires, disabling it & allowing Courtesy to repossess it
– Patterson sues Blair & Courtesy
– Is Courtesy liable for Blair’s actions?
• Was Blair Courtesy’s employee?
• Was the shooting within Blair’s SoE?
– R3A §7.07(2) positive tests
• performing work assigned by the employer?
• engaging in a course of conduct subject to
the employer's control?
– R3A §7.07(2) negative test
45
• not intended by the employee to serve any
purpose of the employer
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Respondeat superior
SoE: Patterson v. Blair
•
Purpose test (R3A 7.07(2)): act is within SoE if A subjectively acted
to serve a purpose of the employer
–
Here, no doubt this was Blair’s goal – his purpose in shooting tires was to
repossess the car for Courtesy
What facts, if discovered, would make Blair’s actions out of SoE?
–
•
Foreseeability test (Bushey): act is within SoE if P can foresee that A
might cause T harm of similar kind
–
If similar kind of harm is foreseeable, P is liable even if the particular harm
was unforeseeable
•
–
P not liable if A’s actions do not relate to the employment
•
–
46
E.g., Courtesy would be liable if physical conflict with Patterson was foreseeable, even if
shooting car’s tires was not foreseeable
E.g., no liability if Blair was settling a personal score with Patterson
Is Courtesy liable under the foreseeability test?
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Respondeat superior
SoE: foreseeability vs. purpose
• Restatement commentary acknowledges the existence of the
foreseeability test, and rejects it
• The Patterson court rules that Kentucky follows purpose test
– Most jurisdictions follow the purpose test
– On exam apply purpose test only, unless instructed otherwise
47
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Respondeat superior
Practice questions
• Manning v. Grimsley [CA1, 1981]
– Orioles pitcher Grimsley throws ball at hecklers, injuring Manning
– What would Manning argue to hold the Orioles liable?
• Lyon v. Carey [CADC, 1976]
– Furniture delivery person (Carey) told to collect bill upon delivering the
furniture & to only accept cash. He got into an argument with a customer
(Lyon) who wanted to pay by check. He raped, beat & stabbed her.
– What would Lyon argue to hold Carey’s employer liable?
– Tort must be a direct outgrowth of employer’s instructions or job assignment
(it’s not enough that job provides the opportunity to commit the tort)
48
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External governance
Overview of Chapter 2
a. Liability (to T) for A’s contracts
b. Liability (to T) for A’s torts
c. Asset partitioning (limited liability)
– Policy: benefits & costs of asset partitioning
– Legal analysis of veil-piercing
– Asset partitioning in a GP
49
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Asset partitioning
What is asset partitioning?
• Asset partitioning means that the property, rights &
obligations of the firm are separate from those of the firm’s
SHs (even if the SHs control the firm)
• Example: Abe owns 100% of the shares of AbeCo. AbeCo
borrows money from a bank, but when the loan is due,
AbeCo is insolvent
– Abe does not need to pay the loan; AbeCo’s obligation is not his
obligation
50
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Asset partitioning
What is asset partitioning?
Why didn’t you say ‘limited liability’?
• Limited liability is one side of asset partitioning – the
concept that a SH is not liable for the firm’s obligations
• The other side of asset partitioning is that a firm is not
liable for the obligations of its SHs
– E.g., John & Jane each own 50% of the shares of a firm running a
small grocery store. John declares bankruptcy. The debtors
cannot seize the store’s inventory.
51
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Asset partitioning
What is asset partitioning?
• Asset partitioning is so ubiquitous that it’s easier to study
the exceptions than the rule
– For limited liability (the rule that SHs
are not liable for the firm’s obligations),
the exception is called piercing the
[corporate] veil (“PCV”)
– For the rule that the firm is not liable for
SH’s obligations, the exception is
called reverse piercing
52
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Asset partitioning
Benefits
• Why have limited liability? Diversification
– Diversification in firms with limited liability reduces risk because by dividing
investment between many firms, exceptionally good & bad investments
offset each other
– Why is reducing risk (getting an average return on the investment instead of
a chance of either great or terrible return) a good thing?
• But with unlimited liability, diversification actually increases risk
– A single failed investment can accumulate huge debts that wipe out all
of the investor’s assets
– Better to invest everything in one firm and control it well than invest
small amounts in many firms that you don’t control
• Limited liability facilitates smaller, more risk-averse, and minority
(i.e., non-controlling) equity investments
53
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Asset partitioning
Costs
Do creditors unfairly carry the burden of limited liability?
• Voluntary creditors
• Involuntary creditors
54
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Asset partitioning
Costs: voluntary (contractual) creditors
• A voluntary (contractual) creditor can investigate firm’s creditworthiness and contractually mitigate the risk from default by:
– Demanding a higher interest rate (reflecting the risk of the investment)
– Demanding collateral or personal guarantees (to reduce the loss in case of default)
– Imposing covenants (constraints on firm’s behavior so that if the firm increases its
risky behavior, creditor can demand repayment immediately) to reduce likelihood
of default
– Potential creditor can simply not deal with firm, and so avoid becoming a creditor
• Can a contractual creditor protect herself from default if:
– Firm is undercapitalized (had a high risk of insolvency)
– Firm’s controller “cooked the books” (intentionally falsified financial records)?
– Firm’s accounts contain many unintentional inaccuracies because controller is
absent-minded (e.g., forgetting to reduce firm’s available cash after firm pays
dividends)?
55
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Asset partitioning
Costs: involuntary (tort) creditors
• Hypo: A owns Acme, a taxicab company
– A draws all profits out of Acme, so Acme’s only assets are the (used) cabs
– A’s cab runs over B; B sues Acme, but Acme has insufficient assets to pay
• Tort law protects involuntary creditors by forcing potential tortfeasors
to internalize the costs their torts impose on victims
– Causes drivers to drive carefully and maintain their cars
• But limited liability means SHs get the upside of business profits,
while avoiding the downside by letting the firm become insolvent
– Activities that cause torts will be moved into poorly capitalized corporations
that are undeterred & unable to compensate victim
– Veil piercing is needed to address this loophole
56
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Asset partitioning
Legal analysis of veil-piercing
Debtor
PCV
Firm
Controller
Reverse piercing
Controller
Firm
Enterprise liability
Firm
Sister firm
Controller
Firm
Sister
firm
Legal test for all three forms of veil-piercing:

1.
2.
57
Defendant
Such unity of interest between [Debtor] and [Defendant] that
their separate personalities no longer exist; and
Adherence to fiction of separate corporate existence would
sanction fraud or promote injustice
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Asset partitioning
Legal analysis: (1) unity of interest
•
Can’t distinguish debtor’s assets/liabilities from defendant’s
–
–
•
Siphoning assets from debtor to defendant (“tunneling”)
–
–
58
Due to debtor’s failure to comply with corporate formalities (e.g., sloppy
corporate records misrepresent debtor’s assets/liabilities)
Due to commingling of debtor’s & defendant’s assets
Debtor’s assets gifted or sold below fair value to defendant (including through
dividends)
Failure to respect debtor’s separate entity (e.g., defendant uses debtor’s
assets as its own)
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Asset partitioning
Legal analysis: (1) unity of interest
Example (enterprise liability)
• In one case, court considered whether the corporations had:
–
–
–
–
–
–
–
–
–
–
–
59
Common employees
Common record keeping
Centralized accounting
Same officers
Same shareholders
Same telephone number
A common business name
Services rendered by employees of one corporation on behalf of another
Payment of wages by one corp. to another corp.’s employees
Unclear allocation of profits & losses between the corporations
Undocumented transfers between corporations
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Asset partitioning
Legal analysis: (2) injustice
•
“[C]ircumstances must be such that adherence to the fiction of
separate corporate existence would sanction a fraud or promote
injustice.”
Sea-Land [CA7, 1991]: The prospect of unsatisfied judgment does
not satisfy this prong of the test
The injustice prong is satisfied if:
•
•
–
–
•
60
SH used firm to avoid responsibilities to creditors; or
Firm will be “unjustly enriched”
This is still quite vague; for the course, the analysis of the injustice
prong will track our earlier policy discussion: injustice would occur
when the creditor is unfairly burdened by limited liability
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Asset partitioning
Legal analysis: (2) injustice
• Contract (voluntary) creditors
– To mitigate the risk of corporation defaulting, a contractual creditor can
investigate corporation’s credit-worthiness and:
•
•
•
•
–
–
–
–
Decline to lend
Require higher interest to compensate for the higher risk
Require collateral or personal guarantees
Impose covenants (constraints on the behavior of the borrower)
Is a contract creditor adversely affected when the debtor is undercapitalized?
When debtor fails to abide by formalities?
When debtor moves assets between itself & defendant?
When defendant commits fraud against the creditor?
• Tort (involuntary) creditors
–
–
–
–
61
Is a tort creditor adversely affected when the debtor is undercapitalized?
Is a tort creditor adversely affected when debtor fails to abide by formalities?
When debtor moves assets between itself & defendant?
When defendant commits fraud against the creditor?
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Asset partitioning
Legal analysis: (2) injustice
• For a contract creditor: if the circumstances that caused a unity of
interest (failure to observe formalities or siphoning of assets)
prevented the creditor from contractual protection against default
• For a tort creditor: if debtor was undercapitalized
62
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Asset partitioning
Asset partitioning in a GP
• Firm’s liability for SH debts
– Hypo: April, Bev & Chris are partners in ABC law firm. Dave has a judgment
against Bev & wants to collect from ABC.
– RUPA §501: “A partner is not a co-owner of partnership property and has no
interest in partnership property which can be transferred…”
– RUPA §502: A partner’s share of the profits & losses & partner’s right to receive
distributions from the partnership (together, the partner’s “transferable
interest”) is personal property, so creditor can seize Bev’s transferable interest
in ABC
– RUPA §504: Allows a creditor to petition court to issue a charging order (a lien)
against a partner’s transferable interest. Court may then order foreclosure
(sale of the transferable interest to a third party, with proceeds used to pay
debt to creditor)
63
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Asset partitioning
Asset partitioning in a GP
• SH’s liability for firm’s debts (unlimited liability)
– Example: April, Bev & Chris are partners in ABC law firm. Dave has a judgment
against ABC & wants to collect from Chris.
– RUPA §306: All partners are liable jointly & severally for all obligations of the
partnership unless:
•
•
•
•
Otherwise agreed by the claimant
Otherwise provided by law
Partner admitted into partnership after obligation was incurred
Obligation incurred while partnership is an LLP
– RUPA §307(d): Creditor must first attempt & fail to collect the debt from the
partnership (exhaust partnership assets), unless:
64
• Partnership is a debtor in bankruptcy
• Partner agreed that creditor need not exhaust partnership assets
• Court permitted collecting from partner because partnership assets are clearly
insufficient to satisfy judgment or exhaustion of partnership assets is
excessively burdensome
• Partner is directly liable for debt
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