Business
Associations Class Notes
Here
come two white books containing some
Business (or for-profit) corporations
In
The corporate family tree
Investors are people who invest money
in the corporation. “Money to a corporation
is like blood to humans: without it, you die.”
Creditors (e.g. owners of company
bonds) take first upon dissolution. Dissolution has a different context in a
corporate situation than in a partnership situation: it means termination of legal existence. Creditors take first, and if there’s anything
left, then the equity investors take what’s left.
Where
does the term “equity” in “equity investor” come from? It comes from the law of mortgage. Debtors would secure a loan by giving
creditors a deed that is absolute on its face.
Needless to say, some creditors applied very unfair procedures, and in response,
the debtors went to the courts of equity (
All
investors other than creditors are thus called equity investors. A prime example of this classification are owners of common
stock. Another example is owners of
preferred stock. That is an equity
investment too, but upon dissolution, a preferred stock owner takes after creditors but before common stock. There
are a number of different “flavors” of equity investors. We will study a little bit about options on
equity in this course, primarily options on common stock. Options are used primarily in the context of executive stock options, which we’ll
study closely. But, the term has a broader application. A warrant
is a long-term option that is transferable. For a few companies in this country, there
are perpetual warrants out there that
are occasionally traded on the stock exchange.
Executive stock options are nearly always non-transferable, with one exception. If you die, your beneficiaries get the option
and usually will have the opportunity to exercise
the option if they want to.
Voting stockholders elect the
directors. Are there non-voting classes
of stock? Yes, in most states, including
both
But
will this go over well in trying to sell the “Class B” stock to the
public? It’s problematic. Academic studies show that if you run things
this way, there is going to be an 8-10% discount from what you could get if you
sold the public voting stock, thus potentially
passing voting control to the public. Why
the discount, though? One theoretical
way for a shareholder in a public company to make out very well is for there to
be a takeover at a bigger company at a substantial premium, like 25-35% over
market price. If the founding family
owns all of the voting stock, is there going to ever be a hostile takeover? No,
never. There will also be fewer
supplicants for a friendly takeover.
Furthermore,
a number of the voting securities broker-dealers will refuse to handle the sale
of non-voting stock. You can always find
someone who will, though, but you might have to pay them more. The reason some broker-dealers won’t take on
an IPO of non-voting stock is that “you sell the sizzle, not the steak”. If the broker-dealer can’t sell all the stock
in the new company, then they have to “eat” it.
They just have to hold on to the stock they can’t sell in the IPO until
they can find enough buyers. The
financial markets go as much by “sizzle” as by rationality, according to
Shipman.
The
directors have several jobs. The most important one is the hiring and
firing of officers. Officers are very high-level management employees
with a formal legal title: “executive vice president” or whatever. The other roles of the directors are to pass major
transactions, to monitor the officers, and to set long-range plans and policies. The directors are advised by lawyers, CPAs,
management consultants, and investment bankers.
They are not expected to be super-experts in all those areas, or even be
super-experts in what the company does.
Warren Buffett is a director of Coca-Cola, but
he doesn’t know anything about how to run a bottling operation. However, he does know how to pick out people
who do know how to run bottling
operations. Those officers are agents.
Agency
Agency is a legal relationship
that is crucial to any common law legal system because most of the work in the
world is done by agents working for
their principal. Is the law of agency limited to business
transactions? No way! It covers both personal activities and business activities. It’s another “AC/DC”. In order to have an agency relationship, do
you need to have a contract or consideration or both? No way!!!
Very often, there is a contract
and consideration. Take, for example,
Joe Smith running a hamburger joint as a sole proprietor. He hires Mr. Jones under a signed, written
two year contract as general manager of “Hamburger Joint Unlimited”. It’s a valid contract. There’s consideration on both sides. That’s an example of where there would be a contract and consideration.
But
very often in the personal area, and even in other areas, there is no contract
or consideration. Let’s say it’s
Thanksgiving and a student comes home from college to be with her family. It’s the day before, and her father is
cooking the turkey, and he is missing a certain ingredient. He says: “Hey daughter! Drive to the 7-11 and get Item X!” Then he gives her $20. She gets in the car,
and on the way to 7-11 she’s negligent and she kills a neurosurgeon making $2
million a year. The neurosurgeon was not
negligent at all. Can we say that she
was negligently entrusted? No! She’s usually a good driver! The father has not only a $300,000 auto
policy, but also a $2,000,000 umbrella policy.
In many states, the family errand
doctrine is such that the father can be reached. The daughter is presumably insolvent. Under agency principles, many states will say
that the daughter is an agent for the father on family business. But that doesn’t require consideration or a contract! Does agency require a business setting? No! It
often is a business setting, but that’s not required. The widow of the neurosurgeon can reach the
father and his two insurance policies under the family errand doctrine. It’s not a sure shot, but in many states it
would work.
Why
do we learn agency? Most of the work of
the world is done by agents working
for principals. Agency is a conductor of liability. Plaintiffs’
lawyers are always looking for financially
solvent parties who are reachable.
What,
then, is an agency? Agency is an agreement by one person (an agent) to act for a principal at the principal’s
direction and control.
We
have established the definition of agency that we’ll work with: now let’s look
at the three subdivisions of agency: (1)
the servant-agent, (2) the non-servant agent, and (3) the non-agent.
The servant-agent
The
servant-agent means precisely the same thing as “common law employee”. If the principal has legal power to control the agent’s time allocation as well as how and when the agent works, then the person is a servant-agent. So where does this come up? It comes up in tax and other statutes that
refer to the word “employee”. Both of
the Supreme Court cases we read for today get into this issue. Also, respondeat
superior depends on this distinction.
In
the corporate scheme of things, how do board members fit? If a person is a director and only a director, then that person is not
any type of agent. How come?
An agent is one who agrees to act for
the principal and at the principal’s
control and direction. This definition
doesn’t fit a director qua director,
because they are the ones who determine the principal’s policies! This has practical ramifications: there is no
wage withholding from the pay of directors.
They get a check from the company and they have to pay by declaration of
estimated tax. Furthermore, in almost
all states, a person who is a director and only a director is not covered by
Worker’s Compensation or Equal Employment statutes. It’s the same way with a partner in a general
partnership. The partners, acting
together, determine the partnership
policy. Thus, a partner of a partnership
is not an employee of the partnership and has no wage withholding.
There
are two statutory “curlicues” for this.
In
Is
the top officer of a corporation a servant-agent? Yes.
If you carefully go through the definition, you’ll find that the principal is the board of directors in
this case. They have the legal power to
allocate the time of the president. The
president of a corporation is a servant-agent.
The president’s salary is withheld, and the president is covered by
Workers’ Comp and Equal Employment statutes.
The non-servant agent
An
example of this would be a law firm that you hire to handle a legal
problem. You go talk to a partner of a
law firm, work out a fee, and they work on your problem (draft your will or
whatever). The partner offers to drive
out and talk to you at your house. The partner
of the law firm, while on the way to your house to see you, negligently runs
over and kills a baby. Nobody else is negligent. Does respondeat superior apply? No. The
doctrine of respondeat superior applies only where the agent is a servant-agent. With the law firm downtown, I don’t have the
legal power to tell them how and when to do the work for me. I can control the result, but I can’t control
the process. Respondeat superior is
built upon the premise that where there is a servant-agent over whom the
principal has the legal power over their physical activities, the principal is liable
whether or not he is negligent in hiring and training that agent. On the other hand, respondeat superior doesn’t
apply to a non-servant agent. Does that
mean that the plaintiff’s mother is out of legal theories? No. If
I was negligent in hiring the firm, that is, I negligently entrusted them to
drive to my home, then I am liable. But
how can that be proved? Maybe the partners of the firm had run over
10 babies in the last year, and I became aware of this. Then my hiring of the law firm to come to my
home may be negligent.
Why
doesn’t Shipman use the term independent contractor? “It’s because it’s the work of the devil.” The Restatement uses it to include people who
are not agents and those who are not servant-agents. Courts use it to mean something
different. So use Shipman’s topology and
you won’t get screwed up!
The
president of GM is a common law employee, or servant-agent, or GM. But the outside law firm of GM is not a servant-agent of GM. So we have defined agency. It can be personal or business-related. It can be contractual or not. It need not be in writing, usually.
In
Consequences of agency
Agency
is very broad. What are some of the
consequences of agency? One of the most
crucial consequences is that any agency relationship creates heavy fiduciary duties running both ways. For example, in Russ v. TRW, an Ohio Supreme Court case post-1980, a huge
Cleveland-based defense contractor was doing very profitable work for the
Defense Department. Russ was a young
accountant assigned to calculate the cost figure in “cost plus”. He came up with figure “x”, and went to his
boss, who said “this figure is too small”.
He was told to change the figure to “5x”. The Defense Department finally figured out
the scam. There are lots of fraud statutes
on the books. An investigation uncovers
the young accountant, who is taken into the FBI Headquarters and “scared
shitless”. They play psychological
hardball with him. They tell him about
Russ
sued under a section of the Restatement of Agency saying the following: “If the
principal knows that what the principal is ordering the agent to do is criminal,
the principal must tell the agent up front that what the agent is being told to
do is a crime.” The Ohio Supreme Court
held that this fiduciary duty was violated.
They granted punitive damages (and in
A major
fiduciary duty running from the agent
to the principal is a duty to promptly and accurately account and disclose. Here’s a hypo: you’re hired as a debt
collector, and you’re dealing with very poor people. You collect in cash. At the end of each day, you must write out a
report on what you’ve collected and turn it over. That’s a fiduciary duty. In the corporate area, directors, officers,
all employees, promoters, and controlling persons owe a heavy fiduciary duty to
the corporation, and in some cases they also owe the duty to the minority
shareholders. The law of fiduciary duty
is a big part of this course.
The agent’s lien
A lien is a charge upon, or interest in,
property. Speaking poetically, it is a rough form of co-ownership. How do we know that? We read the Graham memo on attorney’s
liens. Your attorney is your non-servant
agent. You can’t tell him how to do his
job. You can control the result, but not
the exact process. A general rule is
that an agent not paid what the
principal promises to pay him may (emphasis on may) have a lien on property of
the principal in his possession. Graham
discusses how in the personal injury context, if you go to a lawyer and retain
him for a one-third contingent fee, and he drafts an engagement letter with
strong attorney’s lien language in it, and the attorney for the defendant knows of that lien, and the defendant
settles with your client without your knowledge, cuts the check solely to your
client, the defendant is going to have to pay twice as to your one-third.
Why? If you had the lien through
the right language in the contract and the defendant knew about it, you, as a
lawyer have a “hard-core” property interest in that cause of action. It can be settled without liability to the defendant
only with two signatures: yours and
the defendant’s. If an insurance company
has a subrogation right to the settlement, there may need to be three
signatures on the settlement agreement. Liens
are important!!!
So
we have this guy collecting money, in cash, from poor people. He doesn’t use force and he doesn’t lie, but
he is persistent. Let’s say the deal he
has with his principal is that the agent gets to keep 20% of what he
collects. He’ll come by at the end of
the day with the money and the statement of account, and the principal will
write the agent a check for the 20%. Let’s
say everything goes well for six months.
One day, you collect $1,000. You
give the principal the report and say that he’ll get the cash when you get the
check for your 20% ($200). The principal
says: “No. You’re being paid too
much. Give me the money!” The agent can count out $800 in cash, give it
to him, keep the $200 and walk out. That
would be a perfectly valid agent’s lien because the deal is 20%.
Liens
of agents are crucial, and attorney’s liens are one of the most important. Graham’s memo also develops the concept of
subrogation. An insurance company would
have a lien on the settlement of the personal injury claim by way of
subrogation.
Here’s
another hypo: there’s both a first and second mortgage on property. The mortgagor missed a mortgage payment and
the first mortgage forecloses. Under the
law in most states, the second mortgage will lose its in rem rights
against the property with the foreclosure of the first mortgage. It won’t lose the in personam rights on the note.
Therefore, when a first mortgage is foreclosed, very often the second
mortgagee, to protect themselves, will buy
in at the foreclosure sale (will be the high bidder). Braunstein can tell us why this is so, but
Shipman doesn’t know. When the second
mortgagee buys the first mortgagee’s interest, most courts hold that, by
subrogation, the second mortgagee gets all
of the rights of the first mortgagee, and that can be crucial.
Notice
Notice
to a sufficiently important agent of a principal is notice to the principal
itself at common law. In the U.S.
Supreme Court, post-1990, Chief Justice Rehnquist wrote an opinion regarding an
EEOC proceeding where the plaintiff lost at the administrative agency
level. The statute says that a losing
claimant may appeal within 30 days of notice
to him. The lawyer tried the case,
went on a European vacation, and didn’t leave the memo with his secretary of
what to do if things happen during your absence. That’s malpractice per se. The lawyer was in
There’s
an exception in Article I of the Uniform Commercial Code that tries to reverse
the common law rule. If you want to get
fast notice, and you’re dealing with an organization, give notice not only to
the local guy but also to the president in