Business Associations Class Notes 6/17/04

Agency in the contract setting

We’ve looked at agency in the tort setting; now we’ll look at three prototypical agency cases in the contract setting. Say you have X, Inc., and Ms. Jones, president of the company. Say Ms. Jones enters into a large but not extraordinary construction contract. When you get to extraordinary items, you’ll have to have the approval of the board of directors. That’s why we presume the contract is not extraordinary. The contract is in writing and is described in the first paragraph as a contract between TP (Third Party) and X, Inc. Then at the signature block at the bottom, we find it set up as follows: “X, INC., by: Jane Jones, Pres.” TP will sign above. Jane Jones signs on the dotted line. That means that Jones has signed in her corporate capacity.

If there is (1) actual authority on the part of the agent, (2) the contract describes itself as a contract between TP and X, Inc. and (3) the signature block reads properly (agency capacity) then there is a valid contract between TP and X, Inc. and Jones has no personal liability on such a contract, with the exception of fraud, in which case TP may sue Jones and clearly sue X, Inc. for rescission and, in some states, TP can sue X, Inc. for damages. If TP wants Jones to have personal liability, there will have to be material below the line reading: “I, Jane Jones, in my individual capacity, do hereby guarantee the performance and payment of this contract.” Then she’ll sign again, just simply as “Jane Jones” with nothing under the signature. That is not present in our example here. If there is actual authority, the fact that the third party does not believe there is actual authority is totally irrelevant. Usually the third party will believe it, but if, in fact, TP didn’t really believe it, it doesn’t matter.

Actual authority

It comes in two flavors: (1) express and (2) implied. Either flavor suffices. The difference between the two goes back to McCullough v. Maryland and Chief Justice Marshall’s opinion dealing with the Bank of the United States. He said: “Let the end be legitimate and proper and all powers necessary to reach that end are implied.” That’s a Constitutional Law principle. Conceptually, actual authority results from manifestations by the principal to the agent that she has such authority. These manifestations can come in various ways: (1) in the charter, (2) in the regulations, (3) in the resolutions of the board of directors, or (4) if the principal has ratified similar transactions by the agent in the past.

If you are dealing with a big corporation that is heavy on paperwork, on a big transaction, supplies will sometimes require a purchase order or a board of directors resolution up front because they don’t want to get into litigation. The flip side is that if you are the third party and you’re dealing with the president, and you submit the bill to the corporate treasury for payment, the treasurer may ask the president where the purchase order or board of directors resolution can be found. That is a practical matter. In addition, a sophisticated supplier not under pressure in a big transaction will request the signed, written opinion of the outside counsel to the corporation because this will get everyone in gear to make sure the paperwork is clear.

What about powers of attorney? A power of attorney is a written instrument creating agency. You’ll have a serious operation, for example, with a lot of bad medicine for six weeks. You would stop and fill out a power of attorney to your spouse, parent, or close friend, sign it, and give it to them. Powers of attorney come in two flavors: (1) general power of attorney, and (2) special power of attorney, which is more limited.

There is an old Third Circuit case from the 1940’s called Von Wedel. In New York City, there was a married couple where the wife was a United States citizen and the husband had a Green Card but was a German citizen. It was 1940, 18 months before the United States entered the war. The husband decided he had to go back to Germany and fight. Before he left, he made out a power of attorney to his friend X with the broadest possible general powers in it. X can do anything that husband was allowed to do. X thought the husband’s assets were about to be seized by the United States government. X uses the power of attorney to transfer all of the husband’s assets to the wife. The United States Department of Justice challenged the transfer, and the Third Circuit found that gifts of all assets were so unusual that it could not be done under even the most general power of attorney. What should the husband have done? He should have transferred the assets himself before he left, because that would have been unchallenged.

Today we deal with something similar to special power of attorney. We’re dealing with the actions of partners, directors, or high officers of business associations. Take the facts of the example above, and let’s say that in the articles of incorporation of X, Inc. is a provision that says “no officer or employee shall cause a corporate contract to be entered into for more than $5,000, unless the board of directors first authorizes.” Let us say for the sake of argument that the contract in question is for $50,000. In the past three years, Jones, as president, on behalf of X with respect to everyone she’s dealt with, she has signed contracts for $50,000 or $100,000 and the parties have been paid. This shows apparent though not actual authority.

Apparent authority

Let’s say more specifically that TP is unaware of the $5,000 limit in the articles of incorporation. The goods are delivered to X, Inc. and the invoice is sent to the treasurer of X. He gets a nasty letter back with a certified copy of the provision of the articles of incorporation. Under these facts, TP can hold X to the contract because a type of reliance has been proven by TP. TP has shown that it did not know of the restriction on actual authority. Thus, apparent authority kicks in. X is liable on the contract, and has, in theory, a cause of action against Jones for any damages they can prove. The cause of action of X, Inc. against Jones will disappear if the board of directors of X, Inc. expressly, implicitly, or by conduct ratifies or adopts the contract. This action will make it as if there was actual authority from the beginning. But if the board of directors does not ratify, TP has a cause of action in restitution against X, Inc. There may also be hardcore estoppel, fraud, and so on. The tricky thing is that TP has an action against Jones for breach of the implied warranty or implied representation of authority. An agent signing impliedly represents or warrants that he or she has authority (in some states, this is watered down to “reasonably believes he or she has authority”).

On the other hand, let’s change the facts such that TP is aware of the $5,000 limit in the articles of incorporation. TP went to the statehouse and read X’s charter before dealing with Jane Jones. There is no apparent authority in Jones in this case, because TP cannot make out an apparent authority case if TP knows there is no actual authority.

Along the same lines of the agent’s liability, under the UCC, if you sign a negotiable instrument as an agent and you do not bind the principal, under the UCC, you as agent have total, automatic liability. Furthermore, in about four states, if an agent signs as an agent and doesn’t bind the principal, then it’s automatic personal liability. But that’s a minority view.

If you’re dealing with federal, state, or local government, the agent you’re dealing with must have actual authority, or none at all. There is no such thing as apparent authority when it comes to government. Obviously, however, restitution may be available against a government. If the government commits fraud, you must check the Federal Tort Claims Act, which tends to negate fraud. It has numerous exceptions, including acts by the United States government abroad. If you’re in France, for example, and a United States government army truck runs you over negligently, you probably have no claim under the FTCA. When your back is to the wall, don’t forget the possibilities of restitution and true estoppel (where the principal has held out and you have relied to your detriment).

Consider the case of Maglica v. Maglica. Maglica started Mag-Lite in his garage 35 years ago. He had been married and divorced. He met a woman about his age who had also been married and divorced. The woman became active in the business for 20 or 25 years. One day, he booted her out. She sued under various theories including restitution (benefits conferred). The business was worth about $600 million at the time, and she sued for $300 million. The jury came back with a verdict for hundreds of millions of dollars. The Court of Appeals sent it back for a new trial because they said the instructions were insufficient. Restitution is the smaller of the work you put out versus the reasonable value of the benefits conferred. She settled for $30 million.

There was also Marvin v. Marvin. A young woman moved in with Lee Marvin. Later, he booted her out and there was a suit for the reasonable value of services. This opinion lays out the issues nicely. The first issue is whether it is the transaction is more or less prostitution and thus against public policy. They found that she could recover something. But in many other states, it’s a complete non-starter. In Virginia, by statute or constitutional amendment, they recently prohibited Marvin v. Marvin kinds of lawsuits.

So first you consider whether you have the approval of the board of directors. In the cases we’re dealing with today, we are assuming that these are instances where you don’t need the board’s approval. In a close corporation, the standards can vary, either tighter or looser. Shipman has seen cases going both ways. In a tearjerker of a case, Brandywine Racing in the Delaware Court of Chancery in the 1940’s, a group of guys got together, deciding that Delaware needed a new racetrack. To build a racetrack, you need approval from the racing commission. To get the racing commission’s approval, you need good architects’ plans. The company was formed, and a couple of the directors went to the architect, asking if he would expedite the drafting of the plans. The board of directors did not formally act. The two people who negotiated with the architect did not own a substantial percentage of the company. The architect delivered the plans on time and the racing commission delivered permission for the track. Sounds good so far.

But “who knows what evil lurks in the hearts of men”? The architect sends a bill to the company. The two directors didn’t have the actual authority to make the deal! The company tells the architect that they will get nothing! A lawsuit was brought, and it went to a bench trial. The court holds that there was no actual or apparent authority for the directors to do the deal with the architect. The lawyer says to the court: “Give us the same amount under restitution: benefits conferred!” The judge got the complaint out and found there was no count two for restitution. The architect is screwed! The moral of the story is, always put in count two for restitution! The law firm committed malpractice! Always look at all of you theories, because the typical case today will have five or six different causes of action.

Consider a Pennsylvania case from the late 1940’s involving a close corporation. The war broke out in late 1941, and a lot of people did a lot of patriotic things. A top officer at this close corporation circulated a memo to the plant workers and told them that those who wanted to enlist and serve would be given a check for the difference between their military pay and their civilian pay at the plant. Many employees did enlist, and most came back and did not submit the claim for reimbursement. The plaintiff did and was fired! (Today, that would be an abusive discharge under Ohio law.) There was a big trial in which the court decided that the offer was so momentous that only the board of directors could have authorized it. The board of directors never formally took up the proposal. But the court held, however, that since it’s a close corporation and two directors knew about it, there was implied ratification or adoption.

Tomorrow at noon is the first voluntary review session.

National Biscuit Co. v. Stroud

Here we have a 50-50 two man partnership running a grocery store. The first partner said: “Don’t buy from X.” The second partner continued to buy from X, who knew about the dispute. There could be no apparent authority. They read § 18 of the Uniform Partnership Act, which says that when you have a deadlock among partners on this particular issue, any partner has actual authority for any typical transaction. Substantially the same result would have been reached under restitution. But the court upheld the contract.

Smith v. Dixon

Under § 9, limits are imposed on partnership. If you’re a bank making a loan to a law firm that will be a business loan, cognovit clauses will be used by the bank. That’s okay for a business transaction in Ohio. But there’s a surprise in § 9…you’ll have to have the signature of every partner! It’s the same for an arbitration agreement, the sale of all assets, or the sale of goodwill. The law firm will handle this by getting a power of attorney from each new partner as they are admitted for limited purposes such as those specifically mentioned in § 9. The senior partner will sign once for himself, and then once for each other partner, with an asterisk indicating that he’s using the power of attorney he got earlier.

Here we have a family farming partnership in Arkansas. Various members of the family are partners. They met one Sunday and authorized the old man to sell the farm. But they told him not to go below $230,000. The old man signs for the partnership at $210,000. It is binding on the partnership and the other partners? Applying our catechisms, there was no actual authority because the partnership assembled and under § 18 gave him binding instructions not to go under $230,000. However, as the court held, there was apparent authority and the third party did not know of the secret limitation on the price. “Apparent authority makes the world go round!” Therefore, there was a valid contract binding on everyone.

In the Matter of Drive-In Development Corp.

P, Inc. owned 100% of S, Inc. P, Inc. is borrowing money from a bank. P, Inc. happens to be in pretty bad shape itself, while the subsidiary, S, happens to be in good financial shape. The bank wants what is known as an “upstream written guaranty” by S, Inc. of S’s liability to the bank. The corporate secretary for S, Inc. fills out a certificate and delivers it to the bank stating that S’s board of directors has duly met and has unanimously approved the S guaranty. Based on that, S’s president has signed the guaranty on behalf of S, Inc. Later, there is a bankruptcy and the bank files its claim both against P, Inc. and S, Inc. There are two touchy issues: (1) It just so happened that the board of directors of S, Inc. didn’t actually meet, and an upstream guaranty is so unusual that only the board of directors could approve it. S, Inc. says “Sorry, the board didn’t meet, despite what the corporate secretary did. Without a board meeting, we’re not liable on the guaranty!” On the agency issue, the court holds that there is apparent authority. The notes indicate some contrary authority. In the later case, a reasonable person would have been put on notice if the secretary was lying. (2) There also were the fraudulent conveyance statutes. Here, the attorney for S did not properly raise the issue in the bankruptcy court. In a big 1990’s Third Circuit case, upstream guaranties were said not to be per se fraudulent.

Black v. Harrison Home Co.

Here we have a closely held corporation buying land to sell lot by lot. As you come to the last lots, you’re selling substantially all of your assets. Does that mean that the company must have board of directors and shareholders’ approval for the last lots? When a land company contemplates that they’ll sell off the lots one by one, the officers themselves can do it. In the bylaws of the company, it said that there had to be two officers’ signatures on a contract for it to be valid. The parents started dying off and the daughter was effectively the only owner and the only officer. She signed a contract on behalf of the company for the sale of the last lot. Then she dies. Her estate has not yet been probated. The court held that there was no actual authority for her to sell with one signature and that therefore the company could not be bound. The case is clearly wrong on modern standards because though she did not have actual authority, she did have apparent authority because the third party had no reason to know of the unusual bylaw with the two signature requirement. The plaintiff’s last theory was that the corporate fiction should be disregarded because the daughter owned all the stock and it would be silly to talk about lack of authority as an officer. The court said that would be true if her estate is solvent enough to pay off all her creditors. But the plaintiff’s counsel neglected to allege that to be the case, and the court won’t go along with them.

Lee v. Jenkins Bros.

Here we have a closely held corporation where the president orally assured a guy of a pension if he would switch employers. He worked for twenty years, after which he was laid off without a pension. He sues the company. There are two defenses: (1) statute of frauds, and (2) no authority on the part of the president to make this contract. The district judge held that in Connecticut at that time the statute of frauds was a complete defense. He did not reach the authority issue. Then it goes to the Second Circuit which held that the authority issue ought to be looked at too. In Ohio and in a number of states, very substantial partial performance will take you out of the statute of frauds. In terms of authority, lifetime contracts and contracts for a pension are viewed with much suspicion by courts. In Ohio and in a number of states, if you’re an employee, you’re better off with a limited but long-term contract (10 or 20 years). Many states will say that a lifetime contract is “too rich” and “too indefinite”. The case has a good discussion of apparent and actual authority. The court makes the point that if the board of directors ratifies similar transactions, that can create actual authority in that it’s a signal to the agent that he has the authority. It can also create apparent authority to the world at large. The employee should have gotten the promise in writing, and he should have gotten the board of directors to approve! Since the president owned most of the stock, in a number of states, they would go with the employee on the agency issue and it would help on the statute of frauds issue.

Davis v. Sheerin

Here we have despicable conduct on the part of the majority shareholder. The majority shareholder claims that the minority shareholder isn’t a shareholder at all! The minority shareholder brings an action for oppression. Since what the majority shareholder was doing was arguably oppressive, the minority shareholder claims that the court should enter an order forcing the majority shareholder to buy the minority shareholder’s shares at market value without a minority discount. The problem was that until five years before, Texas had a statute authorizing this remedy. The statute was modeled after Michigan and California. (Ohio is silent on this issue right now.) The Texas legislature had repealed the statute. The court held that as a court of equity they have inherent jurisdiction under judge-made law to enter the order. The order will cause a sale of several hundred thousand dollars. In Ohio, you would have to hook up with Crosby v. Bing. You would have a pretty good chance, in Shipman’s view. The notes after this case discuss oppression, which is a post-1960 buzzword. Just what is oppressive, though? You don’t need violence or fraud in order to have oppression. There was a Minnesota case where the majority shareholder ran the place and the minority shareholder was simply ignored. That was seen to be oppressive.

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