Business associations
Section 2:
External governance
(corporate compliance)
Prof. Amitai Aviram
Aviram@illinois.edu
University of Illinois College of Law
Copyright © Amitai Aviram. All Rights Reserved
F16
© Amitai Aviram. All rights reserved.
External governance
Overview of Chapter 2
a. Liability (to T) for A’s contracts
1.
2.
3.
4.
Liability framework in contracts
Apparent authority
Estoppel
Virtual apparent authority
b. Liability (to T) for A’s torts
c. Defendant eugenics: additional tools
2
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Liability framework
3
The shielding problem
• Any time B is liable for unauthorized acts of A, we are undermining
the ability of B to control A through authority
– And therefore increasing the cost to B of using actors
– So, from the perspective of the agency problem between A & B, we would want
B to be liable only for A’s authorized acts
• However, acting through others creates a second problem (besides
the agency problem): the shielding problem
– The shielding problem: inefficiencies between B & T caused by the ability to act
through others
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Liability framework
4
The shielding problem (in contracts)
• The shielding problem from T’s perspective: How little we know…
– Prof. A is an agent of law school B
– Prof. A shows up at the assigned time in the assigned classroom for the BA class
– How do the students (T) know whether B 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 B to A,
so it doesn’t create authority
– Sometimes only B and A know what the actual authority was, and neither may
have an incentive to tell T (B won’t want to be liable, and A might not want to
antagonize B)
– 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 is unlikely to have evidence of actual authority, so allowing this problem to
exist would make T less willing to deal with A
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Liability framework
5
The shielding problem (in contracts)
• The shielding problem from B’s perspective: Heads I win, tails you lose…
– BigBiz, an hedge fund, hires agent Andy, who is judgment-proof
– BigBiz 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 BigBiz’s office;
they agree BigBiz will buy Tim’s stock at 1% above current market price
• If Google increased more than 1% in price, BigBiz could ratify the contract and
make a quick profit
– But Google drops 2% & BigBiz 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)
– Tim can sue Andy for breaching his implied warranty of authority (R3A §6.10),
but Andy is judgment-proof
– B knows it can get a free option by hiring judgment-proof agents, so allowing
this problem to exist will cause dishonest Bs to hire many judgment-proof As,
increasing fraud and eroding trust in the use of corporate actors
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Liability framework
6
Sources for B’s liability to T in contracts
• Solution: B may be liable to T for a contract that A made with T on B’s
behalf, based on the any of the following sources of liability:
– Actual authority (including via ratification)
– Apparent authority
– Estoppel
– “Virtual apparent authority” (special rule for undisclosed principals)
7
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Liability framework
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
T has notice of
P’s identity
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Liability framework
8
Liability based on P’s type
• Disclosed principal [R3A §6.01]
– If A acted with authority, apparent authority or if estoppel applies, P & T are
parties to the contract; by default, A is not a party (unless A & T agree otherwise)
– Otherwise, no contract formed (but A may be liable to T under R3A §6.10)
• Unidentified principal [R3A §6.02]
– If A acted with authority, apparent authority or if estoppel applies, P & T are
parties to the contract; by default, A is a party (unless A & T agree otherwise)
– Otherwise, no contract formed (but A may be liable to T under R3A §6.10)
• 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 may be liable to T under R3A §6.10
• P’s liable if A had “virtual apparent authority” or if estoppel applies
• Non-existent principal [R3A §6.04]
– If A knows/had reason to know that P did not exist/lacked capacity, by default A
& T are parties; P may later adopt the contract
– Otherwise, no contract formed (but A may be liable to T under R3A §6.10)
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Liability framework
A’s 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
9
© Amitai Aviram. All rights reserved.
External governance
Overview of Chapter 2
a. Liability (to T) for A’s contracts
1.
2.
3.
4.
Liability framework in contracts
Apparent authority
Estoppel
Virtual apparent authority
b. Liability (to T) for A’s torts
c. Defendant eugenics: additional tools
10
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Apparent authority
11
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”, because T can rely on manifestations
she received from P
• Addresses “heads I win, tails you lose”, because P cannot avoid a deal
based on unreasonable limits to A’s actual authority
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Apparent authority
12
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?
• 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.
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
13
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.
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?
–
Assume earlier P told A that she isn’t authorized to hire anyone
14
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Apparent authority
Lind v. Schenley [CA3 1960]
• What was the main issue in Lind?
Parties in Lind
Role (P/A/T)
Lind
Promoted to District Manager
Third party
Park & Tilford
Lind’s company
Principal
Herrfeldt
P&T’s VP & General Sales Manager
Superior co-agent
Kaufman
N.Y. Sales manager; Lind’s new boss
Subordinate co-agent
• Did Herrfeldt/Kaufman have authority to offer Lind the commission?
• Did they have 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
15
Acts of firm’s autonomous fiduciaries
• If the autonomous fiduciary’s act is not authorized by law, the firm is
not bound by it
– For the board, this is rare issue since DGCL §141 gives the board plenary
authority, so the board is authorized by law to do any act on behalf of firm
unless case law/statutory law/charter limits board authority)
• If the autonomous fiduciary’s act is authorized by law, the firm is
bound by it
• Partial exception: 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 for
reliance but doesn’t get anticipated profits of contract [DGCL §124(1)]
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Apparent authority
16
Limits in the charter (ultra vires)
• Ultra vires (Latin for “beyond its powers”) is a (mostly obsolete)
doctrine regarding the corporation’s powers
– History & erosion of ultra vires doctrine
• Doctrine of ultra vires originally stated that an act of the corporation that was not
specifically authorized in the charter was void, meaning that it did not bind the
corporation or third parties and could not be ratified by SHs
• Doctrine steadily eroded through liberal interpretation of “implied powers” & expansion
of statutorily specified powers (e.g., DGCL §122)
• Eventually, statutes allowed corporations to state that they had the power to “conduct or
promote any lawful business or purposes” (DGCL §101(b) & 102(a)(3)) or “engag[e] in
any lawful business” (MBCA §3.01(a))
– Today, ultra vires may still occur when firm acts in violation of its charter
• E.g., in SEPTA v. Volgenau [Del. Ch. 2012], firm merged & gave different consideration to
some SHs, when charter stated that all SHs will receive equal consideration in a merger
• DGCL 124/MBCA 3.04 allows raising ultra vires claims only in:
– Suits by state Attorney General to dissolve corp or enjoin ultra vires act
– Suits by SHs to enjoin the ultra vires act
– Suits by corporation (itself or derivatively by SHs) against the actor for damages
from ultra vires act
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Apparent authority
17
Limits in the bylaws
• The bylaws are considered a contract between the firm and the SHs;
third parties are not parties to the bylaws and do not have
constructive knowledge of the content of the bylaws
• Example: Bylaws say that CEO may purchase property up to $1M, but
that firm’s purchase of property worth more than $1M requires
board approval
– CEO buys from Tanya machines worth $2M, without securing board permission
– CEO lacked authority, but may have had apparent authority if Tanya reasonably
believed that CEO was authorized to conduct that purchase
– But there would be no apparent authority if firm can prove that Tanya was in
fact aware of the bylaw
– If firm is liable to Tanya, it may sue CEO for exceeding authority
• Note that a bylaw limiting board authority is likely to be held invalid,
since it contradicts DGCL §141(a), which gives board authority to
manage the business of the firm (bylaws may not violate law/charter)
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Apparent authority
18
Apparent authority in a GP
• Reminder: Each partner is an agent of the partnership, yet RUPA
401(j) requires some collective consent to grant authority. What
happens when a partner acts without authority?
– RUPA §301(1): “…An act of a partner… for apparently carrying on in the
ordinary course the partnership business… binds the partnership, unless the
partner had no authority to act for the partnership in the particular matter and
the person with whom he was dealing knew or had received a notification that
the partner lacked authority.”
– RUPA §301(2): “An act of a partner which is not apparently for carrying on in
the ordinary course the partnership business… binds the partnership only if the
act was authorized by the other partners.”
• In other words, partnership is liable if either
– A had (actual) authority, or
– A acted in the ordinary course of business & T doesn’t know/have knowledge
that A lacked authority
• This is the same rule as in agency: partnership liable if partner acted
with either actual authority or apparent authority
– Actual authority: RUPA §401(j)
– Apparent authority: RUPA §301 creates a presumption that a reasonable T would
believe that a partner has authority to act in the ordinary course of partnership
business, and doesn’t have authority to act outside the ordinary course of business
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Apparent authority
19
Limiting apparent authority in a GP [RUPA §303]
• RUPA 303 allows a partnership to file a statement of authority
– Power regarding transfer of real property: GP may file a statement of authority
with the office for recording transfers of that real property. Irrebutable
presumption that T knows the contents of this statement (i.e., this is the
manifestation from P to T regarding authority)
– All other powers: GP may file a statement of authority with the Secretary of
State. If T knows about the statement, T may rely on the statement as a
manifestation from P to T regarding authority, but T is not presumed to know
about the statement.
© Amitai Aviram. All rights reserved.
External governance
Overview of Chapter 2
a. Liability (to T) for A’s contracts
1.
2.
3.
4.
Liability framework in contracts
Apparent authority
Estoppel
Virtual apparent authority
b. Liability (to T) for A’s torts
c. Defendant eugenics: additional tools
20
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Estoppel
21
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
22
Example
• BigBiz is a hedge fund. Tim meets Andy in BigBiz’s office (in a room
with a sign saying “trading manager”) and they agree that BigBiz will
buy Tim’s stock at 1% above the current market price.
• Google drops 2% in price; BigBiz denies Andy was its agent
• Tim lacks proof of the conversation between BigBiz & 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
23
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
– Court remands to trial court to determine liability by estoppel
– Is the store liable due to estoppel?
• T makes detrimental change in position
– Yes; Hoddeson lost the cash she paid
• T’s change in position is due to being justifiably induced
– Depends on whether salespeople wore uniforms/badges & where money was normally accepted
• P either
– intentionally or carelessly caused such belief?
– had notice of T’s inducement & didn’t take reasonable steps to notify T
– Carelessness depends on whether employees heard him purport to work there & on how similar he
was to employees; notice also depends on A’s conspicuousness
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Estoppel
‘Best Buy’ prank
– ~ 80 ‘fake employees’
http://www.improveverywhere.com/2006/04/23/best-buy/
24
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External governance
Overview of Chapter 2
a. Liability (to T) for A’s contracts
1.
2.
3.
4.
Liability framework in contracts
Apparent authority
Estoppel
Virtual apparent authority (special rule for undisclosed Ps)
b. Liability (to T) for A’s torts
c. Defendant eugenics: additional tools
25
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Undisclosed principal
26
What’s the problem?
• Tricking T into dealing with P?
–
•
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
27
What’s the problem?
1. “How little we know”?
– Not a problem: T doesn’t care what A’s authority was to bind B,
since he didn’t even know A was acting for B
2. “Heads I win, tails you lose”?
–
–
This is still a problem: B has an incentive to be dishonest, hire
judgment-proof As & send them out with little authority to trick Ts
Tradeoff: windfall for P vs. windfall for T
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Undisclosed principal
28
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
29
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
• 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
30
“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
31
Sources for P’s liability to T in contracts
• Actual authority
1.
2.
P & A have an agency relationship; and
Either:
•
•
Manifestations by P that are perceived by A, that cause A to reasonably believe that A has
authority to act in a certain way on P’s behalf
P ratified A’s act
• Apparent authority
1.
2.
Manifestations by P that are perceived by T
These manifestation cause T to reasonably believe that A has authority to act
in a certain way on P’s behalf
• 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
• Virtual apparent authority
1.
2.
3.
P & A have an agency relationship
P is an undisclosed principal
Assuming (counterfactually) that P was disclosed, would T reasonably believe
that A had authority to undertake the specific act on behalf of P?
© Amitai Aviram. All rights reserved.
External governance
Overview of Chapter 2
a. Liability (to T) for A’s contracts
b. Liability (to T) for A’s torts
– Actual authority / Apparent authority / B’s negligence
– Respondeat superior
c. Defendant eugenics: additional tools
32
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Liability for A’s torts
33
Liability framework in torts
• A’s liability to T
– 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 B doesn’t make A liable to T
• Relationship between A’s liability & B’s liability
– Generally, B can only be liable in torts for A’s behavior if A is also liable in torts
– Exception: B is liable in torts even when A is not, if B would be liable had he
committed A’s acts [R3A §7.04(2)]
• Example: B sends A – a child too young to be liable in torts – to assault T.
B will be liable for the assault even though A is not liable.
• Why is B liable for A’s unauthorized torts? The shielding problem: B
can exploit T by acting tortuously through A
– Liability deters B from exploiting T (but only if B can do something to prevent A
from committing a tort)
– Liability increases likelihood T is compensated: A is often able to inflict greater
harm on T because of the resources provided by the agency relationship
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Liability for A’s torts
34
Sources for B’s liability to T in torts
• A acted with actual authority or B ratified A’s conduct [R3A §7.04]
– Because agency relationship + actual authority + A’s act = B’s act
• Acts taken by A with apparent authority constitute the tort [R3A §7.08]
– Prevents B from limiting liability by artificially restricting authority (and ratifying
after the fact only when B likes the outcome)
– But unlike in contracts, apparent authority in torts is only relevant in a few
cases, because tort victims usually don’t rely on A’s authority
• B is negligent in selecting/supervising/controlling A [R3A §7.05]
– This is simply an application of general torts principles
– Negligence treats all agency relationships alike & bases liability on B’s conduct;
better to base liability on B’s ability to control A & on tort’s connection to
agency relationship
– Therefore, duty of care is limited to T’s with a special relationship to B
• Respondeat superior: employee acting within scope of employment
[“SoE”] [R3A §§7.07, 2.04]
– These four sources are sometimes categorized as direct liability (negligence, actual
authority) & vicarious liability (respondeat superior, apparent authority)
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Liability for A’s torts
Actual authority
• B is liable for A’s authorized conduct [R3A §7.04(1)]
• E.g.: B gave instructions that A believed, and a reasonable A would also
believe, authorized the tortuous conduct
• Same liability if B ratified A’s conduct
– Since ratification retroactively grants A actual authority
35
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Liability for A’s torts
36
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
37
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 B) – 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
38
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 R3A §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.
• 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
39
B’s negligence
• B is liable in torts to T for A’s conduct if the harm was due to B’s
negligence in selecting or controlling agent & B owed T a duty of care
– 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 B 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 B. 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
© Amitai Aviram. All rights reserved.
External governance
Overview of Chapter 2
a. Liability (to T) for A’s contracts
b. Liability (to T) for A’s torts
– Actual authority / Apparent authority / B’s negligence
– Respondeat superior
• Employee
• Scope of employment
c. Defendant eugenics: additional tools
40
41
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Liability for A’s torts
Respondeat superior: employee
Modern term
(R3A)
Traditional term
(R2A)
On P’s behalf
Subject to P’s control
Controls
results
only
Non-agent
[service provider]
Independent contractor
(agent)
Employee
Servant
“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)]
–
•
Independent contractor Not both on P’s behalf & subject to P’s control
(non-agent)
Non-employee
agent
•
Controls
results &
physical
conduct
A gratuitous agent may be an employee [R3A §7.07(3)(b)]
Colloquially, you may think of what distinguishes an employer from other
principals (“controlling the manner & means”) as the “right to micromanage”
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Respondeat superior
42
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
–
–
•
Ferand causes an accident that kills him & injures Brooks
Brooks sues Grams; trial court finds Ferand was not an agent
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
–
–
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
43
Employee: Brooks v. Grams, Inc.
•
a)
b)
Court: Ferand was not an employee
•
•
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? [distinct = non-employee]
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)
•
•
•
•
•
•
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
44
Employee: Prep for class exercise
•
•
•
Uber is a firm that operates the Uber mobile app, which allows
consumers with smartphones to submit a trip request which is then
routed to Uber drivers who use their own cars
In class we will discuss whether drivers who work through Uber are
Uber employees (for the purpose of Respondeat superior)
Prior to class, do some research online regarding the relationship
between Uber and the its driver “partners”, focusing on facts that
would be relevant to whether the drivers are its agents, and if so,
are they its employees
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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
• Employee
• Scope of employment
c. Defendant eugenics: additional tools
45
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Respondeat superior
46
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.”
–
•
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
47
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
• not intended by the employee to serve any
purpose of the employer
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Respondeat superior
48
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?
–
•
•
E.g., personal grudge; Blair was trying to rob Patterson; Blair didn’t know it was Patterson
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
•
E.g., Courtesy would be liable if physical conflict with Patterson was foreseeable, even if
shooting car’s tires was not foreseeable
–
P not liable if A’s actions do not relate to the employment
•
E.g., no liability if Blair was settling a personal score with Patterson
–
Is Courtesy liable under the foreseeability test?
•
Probably yes. Blair Sr. (owner) knew his son was going to try to repossess the car & knew
Patterson threatened violence, so violent conflict was foreseeable
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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 (but some indirectly consider
foreseeability, e.g., viewing unforeseeable conduct as so unusual that there
must have been a personal motivation to A’s conduct)
– On exam apply purpose test only, unless instructed otherwise
49
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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. Defendant eugenics: additional tools
– Veil piercing
• Policy: benefits & costs of asset partitioning
• Legal analysis of veil-piercing
• Asset partitioning in a GP
– Aiding & abetting FD breach
50
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Defendant eugenics
51
Connection of Section 2c to the rest of Chapter 2
•
Two ways to look at corporate compliance
–
From defendant’s perspective: when is the beneficiary liable for an actor’s
actions?
•
–
This is what we did in sections 2a / 2b
From plaintiff’s perspective: how can I extend, to a more desirable defendant, a
cause of action I have against another person?
We call the person you directly have a cause of action against the debtor, and
the person you wish to extend the cause of action to the defendant
• I call the tools plaintiffs use for this purpose “defendant eugenics”: plaintiff’s
attempt to create a “better” defendant
•
• What is a “better” defendant (from plaintiff’s perspective)?
– Wealthier or better insured (B can pay the full damages while A cannot)
– A can escape the jurisdiction of the court or lacks assets in that jurisdiction,
while B has assets that can be seized by the court
– Judge or jury would likely be less sympathetic to B than to A
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Defendant eugenics
52
Tools
1.
Agency
–
–
2.
Partnership
–
–
3.
E.g., in Cargill (expanding from Warren to Cargill)
Relevant if debtor can be said to have acted on behalf of defendant
E.g., in Martin (expanding from KNK to PPF)
Relevant if debtor can be said to have shared control & profits with defendant
Veil piercing
– Piercing the corporate veil (relevant if defendant controlled debtor as a SH)
– Reverse piercing (relevant if debtor controlled defendant as a SH)
– Enterprise liability (relevant if debtor shares the same controller as defendant
(sister companies))
4.
Aiding & abetting FD breach
–
Relevant if debtor breached FD to plaintiff & defendant knowingly participated
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Veil piercing
53
Asset partitioning
• A basic feature of most firms is 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 1: Abe owns shares in AbeCo. AbeCo borrows money from a bank, but
when the loan is due, AbeCo is insolvent. Abe isn’t liable for the loan; AbeCo’s
obligation is not his obligation.
– Example 2: Likewise, if Abe owed gambling debts, his creditors could not collect
it from AbeCo’s assets (though they could seize Abe’s shares in AbeCo, which
are Abe’s personal property)
• This feature is known as asset partitioning (one aspect of that feature
– that a SH is not liable for the obligations of the firm – is known as
limited liability)
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Veil piercing
54
Veil piercing: the exception to asset partitioning
• Asset partitioning can be abused to unfairly shield a person from
liability. In those cases, an exception is made to the general principle:
– 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
• The test for PCV and reverse piercing is the same
– To understand it, we should first discuss why we have asset partitioning and
how it can be abused
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Veil piercing
55
Benefits of asset partitioning
• Why have asset partitioning? Allow SHs to diversify their investments
– 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
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Veil piercing
56
Costs of asset partitioning
Do creditors unfairly carry the burden of asset partitioning?
• Voluntary creditors (contracts)
• Involuntary creditors (torts)
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Veil piercing
57
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 (pricing the risk of the investment)
– Demanding collateral or personal guarantees (to reduce the loss in case of default)
– Imposing covenants (constraints on debtor’s behavior so that if debtor increases its
risky behavior, creditor can demand repayment immediately) to reduce likelihood
of default
– Potential creditor can simply not deal with debtor, and so avoid becoming a creditor
• Can a contractual creditor protect herself from default if:
– Firm is undercapitalized (has a high risk of insolvency)
– Firm’s controller 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)?
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Veil piercing
58
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
– PCV is needed to address this loophole
59
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Veil piercing
Legal analysis of veil piercing
Debtor
Defendant
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.
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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Veil piercing
60
Legal analysis: (1) unity of interest
•
Can’t distinguish debtor’s assets/liabilities from defendant’s
–
–
•
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
Siphoning assets from debtor to defendant (“tunneling”)
–
–
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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Veil piercing
Legal analysis: (1) unity of interest
Example (enterprise liability)
• In one case, court considered whether the corporations had:
–
–
–
–
–
–
–
–
–
–
–
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
61
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Veil piercing
62
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. Injustice occurs if:
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
• 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
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Veil piercing
63
Asset partitioning in a GP
• Firm’s liability for SH debts
– Hypo: April, Bev & Chris are partners in ABC law firm. Paul 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)
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Veil piercing
64
Asset partitioning in a GP
• SH’s liability for firm’s debts (unlimited liability)
– Example: April, Bev & Chris are partners in ABC law firm. Paul 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:
• 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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Defendant eugenics
65
Aiding & abetting FD breach
•
•
FD is owed by A, not by T, so P has no claim against T for breach of FD
B has a claim against T for aiding & abetting a breach of FD if B can prove:
1.
Existence of a fiduciary relationship
•
2.
Breach of the fiduciary's duty
•
3.
Will be discussed in Section 3a (until then, facts will stipulate if FD was breached)
Knowing participation in that breach by T
•
4.
Fiduciary relationship exists when A is a director or an agent
Discussed below
Damages proximately caused by the breach
• Knowing participation: Malpiede v. Townson [Del. 2001]
– T's acquisition of favorable terms through arm's-length negotiations is not
knowing participation
– T knowingly participates if T attempts to create or exploit conflicts of interest in
A, or where T and A conspire in or agree to the FD breach
– Conflicting authorities as to whether T can knowingly participate in a breach of
DoC (i.e., when A doesn’t intentionally breach FD)