Entrepreneurship:
Sole Proprietorships
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Entrepreneur
A person who forms and
operates a new business either
by him- or herself or with
others.
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Entrepreneurial Forms of
Conducting Business
Sole
Proprietorship
General
Partnership
Limited
Partnership
Limited Liability
Partnership
Limited Liability
Company
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Sole Proprietorship
• Owner is actually the business.
• Business is not a separate legal
entity.
• Most common form of business
organization in the United States.
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Advantages of a Sole
Proprietorship
• Ease and low cost of formation.
• Owner can make all
management decisions.
– hiring and firing employees.
– No other approvals required.
• Sole proprietor owns all of the
business
• Has the right to receive all of the
business’s profits.
• Easily transferred or sold
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Disadvantages of a Sole
Proprietorship
• Access to capital is limited to:
– personal funds plus
– any loans he or she can obtain.
• Legally responsible for the
business’s contracts
• Responsible for any torts
committed in the course of
employment.
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Creation of a Sole
Proprietorship
• No formalities.
• No federal or state government
approval is required.
• Some local governments require a
license to do business within the
city.
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Personal Liability of a Sole
Proprietor
• The sole proprietor bears the risk of
loss of the business.
– Will lose his or her entire capital
contribution if the business fails.
• The sole proprietor has unlimited
personal liability.
• Creditors may recover claims
against the business from the sole
proprietor’s personal assets.
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Personal Liability of a Sole
Proprietor (continued)
Sole
Proprietorship
Debt or obligation
owed
Third Party
Capital investment
Sole
Proprietor
(Owner)
Personal liability for sole
proprietorship’s debts and
obligations
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Agency Formation and Termination
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The Nature of Agency
• Agency relationships are formed
by the mutual consent of a
principal and an agent.
• Agency is the fiduciary
relationship “which results from the
manifestation of consent by one
person to another that the other
shall act in his behalf and subject
to his control, and consent by the
other so to act.”
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The Nature of Agency
(continued)
• Agency Law – The large body of
common law that governs
agency.
– A mixture of contract law and
tort law.
• Principal – The party who employs
another person to act on his or her
behalf.
• Agent – The party who agrees to
act on behalf of another.
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The Principal-Agent
Relationship
Principal’s
obligation to
perform the
contract
Principal
Agency
Contract
Agent
Third Party
Contract with third
party on behalf of
principal
© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman
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Persons Who Can Initiate an
Agency Relationship
• Any person who has the capacity
to contract can appoint an agent
to act on his or her behalf.
• Persons who lack contractual
capacity cannot appoint an
agent.
– e.g., insane persons and minors
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Persons Who Can Initiate an
Agency Relationship (continued)
• An agency can be created only
to accomplish a lawful purpose.
• [Agency contracts that are
created for illegal purposes or are
against public policy are void and
unenforceable.]
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Kinds of Employment Relationships
Employer-Employee
Relationship
Principal-Agent
Relationship
Principal-Independent
Contractor Relationship
© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman
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Employer-Employee
Relationship
• A relationship that results when an
employer hires an employee to
perform some form of physical
service.
• An employee is not an agent
unless he or she is specifically
empowered to enter into
contracts on the principal
employer’s behalf.
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Principal-Agent Relationship
• An employer hires an employee
and gives that employee authority
to act and enter into contracts on
his or her behalf.
• The extent of this authority is
governed by any express
agreement between the parties
and implied from the
circumstances of the agency.
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Principal-Independent
Contractor Relationship
• Principals employ persons or
businesses who are not employees
to perform certain tasks on their
behalf.
– These persons and businesses
are called independent
contractors.
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Principal-Independent
Contractor Relationship (continued)
• A principal can authorize an independent
contractor to enter into contracts.
– Principals are bound by the authorized
contracts of their independent
contractors.
• The crucial factor in determining
whether a person is an employee or
an independent contractor is the
degree of control that the principal
has over that person.
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Summary: Kinds of Employment Relationships
Type of
Relationship
Description
EmployerEmployee
The employer has the right to control the
physical conduct of the employee.
Principal-Agent
The agent has the authority to act on behalf
of the principal as authorized by the
principal and implied from the agency.
An employee is often the agent of his
employer.
PrincipalIndependent
Contractor
The principal has no control over the details
of the independent contractor’s conduct.
An independent contractor is usually not an
agent of the principal.
© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman
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Formation of the Agency
Relationship
Express
Agency
Agency by
Ratification
© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman
Implied
Agency
Apparent
Agency
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Express Agency
• An agency that occurs when a
principal and an agent expressly
agree to enter into an agency
agreement with each other.
– Exclusive agency contract
– Power of attorney
• Express agency contracts can be
either oral or written unless the
Statute of Frauds stipulates that
they must be written.
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Implied Agency
• An agency that occurs when a
principal and an agent do not
expressly create an agency.
• The agency is implied from the
conduct of the parties.
• The extent of the agent’s authority
is determined from the particular
facts and circumstances of the
particular situation.
– Incidental authority is the
implied authority to act.
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Apparent Agency
• Agency that arises when a
principal creates the appearance
of an agency that in actuality
does not exist.
• When an apparent agency is
established, the principal is
estopped from denying the
agency relationship.
• It is the principal’s actions that
create an apparent agency.
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Agency by Ratification
An agency that occurs when:
1. A person misrepresents himself or
herself as another’s agent when
in fact he or she is not, and
2. The purported principal ratifies
(accepts) the unauthorized act.
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Summary: Formation of Agency Relationships
(1 of 2)
Type of
Agency
Definition
Enforcement of the
Contract
Express
Authority is
expressly given to
the agent by the
principal.
Principal and third
party are bound to the
contract.
Implied
Authority is implied
from the conduct of
the parties, custom
and usage of trade,
or act incidental to
carrying out the
agent’s duties.
Principal and third
party acts are bound to
the contract.
© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman
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Summary: Formation of Agency Relationships
(2 of 2)
Type of
Agency
Definition
Enforcement of the
Contract
Apparent
Authority created
when the principal
leads a third party
into believing that
the agent has
authority.
Principal and third
party are bound to the
contract.
By
Acts of the agent
Ratification committed outside
the scope of his
authority.
Principal and third
party are not bound to
the contract unless the
principal ratifies the
contract.
© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman
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Principal’s Duties
•
•
The principal has a duty to
compensate an agent for services
provided within a mutually
agreeable time.
If the agent spends his or her own
money, on the principal’s behalf, the
principal owes a duty to reimburse
the agent for all such expenses if
they were:
1. Authorized by the principal.
2. Within the scope of the agency.
3. Necessary to discharge the agent’s
duties in carrying out the agency.
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Principal’s Duties
(continued)
• A principal owes a duty to
indemnify the agent for any losses
the agent suffers because of the
principal. Such duty arises when
the agent is held liable for the
principal’s misconduct.
• The principal owes a duty to
cooperate with and assist the
agent in the performance of the
agent’s duties and
accomplishments of the agency.
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Agent’s Duties
• An agent who enters into a
contract with a principal
has two distinct obligations.
• Collectively, these are
referred to as the agent’s
duty of performance.
–
–
Performing the lawful duties
expressed in the contract
Meeting the standards of
reasonable care, skill, and
diligence implicit in all
contracts.
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Agent’s Duties
(continued)
• Duty of notification
– The agent’s has a duty to notify
the principal of any information
that is important,
– Imputed knowledge
• Duty of accountability
– Agent has duty to maintain
accurate accounting of all
transactions undertaken on the
principal’s behalf.
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Termination of an Agency
• An agency contract is similar to
other contracts in that it can be
terminated by:
– Acts of the parties, or
– Operation of law
• Once an agency relationship is
terminated, the agent can no
longer represent the principal or
bind the principal to contracts.
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Termination by Acts of the
Parties
1.
2.
3.
4.
An agency may be terminated
by the following acts of the
parties:
Mutual agreement
Lapse of time
Purpose achieved
Occurrence of a specified
event
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Notification Required
• The principal is responsible to
give certain third parties
notification of the agency
termination.
– Parties who dealt with the
agent must be given direct
notice
– Parties who have knowledge of
the agency must be given
direct or constructive notice
– Parties who have no
knowledge of the agency are
owed no notice
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Termination by Operation of
Law
1.
2.
3.
4.
5.
6.
An agency is terminated by
operation of law, including:
Death of the principal or agent
Insanity of the principal or agent
Bankruptcy of the principal
Impossibility of performance
Changed circumstances
War between the principal’s
and agent’s countries
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Wrongful Termination of an
Agency or Employment Contract
• The termination of an agency
contract in violation of the terms
of the agency contract.
• The nonbreaching party may
recover damages from the
breaching party.
• The distinction between the
power and the right to terminate
an agency is critical.
– Revocation of authority
– Renunciation of authority
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Liability of Principals and Agents
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Agent’s Duties to the Principal
Performance
Accountability
© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman
Notification
Loyalty
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Agent’s Duty of Loyalty to
Principal
An agent owes a fiduciary duty
not to act adversely to the
interests of the principal.
Common breaches include:
Self-Dealing
•
–
•
Agents are generally prohibited
from undisclosed self-dealing with
the principal.
Usurping an Opportunity
–
An agent cannot usurp an
opportunity that belongs to the
principal.
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Agent’s Duty of Loyalty to
Principal (continued)
• Competing with the Principal
– Agents are prohibited from
competing with the principal.
• Misuse of Confidential Information
– The agent is under a legal duty not to
disclose or misuse confidential
information during or after course of
the agency.
• Dual Agency
– An agent cannot meet a duty of
loyalty to two parties with conflicting
interests.
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Contract Liability to Third
Parties
• A principal who authorizes
an agent to enter into a
contract with a third party is
liable on the contract.
– The third party can
enforce the contract and
recover damages from
the principal .
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Fully Disclosed Agency
• When the third party entering into
the contract knows:
– That the agent is acting as an
agent for a principal, and
– The actual identity of the
principal
• The principal is liable to the third
party.
• The agent is not liable.
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Partially Disclosed Agency
• An agency that occurs if:
– The agent discloses his or her
agency status but does not
reveal the principal’s identity,
and
– The third party does not know
the principal’s identity from
another source
• Both the principal and the agent
are liable to the third party if the
principal fails to perform the
contract.
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Undisclosed Agency
• An agency that occurs when the
third party is unaware of either:
– The existence of an agency, or
– The principal’s identity
• Both the principal and the agent
are liable to the third party if the
principal fails to perform the
contract.
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Agent Exceeding the
Scope of Authority
• An agent who enters into a
contract on behalf of another
party impliedly warrants that he or
she has the authority to do so.
• If the agent exceeds the scope of
his or her authority, the principal is
not liable on the contract unless
the principal ratifies it.
• The agent is liable to the third
party for breaching the implied
warrant of authority.
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Tort Liability to Third Parties
• The principal and the agent are
each personally liable for their
own tortious conduct.
• The principal is liable for the
tortious conduct of an agent who
is acting within the scope of his or
her authority.
• The agent only is liable for the
tortious conduct of the principal if
he or she directly or indirectly
participates in or aids and abets
the principal’s conduct.
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Negligence
• Principals are liable for negligent
conduct of agents acting within
the scope of their employment.
• Liability is based on the common
law doctrine respondent superior.
– This doctrine rests on the principle that
if anyone (principal) expects to derive
certain benefits from acting through
others (agent), that the person should
also bear the liability for injuries
caused to the third party by the
negligent conduct of an agent who is
acting within the scope of their
employment.
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Negligence (continued)
• Frolic and Detour
– Agents sometimes do things during
the course of his or her employment
to further their own interests, rather
than the principal’s.
• “Coming and Going” Rule
– Principal is generally not liable for
injuries caused by its agents and
employees while they are on their
way to or from work.
• Dual-Purpose Mission
– An errand or other act that principal
requests of an agent while the agent
is on his or her own personal business.
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Intentional Torts
• The principal is not liable for
intentional torts of agents
and employees that are
committed outside the
principal’s scope of
business.
• Two tests to determine the
scope of employment
boundaries:
1. Motivation Test
2. Work-Related Test
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Motivation Test
• If the agent’s motivation in
committing an intentional
tort is to promote the
principal’s business, the
principal is liable for injuries
caused by the tort.
• If agent’s motivation is
personal, principal is not
liable.
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Misrepresentation
• A principal is liable for the
intentional and innocent
misrepresentations made by an
agent within the scope of
employment.
– Intentional misrepresentation
occurs when an agent makes
statements that he or she
knows are untrue.
– Innocent misrepresentation
occurs when an agent
negligently makes a
misrepresentation to a third
party.
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Tort Liability of Principals and Agents to Third
Parties (1 of 2)
Agent’s
Conduct
Agent Principal Liable
Liable
Misrepresentation
Yes
The principal is liable for the
intentional and innocent
misrepresentations made by an
agent acting within the scope of
his or her authority.
Negligence
Yes
The principal is liable under the
doctrine of respondeat superior if
the agent’s negligent act was
committed within his scope of
employment.
© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman
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Tort Liability of Principals and Agents to Third
Parties (2 of 2)
Agent’s
Conduct
Agent Principal Liable
Liable
Intentional
Tort
Yes
Motivation Test: The principal is
liable if the agent’s motivation in
committing the intentional tort was
to promote the principal’s
business.
Intentional
Tort
Yes
Work-Related Test: The principal is
liable if the agent committed the
intentional tort within work-related
time and space.
© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman
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Independent Contractor
• Principals often employ outsiders
(persons or businesses who are not
employees) to perform certain
tasks on their behalf.
Principal
Contract
Independent
Contractor
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Liability for Independent
Contractor’s Torts
• A principal is generally not liable
for the tortious conduct of
independent contractors it hires.
• Independent contractors are
personally liable for their own torts.
• The rationale behind this rule is
that principals do not control the
means by which the results are
accomplished.
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Liability for Independent
Contractor’s Torts (continued)
• A principal is, however, liable for
the tortious conduct of an
independent contractor involving:
– Inherently dangerous activities.
– The negligent selection of the
independent contractor
• Crucial factor is degree of control
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