business associations section 2: external governance (corporate compliance) prof. amitai aviram...

Business associationsSection 2:

External governance (corporate compliance)

Prof. Amitai [email protected]

University of Illinois College of LawCopyright © Amitai Aviram. All Rights Reserved

F15D

External governanceOverview of Chapter 2

a. Liability (to T) for A’s contracts1. A’s liability to T for A’s contracts2. Apparent authority3. Estoppel4. Virtual apparent authority (special rule for undisclosed Ps)

b. Liability (to T) for A’s tortsc. Asset partitioning (limited liability)

© Amitai Aviram. All rights reserved.2

Agent’s liability to TTypes of principals [R3A § 1.04(2)]

• Determined at time that A & T interact

Principal Type T has notice that A acts on behalf of someone else

T has notice of P’s identity

Disclosed

Unidentified

Undisclosed


Agent’s liability to TStatus based on P’s type

• Disclosed principal [R3A §6.01]– P & T are parties to the contract; by default, A isn’t a party (unless A & T agree

otherwise)• Unidentified principal [R3A §6.02]

– P & T are parties to the contract; by default, A is a party (unless A & T agree otherwise)

• Undisclosed principal [R3A §§6.03, 2.06]– If A acted with actual authority

• A & T are parties to the contract; by default: P is a party (unless excluded by the contract)

– If A acted without actual authority• A is liable to T under R3A §6.10 (see next slide)• P’s liability to T discussed in “special rule for undisclosed P”

• Non-existent principal [R3A §6.04]– P doesn’t exist (or has no capacity to contract), so P cannot be a party– By default, A & T are parties, if A knows/had reason to know that P did not

exist/lacked capacity– If A doesn’t know that P doesn’t exist then no contract exists, but A may be

liable for breach of implied warranty of authority (see next slide)


• 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

Agent’s liability to TLiability for exceeding authority


AuthorityElements of actual authority [R3A §§2.01/3.01]

1. Manifestations by P that are perceived by A2. These manifestation cause A to reasonably believe that A is

authorized to act in a certain way on behalf of P• R3A §2.02(1): A has actual authority for acts that are “necessary or

incidental” to achieving the principal’s objectives– Practical tip: if you find there’s actual authority for act Z under R3A §2.01, you can

use R3A §2.02(1) to expand actual authority to other acts that are “necessary or incidental” to act Z

• Hypo: Patty owns an apartment building & hires Andy to manage it– P tells A to hire someone to fix the elevators– A invites Tim to the manager’s office of the building, tells T he is Patty’s

apartment manager & hires T to fix the elevators– A also hires T to clean the apartment building (P said nothing about it)– T does jobs & bills P $60 for fixing the elevators, $40 for cleaning– P refuses to pay. T sues P for breach of contract. Discuss T’s suit.


Apparent authorityExpress & implied actual authority

• Discussion of hypo– T knows A is acting for P, so P is a disclosed principal (R3A §1.02(2)(a)). As a

disclosed principal, Patty is liable if Andy was her agent & acted with authority (R3A §6.01)

a) Is Andy Patty’s agent? (R3A §1.01)b) Was the contract between A & T within A’s authority?

1. Actual authority? (R3A §2.01/3.01, 2.02)2. Apparent authority – relevant; will be discussed later3. Irrelevant in this case: ratification; rule for undisclosed P; estoppel

• Some case law calls 1st situation (fixing elevators) “express actual authority” or “express authority”, and 2nd situation (cleaning) “implied actual authority” or “implied authority”– This is an unnecessary distinction; both are actual authority


Principal’s liability to TSources for P’s liability to T in contracts

• P may be liable to T for a contract that A made with T on P’s behalf, based on the any of the following sources of liability:– Actual authority (including via ratification)– Apparent authority– Estoppel– Special rule for undisclosed principals (“virtual apparent authority”)


Apparent authorityThe problems with having only actual authority

• Problem 1: How little we know…– Prof. A is an agent of law school P– Prof. A shows up at the assigned time in the assigned classroom for the BA class– How do the students (T) know whether P authorized A to teach the BA course?

• Prof. A tells the worried students to rest assured that the Dean authorized him to teach the BA course – but this is a manifestation from A to T, not from P to A, so it doesn’t create authority

– Sometimes only P and A know what the actual authority was, and neither may have an incentive to tell T (P won’t want to be liable, and A might not want to antagonize P)

– If A lacked authority, T can still sue A for breaching his implied warranty of authority (R3A §6.10), but A might be judgment-proof (unattractive to sue because he has no assets/is a sympathetic defendant/can escape judgment)

– T knows it is unlikely to have evidence of actual authority, so allowing this problem to exist would make T less likely to be willing to deal with agents


Apparent authorityThe problems with having only actual authority

• Problem 2: Heads I win, tails you lose…– Prosperity, an hedge fund, hires agent Andy, who is judgment-proof– Prosperity gives Andy actual authority to buy Google stock on its behalf, but

only at a price no higher than 10% of the market value of the stock– Andy meets with Tim (who wants to sell his Google stock) in Prosperity’s office;

they agree Prosperity will buy Tim’s stock at 1% above current market price• If Google increased more than 1% in price, Prosperity could ratify the contract

and make a quick profit– But Google drops 2% & Prosperity points out it is not bound by the deal since the

price was beyond A’s actual authority (101% of market value > 10% of market value)– Again, Tim can sue Andy for breaching his implied warranty of authority (R3A

§6.10), but Andy is judgment-proof– P knows it can get a free option by hiring judgment-proof agents, so allowing

this problem to exist will cause dishonest Ps to hire many judgment-proof As, increasing fraud and eroding trust in the use of agents


Apparent authorityElements [R3A §2.03/3.03]

• Apparent authority was created to address both of these problems:1. Manifestations by P that are perceived by T2. These manifestation cause T to reasonably believe that A is authorized to act

in a certain way on behalf of P• Mirrors the elements of actual authority, except apparent authority

examines P’s manifestations to (& reasonable belief of) T (not A)– Apparent authority binds P to T, but P can sue A if A exceeded actual authority

• Addresses “how little we know” problem, because T can rely on manifestations she received from P– E.g., manifestation of allowing Prof. A to be in class during class times causes

students to reasonably believe that A is authorized to teach the course• Addresses “heads I win, tails you lose” problem, because P cannot

avoid a deal based on unreasonable limits to A’s actual authority– E.g., manifestation that A is P’s securities agent makes it reasonable for T to

believe that A is authorized to buy at 101% of market value, so P is bound© Amitai Aviram. All rights reserved.12

Apparent authorityHypo

• Patty hired Andy to manage her apartment building. She specifically told him not to hire anyone to clean the building. Nonetheless, Andy hires Tim to do so.– It is customary in that region that apartment managers have the power to

hire janitors to clean the buildings they manage– Is Patty bound by the contract with Tim?

• Is Andy Patty’s agent? Yes• Does Andy have actual authority?

1. Manifestations by P that are perceived by A2. 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. Manifestations by P that are perceived by T2. These manifestation cause T to reasonably believe that

A is authorized to act in a certain way on behalf of P© Amitai Aviram. All rights reserved.13

Apparent authorityManifestations by A

• Manifestations by A don’t create actual or apparent authority, but can be circumstances in interpreting P’s manifestations

• Hypo: Pete & Angela talk with Tessa. Angela tells Tessa that she is Pete’s agent and has authority to hire Tessa. Pete hears this and says nothing.

– Assume that an agency relationship exists between P&A• Does Angela have apparent authority to hire Tessa?

1. Manifestations by P that are perceived by T2. 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


• What was the main issue in Lind?

• Issue 1: Agency relationship (R3A §1.01)• Issue 2: Authority

– Actual authority?– Apparent authority?

1. Manifestations by P that are perceived by T2. These manifestation cause T to reasonably believe that A is authorized to act in a

certain way on behalf of P

Apparent authorityLind v. Schenley [CA3 1960]

Parties in Lind Role (P/A/T)?Lind Promoted to District ManagerPark & Tilford Lind’s companyHerrfeldt P&T’s VP & General Sales ManagerKaufman N.Y. Sales manager; Lind’s new boss


Apparent authorityActs 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 but doesn’t get anticipated profits of contract [DGCL §124(1)]


Apparent authorityLimits 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• DGCL §124 limits ultra vires challenges to authority, but the same

action may also breach FD, and §124 doesn’t limit such suits [Volgenau]© Amitai Aviram. All rights reserved.17

Apparent authorityLimits 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– Also, even 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)


Apparent authorityApparent 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:– Ordinary course of business → Partnership liable if either there’s actual

authority or T doesn’t know/have notice that A lacked authority– Outside the ordinary course of business → Actual authority required

• This is the same rule as in agency: partnership liable if partner acted with either actual 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


Apparent authorityLimiting 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.



a. Liability (to T) for A’s contracts1. A’s liability to T for A’s contracts2. Apparent authority3. Estoppel4. Virtual apparent authority (special rule for undisclosed Ps)5. Limiting control powers



EstoppelWhy do we need estoppel?

• Hypo: Heads I win, tails you lose…– Prosperity, an hedge fund, contacts Andy, who is judgment-proof (unattractive

to sue because he has no assets/can escape litigation or judgment)– Prosperity tells Andy if anyone got an option to buy Google stock below market

price, it will fund the purchase & share the profits; but they explicitly agree that Prosperity is not allowing Andy to act as its agent

– Andy meets with Tim (who wants to sell his Google stock) in Prosperity’s office; they agree Prosperity will buy Tim’s stock at 1% above current market price

• If Google increased more than 1% in price, Prosperity could ratify the contract and make a quick profit (which it would share with Andy)

– But Google drops 2% & Prosperity denies Andy was its agent. Is Prosperity correct?– Tim lacks proof of the conversation between Prosperity & Andy, so no evidence

of an agency relationship. Can Tim force Prosperity to buy his Google shares based on apparent authority? How about “virtual apparent authority”?

– Tim can still sue Andy (for breaching his implied warranty of authority (R3A §6.10), but Andy is judgment-proof


EstoppelThe 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 beliefor• 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)


EstoppelThe hypo reconsidered

• Andy meets with Tim in Prosperity’s office and they agree Prosperity will buy Tim’s stock at 1% above the current market price

• Google drops 2% in price; Prosperity denies Andy was its agent• Tim lacks proof of the conversation between Prosperity & Andy• Is Prosperity liable for Andy’s deal with Tim due to estoppel? If so,

what remedy?– T makes detrimental change in position

• An expenditure of money or labor, incurrence of a loss, or subjection to legal liability, but not loss of the benefit of a bargain

• Damages in estoppel are limited to the detrimental change in position– T’s change in position is due to being justifiably induced– P either

• intentionally or carelessly caused such belief?• had notice of T’s inducement & didn’t take reasonable steps to notify T


EstoppelHoddeson v. Koos Bros. [N.J. Super. 1957]

• Hoddeson went to the Koos Brothers furniture store– At the store, she was helped by “a tall man with dark hair frosted at the

temples and clad in a gray suit”– He accepted her order & received money

• The man was not an employee of Koos Brothers– When Hoddeson discovered the fraud, she sued the store– Is the store liable due to apparent authority?– Is the store liable due to estoppel?

• T makes detrimental change in position• T’s change in position is due to being justifiably induced• P either

– intentionally or carelessly caused such belief?– had notice of T’s inducement & didn’t take reasonable steps to notify T


Estoppel‘Best Buy’ prank

– ~ 80 ‘fake employees’http://www.improveverywhere.com/2006/04/23/best-buy/


Undisclosed principalWhat’s the problem?

1. 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


Undisclosed principalWhat’s the problem?

2. Involuntarily asymmetrical relationship (T is bound; P is not)• Hypo

– P hires A to buy T’s Apple shares; agency agreement says A can’t pay >$1– A signs deal with T to buy shares for $200K (market price), not mentioning

she’s buying on P’s behalf• P’s option

– If Apple shares increase in price, P ratifies & closes the deal– If Apple shares decrease in price, P claims no liability (no actual authority &

apparent authority is not possible)• But A is a party to the contract (since it was with an undisclosed P)

– Given that A is liable, is it a problem that P is not?– Yes: windfall for P vs. windfall for T


Undisclosed principalSolution under R2A

• Inherent authority– A minimum level of authority inherent in an agent regardless of

P’s manifestations• This concept was eliminated in R3A


Undisclosed principalSolutions under R3A

• R3A §2.06(1):– Undisclosed P liable to T, if T was justifiably induced to make a

detrimental change in position by A’s unauthorized acts, and P had notice & didn’t take reasonable steps to notify T

– This is estoppel (will be discussed later in this section)• R3A §2.06(2):

– Undisclosed P “may not rely on instructions given an agent that [limit A’s] authority to less than the authority [T] would reasonably believe [A has] under the same circumstances if [P] had been disclosed.”

– I call this “virtual apparent authority”: acts that would have had apparent authority if T knew A was an agent are considered part of the actual authority


Undisclosed principal“Virtual apparent authority”

• Reconsider hypo: P hires A to buy T’s Apple shares; agency agreement says A can’t pay >$1; A signs deal to buy T’s shares for $200K (market price), not mentioning she’s acting on P’s behalf– R3A §2.06(2): Undisclosed P “may not rely on instructions given an agent that

[limit A’s] authority to less than the authority [T] would reasonably believe [A has] under the same circumstances if [P] had been disclosed.”

• If T knew that A was acting on P’s behalf, would T reasonably believe that A had authority to offer $200K?– Probably yes – it would be reasonable for T to believe A was authorized to offer

the market price for the house• Now change the hypo, so that A offers $2M (x10 market price)

– If T knew that A was acting on P’s behalf, would T reasonably believe that A had authority to offer $1M?

– Maybe not – would at least raise a “red flag” as to agent’s authority (similar to Lind)


Liability for A’s contractsSources for P’s liability to T in contracts

• Actual authority (or ratification)1. P & A have an agency relationship; and2. A had actual authority (including via ratification) to undertake the specific act

• Apparent authority1. Manifestations by P that are perceived by T2. These manifestation cause T to reasonably believe that A is authorized to act

in a certain way on behalf of P• Estoppel

1. T makes detrimental change in position2. T’s change in position is due to being justifiably induced3. P either intentionally or carelessly caused such belief, or had notice of T’s

inducement & didn’t take reasonable steps to notify • Special rule for undisclosed principals

1. P & A have an agency relationship2. P is an undisclosed principal3. A has “virtual apparent authority” to undertake the specific act



a. Liability (to T) for A’s contractsb. Liability (to T) for A’s torts

– P’s negligence– Actual authority– Apparent authority– Respondeat superior

c. Asset partitioning (limited liability)


• R3A §7.01: Agency relationship does not absolve agent from liability for A’s tortuous conduct

• R3A §7.02: A’s breach of a duty to P doesn’t make A liable to T

• P’s liability when A is not liable– Generally, P can only be liable in torts for A’s behavior if A is also liable in torts– Exception: P is liable in torts even when A is not, if P would be liable had he

committed A’s acts [R3A §7.04(2)]• Example: P sends A (a child too young to be liable in torts) to assault T. P will be

liable for the assault even though A is not liable

Liability for A’s tortsA’s liability to T in torts


Liability for A’s tortsSources for P’s liability to T in torts

• P is negligent in selecting/supervising/controlling agent [R3A §7.05]– This is a simple application of general torts principles

• A acted with actual authority or P ratified A’s conduct [R3A §7.04]– Because agency relationship + actual authority + A’s act = P’s act

• Acts taken by A with apparent authority constitute the tort [R3A §7.08]– In order to prevent A from limiting liability by artificially restricting actual

authority (and ratifying after the fact only when P likes the outcome)– But unlike in contracts, apparent authority in torts is only relevant in a small

number of cases (misrepresentation, defamation, conversion of property), because tort victims often don’t rely on

• Respondeat superior: employee acting within scope of employment [“SoE”] [R3A §§7.07, 2.04]– What is the justification for vicarious liability? (explained in Patterson v. Blair)– Sources sometimes categorized as direct liability (negligence, actual authority) &

vicarious liability (respondeat superior, apparent authority)


Liability for A’s tortsP’s negligence

• P is liable in torts to T for A’s conduct if the harm was due to P’s negligence in selecting or controlling agent– R3A §7.05(1)

• Liable to whom: any T who foreseeably could be harmed by A’s behavior• For what: hiring/retaining an A who P knew/should have known was unfit for

the job in the sense that employment placed A in position where his unfitness would create a foreseeable danger to others (MacDonald v. Hinton, [Ill.App., 2005])

– R3A §7.05(2)• Liable to whom: T who has a “special relationship” with P. Recognized ‘special

relationships’ (Iseberg v. Gross [Ill., 2007]): common carrier-passenger, innkeeper-guest, business invitor-invitee & voluntary custodian-protectee. Draft of Restatement (3rd) of Torts adds employer-employee, school-student & landlord-tenant.

• For what: foreseeable harm from A’s behavior


Liability for A’s tortsActual authority

• P is liable for A’s conduct if it was within A’s actual authority [7.04(1)]• E.g.: P gave instructions that A believed, and a reasonable agent would also

believe, authorized the tortuous conduct• Same liability if P ratified A’s conduct

– Since ratification retroactively grants A actual authority


Liability for A’s tortsApparent 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


Liability for A’s tortsApparent authority: examples

• Example: misrepresentation– A is a salesperson at a bookstore specializing in rare books. T inquires about a

particular book, and A misrepresents to him that this is an extremely rare book that is worth twice the prices the store is selling it for. Relying on this, T buys the book, which turns out to be common.

– Bookstore is liable to T, if T can show that – based on A’s position as salesperson (manifestation by P) – he reasonably believed that A was authorized to make representations about books. In that case, act with apparent authority constituted the tort (of tortuous misrepresentation).

• Example: conversion of property– A is a salesperson at a bookstore specializing in rare books. T wishes to buy a

particular, fragile book. A takes the money & persuades T to leave the book with the bookstore to properly store it. A then disappears with the cash and the book.


Liability for A’s tortsApparent authority: examples

• Example: defamation– A is a security guard in a store. A falsely accuses shopper T (with whom he has

a private dispute) of shoplifting. Store is liable under §7.08 because T would reasonably believe that A was authorized by the store to act in the way that constituted the tort (A’s shoplifting accusation), based on the manifestation that A is a security guard there.

– Note: outside SoE (personal motivation), so no liability under §7.07• Example: concealing a tort (misrepresentation)

– A works at a bookstore specializing in rare books. Certain book has mold on it, reducing its value. A paints over the mold to hide it (but mold still endangers book, so book’s value still reduced). A sells book to T, not telling T that book has (painted-over) mold.

– Bookstore liable to T if A has apparent authority to fix books & the “fix” concealed the misrepresentation of not disclosing book’s mold problem


Liability for A’s tortsRespondeat superior: employee

• “An employee is an agent whose principal controls or has the right to control the manner and means of the agent’s performance of work” [R3A §7.07(3)(a)]

– A gratuitous agent may be an employee [R3A §7.07(3)(b)]Modern term

(R3A)Traditional term

(R2A)A has power to act on P’s

behalf

P controls results

P controls physical conduct

Non-agent [service provider]

Independent contractor (non-agent)

Non-employee agent

Independent contractor (agent-type)

Employee Servant


Respondeat superiorEmployee: 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


Respondeat superiorEmployee: Brooks v. Grams, Inc.

• Court: Ferand was not an employee [Green=non-emp.; Red=emp.]a) 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)

b) Is A engaged in a distinct occupation/business?• Neither a distinct occupation of driver, nor same occupation (grocer)

c) Is work usually done under P’s direction, or by a specialist wo/ supervision?• Task normally would have been done by Fitzpatrick or Apryl

d) Skill required in the particular occupation [less skill = employee]• Only driving skills required

e) 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)f) Length of time for which A is employed [long = employee]

• Short period of time (one trip to WalMart)g) Method of payment, whether by the time or by the job [by time = emp.]

• No payment at all; Ferand acted gratuitouslyh) Is the work a part of the regular business of P? [yes = employee]

• Yesi) Do the parties believe they are creating an employment relationship?

• No© Amitai Aviram. All rights reserved.44

Respondeat superiorDefining 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.”


Respondeat superiorSoE: 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 anypurpose of the employer


Respondeat superiorSoE: Patterson v. Blair

• Purpose test (R3A 7.07(2)): act is within SoE if A subjectively acted to serve a purpose of the employer

– Here, no doubt this was Blair’s goal – his purpose in shooting tires was to repossess the car for Courtesy

– What facts, if discovered, would make Blair’s actions out of SoE?• Foreseeability test (Bushey): act is within SoE if P can foresee that A

might cause T harm of similar kind– If similar kind of harm is foreseeable, P is liable even if the particular harm

was unforeseeable• 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?


Respondeat superiorSoE: foreseeability vs. purpose

• Restatement commentary acknowledges the existence of the foreseeability test, and rejects it

• The Patterson court rules that Kentucky follows purpose test– Most jurisdictions follow the purpose test– On exam apply purpose test only, unless instructed otherwise


Respondeat superiorPractice questions

• Manning v. Grimsley [CA1, 1981]– Orioles pitcher Grimsley throws ball at hecklers, injuring Manning– What would Manning argue to hold the Orioles liable?

• Lyon v. Carey [CADC, 1976]– Furniture delivery person (Carey) told to collect bill upon delivering the

furniture & to only accept cash. He got into an argument with a customer (Lyon) who wanted to pay by check. He raped, beat & stabbed her.

– What would Lyon argue to hold Carey’s employer liable?– Tort must be a direct outgrowth of employer’s instructions or job assignment

(it’s not enough that job provides the opportunity to commit the tort)



a. Liability (to T) for A’s contractsb. Liability (to T) for A’s tortsc. Asset partitioning (limited liability)

– Policy: benefits & costs of asset partitioning– Legal analysis of veil-piercing– Asset partitioning in a GP


Asset partitioningWhat is asset partitioning?

• Asset partitioning means that the property, rights & obligations of the firm are separate from those of the firm’s SHs (even if the SHs control the firm)

• Example: Abe owns 100% of the shares of AbeCo. AbeCo borrows money from a bank, but when the loan is due, AbeCo is insolvent– Abe does not need to pay the loan; AbeCo’s obligation is not his

obligation


Why didn’t you say ‘limited liability’?• Limited liability is one side of asset partitioning – the

concept that a SH is not liable for the firm’s obligations• The other side of asset partitioning is that a firm is not

liable for the obligations of its SHs– E.g., John & Jane each own 50% of the shares of a firm running a

small grocery store. John declares bankruptcy. The debtors cannot seize the store’s inventory.




• Asset partitioning is so ubiquitous that it’s easier to study the exceptions than the rule– For limited liability (the rule that SHs

are not liable for the firm’s obligations),the exception is called piercing the[corporate] veil (“PCV”)

– For the rule that the firm is not liable forSH’s obligations, the exception iscalled reverse piercing


Asset partitioningBenefits

• Why have limited liability? Diversification– Diversification in firms with limited liability reduces risk because by dividing

investment between many firms, exceptionally good & bad investments offset each other

– Why is reducing risk (getting an average return on the investment instead of a chance of either great or terrible return) a good thing?

• But with unlimited liability, diversification actually increases risk– A single failed investment can accumulate huge debts that wipe out all

of the investor’s assets– Better to invest everything in one firm and control it well than invest

small amounts in many firms that you don’t control• Limited liability facilitates smaller, more risk-averse, and minority

(i.e., non-controlling) equity investments


Asset partitioningCosts

Do creditors unfairly carry the burden of limited liability?

• Voluntary creditors

• Involuntary creditors


Asset partitioningCosts: voluntary (contractual) creditors

• A voluntary (contractual) creditor can investigate firm’s credit-worthiness and contractually mitigate the risk from default by:– Demanding a higher interest rate (reflecting the risk of the investment)– Demanding collateral or personal guarantees (to reduce the loss in case of default)– Imposing covenants (constraints on firm’s behavior so that if the firm increases its

risky behavior, creditor can demand repayment immediately) to reduce likelihood of default

– Potential creditor can simply not deal with firm, and so avoid becoming a creditor• Can a contractual creditor protect herself from default if:

– Firm is undercapitalized (had a high risk of insolvency)– Firm’s controller “cooked the books” (intentionally falsified financial records)?– Firm’s accounts contain many unintentional inaccuracies because controller is

absent-minded (e.g., forgetting to reduce firm’s available cash after firm pays dividends)?


Asset partitioningCosts: involuntary (tort) creditors

• Hypo: A owns Acme, a taxicab company– A draws all profits out of Acme, so Acme’s only assets are the (used) cabs– A’s cab runs over B; B sues Acme, but Acme has insufficient assets to pay

• Tort law protects involuntary creditors by forcing potential tortfeasors to internalize the costs their torts impose on victims– Causes drivers to drive carefully and maintain their cars

• But limited liability means SHs get the upside of business profits, while avoiding the downside by letting the firm become insolvent– Activities that cause torts will be moved into poorly capitalized corporations

that are undeterred & unable to compensate victim– Veil piercing is needed to address this loophole


Asset partitioningLegal analysis of veil-piercing

Controller

Firm Sister firm

Debtor Defendant

PCV Firm Controller

Reverse piercing Controller Firm

Enterprise liability Firm Sister firm

Legal test for all three forms of veil-piercing:1. Such unity of interest between [Debtor] and [Defendant] that

their separate personalities no longer exist; and2. Adherence to fiction of separate corporate existence would

sanction fraud or promote injustice


Asset partitioningLegal 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)


Asset partitioningLegal 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


Asset partitioningLegal analysis: (2) injustice

• “[C]ircumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice.”

• Sea-Land [CA7, 1991]: The prospect of unsatisfied judgment does not satisfy this prong of the test

• The injustice prong is satisfied if:– 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



• Contract (voluntary) creditors– To mitigate the risk of corporation defaulting, a contractual creditor can

investigate corporation’s credit-worthiness and:• Decline to lend• Require higher interest to compensate for the higher risk• Require collateral or personal guarantees• Impose covenants (constraints on the behavior of the borrower)

– Is a contract creditor adversely affected when the debtor is undercapitalized?– When debtor fails to abide by formalities?– When debtor moves assets between itself & defendant? – When defendant commits fraud against the creditor?

• Tort (involuntary) creditors– Is a tort creditor adversely affected when the debtor is undercapitalized?– Is a tort creditor adversely affected when debtor fails to abide by formalities?– When debtor moves assets between itself & defendant?– When defendant commits fraud against the creditor?



• 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


Asset partitioningAsset partitioning in a GP

• Firm’s liability for SH debts– Hypo: April, Bev & Chris are partners in ABC law firm. Dave has a judgment

against Bev & wants to collect from ABC.– RUPA §501: “A partner is not a co-owner of partnership property and has no

interest in partnership property which can be transferred…”– RUPA §502: A partner’s share of the profits & losses & partner’s right to receive

distributions from the partnership (together, the partner’s “transferable interest”) is personal property, so creditor can seize Bev’s transferable interest in ABC

– RUPA §504: Allows a creditor to petition court to issue a charging order (a lien) against a partner’s transferable interest. Court may then order foreclosure (sale of the transferable interest to a third party, with proceeds used to pay debt to creditor)


Asset partitioningAsset partitioning in a GP

• SH’s liability for firm’s debts (unlimited liability)– Example: April, Bev & Chris are partners in ABC law firm. Dave has a judgment

against ABC & wants to collect from Chris.– RUPA §306: All partners are liable jointly & severally for all obligations of the

partnership unless:• Otherwise agreed by the claimant• Otherwise provided by law• Partner admitted into partnership after obligation was incurred• Obligation incurred while partnership is an LLP

– RUPA §307(d): Creditor must first attempt & fail to collect the debt from the partnership (exhaust partnership assets), unless:

• 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© Amitai Aviram. All rights reserved.65

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