Wednesday, April 20, 2011

April 20, 2011 - Chapter 7 Buying an Existing Business (Part II)

Buying a business - part II:

CREATION: An agency relationship results when one party (principal) authorizes another (agent) to represent the principal in business dealings with third parties, and the agent consents to do so.
TERMINATION: Agency may terminate upon: (1) Lapse of time (reasonable if not specified, (2) Happening of a specified event, (3) Change in Circumstances, (4) a unilateral act of principal or agent, (5) Death, or (6) Loss of capacity.
• Irrevocable Agency: An agency is irrevocable if the agent has an interest in the subject matter of the agency.

Terms of Agency: The terms of agency are whatever the parties agree to and the implied terms (by operation of law).
Implied Agent Duties
1. Duty of Loyalty: An agent has a fiduciary duty to act solely for the benefit of the principal. [Dual Agency: An agent may represent principals with adverse interests only if both principals have full knowledge and consent to the dual agency.]
2. Duty of Obedience: An agent has a fiduciary duty to obey all reasonable direction from the principal. (Exception: Illegality).
3. Duty of Care: An agent has a duty to act with skill in the kind of work they are to perform. (This applies to gratuitous agents as well.)
Implied Principal Duties
1. Compensation - A principal has a duty to compensate the agent for services within the course of agency. If no contract was made, the agent may have a claim in quasi-contract (quantum meruit).
2. Reimbursement - The principal owes the agent a duty of indemnification of all expenses or losses reasonably incurred in authorized agency duties.
3. Duty to Cooperate - The principal has a duty to cooperate in agency performance and not frustrate the agents efforts.

A. Third Parties v. Principal (When principal is bound by agent’s actions).
1) Actual Authority - An agent has actual authority to do anything communicated by the principal (1) expressly, or (2) impliedly by need, custom and usage, acquiescence, or emergency.
2) Apparent Authority - An agent has apparent authority when the principal “holds out” to third parties the agent has authority, and third party relies on it.
3) Estoppel - In the absence of actual or apparent authority, the principal may be liable if a third party relies upon agent to their detriment and the principal knew the third party was misled.
4) Respondeat Superior - When an agent is a servant and in the scope of employment. [Distinguish from independent contractor.]
• Servant - Determined by who controlled the method, manner, and means of the action.
• Course of Employment - Frolic is outside, detour is deemed inside. If benefit to employer then likely within scope.
5) Ratification - A principal may be bound by an agent acting without authority if the principal subsequently ratifies the agent’s action (by affirmance or accepting the benefit of the act.)
6) Inherent Power - If no other basis, it is arguable any foreseeable action of the agent yields principal liability.
B. Third Party v. Agent
1) Agent as Party to Contract - Then agent is liable to third party whether principal is or not.
2) Agent Misrepresentation of Agency
a. Disclosed Principal - When the existence and identity of the principal is known to the third party, then principal is always liable on a contract. The agent is liable on the warranty of proper authority.
b. Partially Disclosed Principal - When the existence only of the principal is known, agent and principal are jointly and severally liable on a contract.
c. Undisclosed Principal - Then agent alone is liable.
3) Agent Liability for Torts - An agent is always liable for their own torts. A principal will only be held liable if in an employer-employee setting.
C. Agent v. Third Party - An agent can bring a contract action in the name of the principal, or on his own if he was a party to the contract. Agent can bring tort action against third party (e.g. physical or interference with agency.)
D. Agent v. Principal - An agent may repudiate the agency and bring an action for breach contract (terms or implied duties), seeking damages, reimbursement, indemnification, and possibly an agent’s lien. [NOTE: Agent has a duty to mitigate]. Agents can bring tort actions against principals also.
E. Principal v. Third Party - The Third Party is liable to principal on a contract, unless the principal was undisclosed and (1) agreement with agent precluded liability to another, or (2) principal knew of agent’s non-disclosure and third party would not have entered the agreement. The third party is liable for torts, including interfering with principal/agent relationship.
F. Principal v. Agent - The principal may repudiate the Agency And Bring An Action For Breach Contract (Terms Or Implied Duties), Seeking Damages (Including Secret Profits), Seek An-Accounting, Withhold Compensation, Or Possibly Specific Performance.

CREATION: A partnership is an association of two or more persons to carry on as co-owners, a business for profit. No written or formal partnership agreement is necessary.
• Written Agreement: A written partnership agreement controls the relationship; in its absence, the RUPA provisions apply.
• Proof of Existence of a Partnership: Courts look to the intent of the parties. Sharing of profits is prima facie evidence of a partnership. (Examples non-dispositive includes payment of debt, wages, rent, sharing gross revenues, title to property, designation.)
• Admission of New Partners: New partners are allowed only upon the unanimous consent of the existing partners.

A. Fiduciary Duties: Each partner has a fiduciary duty to all other partners of the utmost good faith, fair dealings, and full disclosure. [Agency duties of obedience, loyalty, and care also.]
B. Use of Partnership Property: Each partner has the right to use any partnership property for partnership purposes. Partnership property cannot be assigned, mortgaged, bequeathed, or attached by creditors of individual partners.
C. Partner’s Economic Interest: Is the right to share in partnership profits and surpluses. It is each partner’s personal property and may be transferred by each partner. HOWEVER, the assignee does not become a partner, they just have rights to that share of the profits/losses.
• Right to Share in Profits and Losses: If not otherwise specified, profits are shared equally; losses are apportioned the same way as profits.
D. Voting and Management: Each partner has an individual vote (regardless of their respective contribution). A majority is required for action.
E. Partner’s Ability to Bind Partnership: Each partner is an agent of the partnership with the authority to carryout partnership business and bind the partnership. (This includes unauthorized actions.)
F. Legal Action Between Partners: Generally not allowed until an accounting and dissolution have occurred. Tort and negligence actions between partners are allowed.

1. Partnership Liability: The partnership is liable for contracts entered by agents with authority to do so. (Agency law applies) The partnership is liable for the torts of agents in the ordinary course of employment.
2. Partner Liability for Partnership Contractual Obligations: All partners are jointly liable for most partnership obligations. Therefore, a third party may bring an action against the partnership, and each partner.
3. Partner Liability for Wrongful Acts (Torts) of Other Partners: Partners are jointly and severally liable for torts committed by a partner in the ordinary course of partnership business.
4. Professional Limited Liability Partnerships: Must have $1 million of malpractice insurance. Then partners are liable only for their own tort or the tort of someone under their direct supervision.

DISSOLUTION: Dissolution of a partnership occurs upon (1) the express will or act of a partner; (2) unlawful partnership activity; (2) death of a partner; or (4) bankruptcy of any partner.
• Contributions to Partnership: Each partner has a right to the return of their original contribution to the corporation upon dissolution.
• Partner Rights After Dissolution: Each partner has the right to have the business liquidated and his share of surplus paid in cash.
• Business After Dissolution: If the partnership continues to transact business after dissolution, it is simply a new partnership (or sole proprietorship if only one person.
• Liability After Dissolution: The partnership and partners are liable for winding up actions, and any activity conducted with third parties who knew of the prior partnership but where unaware of the dissolution.

WINDING UP: After dissolution, old business must be concluded before termination: this is winding up. The assets are then reduced to cash to satisfy in order: outside creditors, partner loans to partnership, contributions of capital, and surplus or profits. If there is a deficiency in satisfying creditors, each partner will contribute to the cure.

TERMINATION: The partnership is not completely terminated until wind-up is complete.


DEFINITION - An LLC is a partnership and corporation hybrid. It is an artificial entity where members have limited liability, some formalities are required, and may have a management structure where some members or another entity are agents.

CREATION - An LLC is requires filing a certificate of formation with the secretary of state listing the name, registered office, principal place of business, and purpose of business of the LLC.
• Written Agreement: A written LLC agreement is common and controls the relationship; in it’s absence, the ULLCA provisions apply.
• A majority is required for action. [BUT, a unanimous vote is required to amend an LLC agreement or admit a new member.]

• Admission of New Members: New members are allowed only upon the unanimous consent of the existing members.
• Withdrawal from Membership: A member may not withdraw unless it is provided for in the agreement or by unanimous consent of all members.
• Termination of Membership: A member automatically ceases being a member upon assignment of his interest to another, removal pursuant to the agreement, bankruptcy of the member, incompetency, death, or judicial order.

A. Fiduciary Duties: Every member and manager has fiduciary duties to the LLC. (No self dealings.)
B. Capital Contributions, Membership: A member’s ownership interest is proportionate to his capital contribution. Contribution can be in the form of cash, property, services rendered, future services, or promissory notes.
C. LLC Property: Whether property belongs to individual members or the entity is determined by the intent of the parties.
D. Member’s Economic Interest in LLC: Owners economic interest is proportionate to his capital contribution; and the interest is personal property. Such interest is fully transferable, but the transferee cannot attain any management rights.
E. Voting and Management: All management authority is vested in its members, who vote based on their percentage of ownership (capital contribution.) Management may be vested in its members or a management structure. Any legal person or entity may be a manager. If management is vested in managers, then members have no management authority and are not agents. (The members do vote for the management though).
F. Negligent Management: Members and managers are not liable for simple negligence in operation of the business (Business Judgment Rule), but are liable for gross negligence, intentional misconduct, and knowing violation of the law.
G. Distributions: No distributions are allowed if it would render the LLC insolvent. A member, who receives a distribution knowing it will render the LLC insolvent, must return it.

1. Entity Liability: Traditional agency rules apply. (Members/Managers as agents for LLC). Contract liability depends on level of authority. Tort liability may result if the tort occurred in the ordinary course of the LLC’s business.
2. Personal Liability for Members and Managers: Veil of Limited Liability applies. Neither members, nor managers, are liable for contract or tort liability (the entity is alone); except, an individual is liable for his own torts.
3. Piercing the Veil: A third party may bring an action against the shareholders if: (1) the corporation does not comply with formalities, or (2) the corporation is undercapitalized at the onset and fraud was present in the interaction. (Piercing the veil does not result in dissolution, nor necessarily apply or affect other plaintiffs.)
4. Professional Limited Liability Companies: Must have $1 million of malpractice insurance.

DISSOLUTION AND TERMINATION: Dissolution is the termination of the entity’s existence. An LLC is dissolved by unanimous written consent, or one member becomes disassociated from the LLC and the remaining members do not consent to continuation of business.

WINDING UP AND DISTRIBUTION OF ASSETS: assets are reduced to cash to satisfy in order: creditors (including member/manager creditors), members for unpaid distributions, to members for repayment of capital contributions, and to members for profits. If there is a deficiency in satisfying creditors, they are out of luck (no personal liability of members).

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