Week 2 Transcript - Agency in Business Law PDF

Introduction to agency. Agency brings us into the second big substantive care category of what we will be studying in business law. It is the basis of how the business world works. Firms hire agents to do work for them. Firms do not have the arms, the legs, the mouths, the eyes to do the necessar...

Introduction to agency. Agency brings us into the second big substantive care category of what we will be studying in business law. It is the basis of how the business world works. Firms hire agents to do work for them. Firms do not have the arms, the legs, the mouths, the eyes to do the necessary work themselves. They work through people, be that the CEO, be that the janitor. They are all agents of the firm. They create benefits and sometimes detriments, reflect back in terms of earnings or in terms of liability to the firm. And that's because an agent is really just an extension of the principal. So in this scenario, we might have a grocery store who hires someone to stock the produce. So our grocery store employee is in the eyes of the law the grocery store when it is within the course and scope of its employment. And this is done through an agreement between the grocery store, the principal, and the grocery store employee. It's important to remember that the principal is the entity, not necessarily your boss. The CEO, the president, the chairman of the board is not the principal in a principal-agent relationship. They are mere sub-agents of the principal itself. Now, agency, as I said, is a relationship where one stands in for another. The agent stands in for the principal because the principal cannot act himself or cannot act as a multitude of agents can. It is the most common relationship we have in the legal arena and is probably the most important legal relationship that we come across. Now, notice I say relationship. Agency is where two parties agree to form a relationship in which one party agrees to act loyally on behalf of the other. It is a standing in the shoes relationship that might be reduced to contractual form but might not. So that's why this continued emphasis on relationship is important. It doesn't mean we have to have a contract. As I noted previously, most employees in the United States are at-will employees. They don't have a business contract that gives definite scope to their employment. They can quit at any time. They can be fired at any time. Now, if we think about what a agency contract might look like in contrast to an agency relationship, it's helpful for us to kind of compare and contrast what we don't know yet about contract law with what we don't know yet about agency relationships. But let's try. If we have any contract-- agency, business, buying, selling, doesn't matter-- any contract has a required five elements. One is an agreement. I agree to send you goods. You agree to pay me money for those goods. We have consideration. That is goods for money, what I am buying and what I am selling, what the exchange medium will be. We also have to have capacity for all parties. That is typically being of the age of majority and not mentally deficient. We must have a legal consideration. That is, if I want to buy Cuban cigars and we have an embargo against Cuba, I cannot have that contract enforced because the subject matter is itself illegal. Lastly, sometimes we need to have contracts in writing. This is because of something known as the statute of frauds. It has less to do with actual fraudulent misrepresentation as it does with slippery memory. But we have decided as a society that some contracts are so important we are not going to rely on oral agreements, but we must reduce it to some type of writing. That's what contract looks like. Let's compare it to what agency might look like. In an agency relationship, we must have an agreement. I agree to work for you. That's the same. However-- let's skip to legality-- it must also be legal. You cannot hire me to do illegal things. However, no consideration is needed. So we can have what is known as a gratuitous agency. If I'm on vacation and I notice on my security camera that there's a package waiting for me on my front step-- it always happens. I go on vacation. There's a package waiting. So I call my next door neighbor and I say, hey, Kaylee, can you come over and pick up that package and hold it for us till we get back from vacation? And she says, sure, Mrs. Butler. No problem. I'm not agreeing to pay her any money. And she is agreeing to do work for me. That is a gratuitous agency. Likewise, agency requires capacity for principal but not for all parties. So in that scenario, which is a real life scenario far too often, Kaylee is my neighbor, and she is 13. So Kaylee is not of the legal age of majority. She can enter into contracts, as we will learn, but they would be voidable at her decision. In this case, agency, we don't need the agent to have capacity. So I can hire a 13-year-old because in the eyes of the law, it's really me picking up the package from my front porch. She is standing in my shoes. As long as I have capacity, I can choose to hire someone who is mentally efficient or someone who is very, very young. Last of all, sometimes agency relationships do have to be in writing. And that is because of something known as the equal dignities rule. So if I have hired someone as an agent to do something that involves a contract and that contract under the statute of frauds must be in writing, then my agreement with my agent must also be in writing. So, for instance, within the statute of frauds is any purchase of real property. If I were to ask an agent to buy property for me, our relationship would need to be reduced to writing because the agreement to buy property would have to be reduced to writing. So formation of the agency relationship through agreement might be done through an actual contract but, as we've seen, doesn't necessarily have to be through an actual contract. So this agreement can take forms multiple ways. It can be expressed, please work for me. I can write it. I can say it. It can be implied by conduct. I see you helping out. I kind of say, oh, this is great. You should continue helping. But I say nothing actually to you, but I continue to give you supplies. I continue to enable you to do what you were doing. That would be implied by conduct. Lastly, the agreement can be what we call a parent. That is, I, as perhaps a principal, have done something to make third parties believe that you work for me, even though you don't. If I have done that, then I am responsible to those third parties as if you were actually my agent. It's confusing, and we'll talk about that more later. I will note at this point-- I have said many times-- most agents, most employees-- and all employees are agents-- most employees are at-will employees. That is, they do not have a contract. They can be fired at any time. They can quit at any time. So there is no what we call property interest. I cannot say, oh, you cannot fire me. There is value in this contract because it promises I will be employed for the next three years. So at-will employment doesn't necessarily have that consideration element. I'm not saying I will continue to employ you, and you are not saying you will continue to come to work. That said, there are three major exceptions to the employment at-will rule-- public policy, implied contract, and the implied covenant of good faith and fair dealing. That means in certain circumstances, although you don't have an employment contract and, in theory, you can be fired at any time or can fire any employee, the law will step in and not allow it. Now, this varies greatly from state to state and jurisdiction to jurisdiction. So you don't need to remember any of these states and their particular rules and exceptions. I just have this graphic for you to look at to understand the wide variety that we have. Notice that most states make a public policy exception. These would be things like I as your boss have asked you to do something illegal. Public policy says, we don't want that to happen. You shouldn't have to follow those rules. New York oddly does not allow even a public policy exception, although most courts would look favorably upon someone who refused to do something that was illegal. There can also be an implied contract. These are scary. We'll talk about them more when we get to actual contract law. But if your HR department has a handbook that has a lot of we wills, this must be done, we promise, even if you have stamped all over the front and last page this is not an employment contract, all employment is at will, many courts are willing to read those promises as an implied contract. Through your conduct, through following the procedures you have set out, you have created an expectation of longevity or some type of procedural safeguards before employment will be terminated. Last but not least, there is often a good faith exception. Good faith says, I can't fire you for any reason, only for good reasons. We no longer need such a large workforce. We need to lay people off because demand has diminished versus-- and this is a particularly famous case-- at a grocery store firing one of its cashiers because her husband, who was a cop, pulled the owner's wife over for DUI. That's just retaliatory. And in many states, that type of termination will not be tolerated. You'll notice in Texas where I am, while we have a public policy exception, we do not use either implied contract or even good faith exceptions. Texas is a strong, employer-centric state as opposed to say California, which is very, very protective of workers' rights. So it very much depends where you are, particularly in the area of agency law, what kind of rules will apply to you as an employee and as an employer. Agency problems. So having people work for us is wonderful. It allows for diversification of labor. It allows us to get so much more done than we possibly could on our own. However, the people that we hire are utility maximizers. That is, they want to do the least amount of work and get the most amount of benefit. That is what rational people do. This leads to some agency problems that we think about when we think about economics, adverse selection, moral hazard. And these definitely play into how we deal with things like employment law and agency law in general. So adverse selection may rear its head in hidden information that we don't know about when we hire someone. You recall when we talked about tort law, we talked about direct liability for an employer for things like negligently supervising an employee. But I also mentioned that there can be tort liability for negligently hiring an employee. So even if an employee-- potential employee-- doesn't give us a full and accurate description of their employment history or personal history, it might behoove us to do some additional outside digging to make sure that we are hiring the right person. Likewise, after we have hired an employee, they may try to back off or, even worse, to somehow sabotage our establishment. That's a moral hazard problem. That's an ex-post employment problem. We want employees to be loyal and hard working, but that perhaps is not their natural way of behaving. What we can do to prevent this is to contract around these problems. You sign some type of document that says, I promise I haven't lied that this is all the information that's possibly out there about me. And I promise to work diligently from 8:00 to 5:00 and to not mess around except on my mandatory break times. The problem with contracting around these natural tendencies is, again, agency is not a contract. We can have a contract, but most businesses, by prevailed preference, don't want contracts. They want at-will employment. And at-will employment isn't a contract. So we can't fix those problems that we normally could fix through contractual provisions. And that's why we have agency law. We have agency law to deal with the agency problems that are inherent in this relationship. So without any complex contracting, we use agency law to fill in the gaps. We think about what a perfect, or at least perfectly generic, employment contract would look like. And we just say, by law, we are writing that into your relationship. If you want extra bells and whistles, like a nondisclosure or a non-compete, you need to add that in separately. But we're going to give you the basics. So what do those basics look like? Well, there are rights and duties that arise from an agency, both on the agent side and on the principal side. We're going to look at an agent's duties first because they are really the most important. Number one is loyalty. When you work for an employer, you owe loyalty to that employer in terms of not working for a competitor, not sharing trade secrets. So remember, trade secret law says, if I am stealing secrets, I cannot give them to third parties. But agency law says, if I am given those as part of my employment, I also can't give it to competitors or use it for my own benefit. Obedience. As long as it's not illegal or somehow against public policy, in general, your choice is do what your employer tells you to do or quit. There is no civil disobedience component to the employment relationship. Care. This means non-negligence. When I do my work, I do my work carefully. I respond as a reasonable person would respond in those particular circumstances. But I'm not sloppy, and I'm not careless. Notification. Recall a while back, we talked about lawyers. And sometimes we're asked to meet maybe with the general counsel of the firm or the corporation because we have information about something that has happened. And we have a duty to tell them that either you yourself or you know of someone else that has done something that has created potential liability for the firm. That is because you have a duty of notification as an agent. Because the nature of the agency relationship is one in which the agent is stepping into the shoes of the principal, is acting as the principal-- remember my neighbor [? Caylea ?] picking up the package from my front porch. She's acting as me in that situation. And so if she was careless, I was careless in the eyes of the law. And if she knew something, she has a duty to notify me of it because the law says I constructively know all material information that my agents know. So if a worker sees another worker dumping toxic waste in the stream out back rather than dealing with it as they should under EPA rules and fails to report that up the ladder, the law doesn't care. The law says president and the CEO and the board of directors should have known because that employee should have notified. Last but not least, accounting. If I as an employee come into possession of material of value-- it might be money, it might be tangible or even intangible-- I must keep that safe and segregated from my personal accounts for the benefit of my employer, for the benefit of my principal. So no commingling of funds. And that duty of care comes back into taking care of property that's been entrusted to me. Now, that's a lot. That's a lot of the kind of basic common sense, really, of what we would want an employee to do. We don't have to put it in a contract because it's there for us by law. I will note that these are the default rules. This is what you get if you don't have a contract. You can contract around most of these. You can contract around I want to work for you, but I don't want to be loyal. I want to be able to have a side job, or I want to be able to invest in companies that might be competitors of yours. It's really hard to get a board of directors to agree to be loyal to a company when it means not being able to have any business relationships in that area outside of this particular entity. So often, when we see board of directors agreements, we'll have carve outs in the area of loyalty especially. Now, the duties of a principal look similar in number, but they are actually very, very minimal compared to an agent's duties. They must cooperate. If they have asked you to do something and you do it because you are obedient, they must not be trying to sabotage your efforts to do so. They must give you safe conditions in which to work. Now, this is, again, founded in common law. These have been rules for a long, long time. The second duty of the principal has really been superseded by our OSHA regulations in the US. There are now very specific rules about what safe conditions look like. But all of OSHA is grounded in the idea that agency law says, if you are doing my work for me, if you are stepping into my shoes, I owe you a safe place to do that. Number three is reimbursement. Remember when I talked, again, about my neighbor, and I said she was a gratuitous agent. I cannot pay her. If I promise to pay her or if I promise to bring her back a trinket from my vacation as payment, then I have to actually pay her what I have promised. But remember, compensation is never required in an agency. Indemnification is also a duty for a principal to its agent or agents. That is, if an agent is wrongfully accused of something that was within the course and scope of their employment and has to pay, the principal must reimburse them. So if they are sued and have court costs or attorney's fees that accompany that suit, the principal has an obligation if the agent is not found to be liable or not found to be guilty to indemnify them. We'll talk a lot more about indemnification when we get to contracts because we'll see indemnification and [? exculpation ?] clauses in lots of contract that we'll encounter. Last but not least, we do have compensation. If I have promised to pay you something, I must pay that to you. Back to reimbursement, I will note, there are also out-of-pocket expenses. If I am working and I need to buy something for my job, I can expect to be reimbursed for that by my employer. "Agency and Independent Contractors." Agency is a fiduciary relationship. You recall, we had a long list-- actually, a list of five-- of fiduciary duties that an agent owes to its principal and complementary list of five duties that a principal owes to its agent. Those are known as the fiduciary duties. And they arise because the principal is controlling the agent. That is the essence of the agency relationship. I step into your shoes to do your work. You are telling me what to do. And I am doing it as if I were you. How do we know that this is an agent who is truly being controlled versus, say, an independent contractor who lacks the control-- hence, the independent in their name? Well, every jurisdiction has its own test. Within jurisdictions, we often have different entities that have different tests. So at the federal level, we have the IRS. Very much is interested in whether someone is an agent or an independent contractor. We have the Department of Labor, which is also very, very interested. At the state level, we may have state level taxing and labor departments. We may also have workers comp agencies that are very, very interested in whether someone is an independent contractor or an actual employee. The most common general definition for whether someone is an employee or an independent contractor comes from the IRS's three-factor test. And with some tinkering, it's the basis for all other agencies and all other state and jurisdiction definitions. And so it's broken down into three major components, looking at behavior, finances, and the relationship. And again, in each of these areas, our focus is on control. So, do I control your training? Do I offer you training? I will train an employee to do what I want how I want it. I will hire an independent contractor, because they already have training in a specific area. I don't have to train them. In addition, an independent contractor would usually bring their own equipment and they would work on their own hours. Whereas, an employee, I would provide them equipment as principal. And I would set the hours that they work. Control over finances is another hallmark. If there is opportunity for loss, that counts against being an employee. So I should make money. I should be reimbursed for any out-of-pocket expenses I should probably-- unless I'm a gratuitous agent-- be paid for my endeavors. However, with an independent contractor, if I just don't really think about what my costs are going to be, and I agree to fix your sink for $300, and it turns out that even the materials run me 500, that sucks to be me. I am out $200. I have the opportunity for loss, because I am truly an independent contractor. If I were an employee, you'd have to pay me for the pipes, and pipe wax, or whatever it is that I had to buy in order to fix that sink. Other hallmarks of employee status would be regular pay and the provision of benefits, neither of which we normally would see with an independent contractor. Lastly, we look at the relationship in general. If it is your core business that this person is helping you with, that tends to make it sound like they are an employee. If my whole business is making ballet shoes and this person is putting the laces in, that's something I need. It is not someone that I would call out for a special expertise in the area type of person to come in and help me with on an ad hoc basis. Likewise, the longer someone has been doing work for me, the more likely they are an employee. If they have independence-- that is, they may have other jobs, they may work for other people, they may work different hours, I may not control the actual way that we relate-- that is, they're going to get the job done but not necessarily on the day or hour I tell them to-- that's the hallmark of an independent contractor. Now, Texas makes it somewhat easy. And a number of other states do, too. I often use Texas as an example just because we're Rice. But Texas makes it nice, because statutorily, they have given us a list of-- don't worry about thinking about all those control areas. These are just definitely principal agent relationship. All employee/employer relationships, all attorney/client relationships, all partners. We'll talk in the next section about entity choice. One of the choices of the way to organize a business is through a general or limited partnership. It's important to understand that all partners are fiduciaries, are agencies of the partnership itself and all the other partners. That can lead to a lot of potential liability that we would like to avoid. And we'll talk about how to do that later. Officers and directors-- officers, and directors are typically employees. And they're just specialized, high-level employees. But we specifically say, yes, they are agents, also. And then things like executors of an estate, or trustees, and spouses, especially in community property states-- a spouse is the fiduciary of their spouse and also, in community property states, of the community itself. So you owe a duty not only to the person, but to the institution. Now, who is not a fiduciary? Let's think through this. Because it starts to get fuzzy when we're faced with real-life scenarios and it's not something that's on the list when we have to apply that IRS three-point rule. If we think about agency, we know all employees are agents. All agents are fiduciaries. They owe those five duties to their principal. We also know that some employees have a contract. I have a contract. I am not an at-will employee. Most employees are at-will employees. This is another of my Venn diagrams that's not to scale. It's not proportional. But it's here to give you an idea. Within who has a contract, however, is all independent contractors. It is in their name. They are contractors. They have a contract. It might not be written. It might be an oral agreement. But it is a contract, nonetheless. There is, however, this little bit of overlap-- which here looks kind of 50/50. It's not-- of independent contractors who are also agents. That is actually a pretty small sliver. The most famous example of an independent contractor agent is probably a lawyer. So I owe my client's fiduciary duties. I am loyal to them. I would never take a case that has a conflict of interest. I owe them an accounting. If I'm holding any type of information or cash for them, it has to be in a special trust account. I owe them a duty of notification. I must tell them what I learned about the case. So it's a classic example of-- while I am there for just one particular thing, be a contractual dispute, a divorce, a bankruptcy, within that contractual relationship, I still owe those fiduciary duties of a normal employee. Now, it is critical to understand the difference between these two. And that's why I've spent so much time so far talking about what makes someone an independent contractor versus an employee. These entities, they care very, very much. They want to know whether you're going to be paying taxes, withholding employment taxes, paying minimum wage, because we pay minimum wage to employees. If an independent contractor wants to negotiate a term that is less than minimum wage, they can do that. But employees, we can't. We need to know whether we can allow unionization. We need to know whether we have to supply workers' compensation to people injured on the job. And so there are a lot of people other than just you and the person working for you that care and will investigate whether you have correctly categorized your workers. So quick little graphic that we can look at that kind of helps flesh out why we care whether someone is an independent contractor or an agent-- one big one, at least for the taxing authorities, is that payment of employment taxes or withholding of employment taxes. We have to do that for our agents. Those other regulatory constraints like minimum wage and rights to unionize, those also apply to employees. Moreover, as an employer, we're owed fiduciary duties from our agents but not necessarily from our independent contractors. The beauty of a relationship with an independent contractor is that you have a contract. So you can add in fiduciary duties to an ordinary contract. It doesn't make them an agent. But it does bind them to be loyal to give you notifications, to act in a careful and workmanlike manner. But that is something that you can contract into, not something that is the default rule. Lastly, and what we will concentrate on most in the next sections of this course, are contractual liability for the principal, tort liability for the principal. If a agent is working with authority to a contract and makes a contract with a third party, the principal will be bound. We'll talk about whether the agent is also bound later. That can sometimes happen. Moreover, if an agent is working within the course and scope of their employment and is careless or sometimes even intentionally hurts another person or another person's property, again, the principal will be vicariously liable for the acts of that agent tortfeasor. Now, the agent is always responsible for their own torts. That's that joint and several liability. Now our victim has two pockets that they can reach into for reimbursement, both the agent and the principal. So the other thing that we must remember is that, once we have decided this person is an agent, this person is an independent contractor, I have either done the thinking-- looking at those three rules the IRS has given us. Or I have wishfully just said, oh, yes, you are an independent contractor, so I will not withhold any late taxes for you. That really doesn't matter much. It is something that we can put forth as evidence, but it is not dispositive. The government or perhaps even our supposed independent contractor or supposed employee can fight that presumption. It doesn't even qualify as a presumption. It is just a self-selected label. So just because you call someone an employee doesn't mean they are. Just because you call someone independent contractor doesn't mean they are that, either. So independent contractors, not fully controlled, employees, a right to control-- it sounds like a pretty simple division. But it does get quite fuzzy, especially when we understand that some employees do have contracts, And some independent contractors, oh, they are contracting partner fiduciary duties. So again, in that area where independent contractors may or may not also be agents, I want to warn you again. Most independent contractors are not agents-- attorneys, yes, plumber, no. I think of plumber as my quintessential independent contractor. I do not have a contractor in my employ that is a plumber. I call him when I need one special thing fixed. He comes, and he does just that. He brings his own materials. He brings his own training. He is an independent contractor. And he owes me no fiduciary duty. So he doesn't work just for me. So independent contractor agents are rare, rare, rare, rare. I can't emphasize that enough. So look for right to control. Look for duty to act primarily for the principal's benefit when looking for, is this really an agent? That's that loyalty component. And ask, does this person have the power to alter the principal's legal relations? My plumber cannot go out and make contracts in my name. But my employee may be authorized to do that. So altering legal relations, acting loyally primarily for the principal's benefit, those are hallmarks. Agencies and third parties. So thus far, we've been looking at the relationship between the agent and the principal. We know there has to be an agreement to have this relationship, it might be a contract, it might not. We have some default rules known as fiduciary duties that are built in when we don't have a contract that spells things out. But thus far, we haven't really concentrated on that third party that interacts with the agent of the principal and what that means for the principal and agent themselves. So, here when we think back and recall the prior matrix we had up in slides, we're going to be concentrating this bottom half, contract liability for the principal tort liability for the principal. And this is, again, that idea of vicarious or imputed liability. It comes from Old Latin respondeat superior, or let the master answer for he controls. This is the stepping in the shoes. So when your employee interacts with the public-- be that a customer, be that a supplier, be that someone who randomly comes in off the street to ask directions-- it is as if your company is answering those questions, it is if your company is making those requests, because you are whether directly or indirectly controlling that behavior. And so this can create liability in two basic areas, one, contract that an agent may make with third parties that bind the principal and torts that an agent may commit within the course and scope of their agency. That may create vicarious or perhaps even direct liability for the principal too. Agency and vicarious liability for tort. First, we're going to look at tort liability for the principle, tort liability for an agent while in the course and scope of employment. And you've heard me say that phrase a lot already, and you're going to hear it a lot more because it is the key question when we talk about tort liability. If an agent most often is working within the course and scope of their employment, the principle will be vicariously liable for that agent's torts. So the principle may be liable if they tell you to do something-- that is, tell the agent to do something-- authorize it-- I'm not telling you to do it, but it's OK-- or actually participate in the tort, that's pretty clear cut. They also may be liable if it is unauthorized contact made within the course and scope of the agency, often the course and scope of employment. That is to say, I told you not to do this, you did it anyway. That doesn't matter, I am still liable because you were still on the job when you did it. Now, on the job and you did it is a layman's version. We'll look at what course in scope means in more depth later. But it's important to understand that just because my agent disobeyed a command-- that is they have fiduciary duties to obey, they didn't do it, they did something that hurt a third party, the principle says, I shouldn't have to pay for, that I told them not to, that's not how the law views it. Remember too that the agent is liable themselves. Tortfeaser is always liable for their own torts. Now, I have a little asterisk there because we have something that the government likes to throw in and says if it is a government employee and you want to sue the government, you have to agree not to sue the individual also. So almost always a tortfeaser is liable for their own torts, but the government protects its own. In the business context, your employee is going to be liable for their own torts. Scope of employment. As I have mentioned, whether an agent is acting within the scope of employment or within the scope of their agency is the key question when we're asking, does a principal have vicarious liability for this tort? Now, whether the actual tort is criminal-- and so we're using tort as a really generic placeholder here for wrongfulness-- or is negligent or intentional, we have an additional question that we ask, which is, should the employer have known? Did they know or should they have known that this type of thing would happen within the course and scope? But the key component, is were they, in layman's terms, on the job? And so we're going to look at what that really means in the next few slides. Scope of employment asks, to what extent were the employer's interests advanced during the action that led to the tort that was committed? Was I trying to benefit my employer or was I off on my own little experience looking to benefit myself? We also ask, did the employer authorize it? If it's something that I am authorized to do, it's much more likely to be within the scope of employment than not. I was told I can or even maybe have to do this. It's those unauthorized acts where we have to rely on other things, like yeah, they didn't have permission to do it, but were they trying to do it for the employer's benefit? We also might ask questions like, did the employer provide the instrumentality that caused the injury? Some people think, well, if a company car is involved, then obviously the company is going to be liable. That's not necessarily true. The fact that it's a company car makes it more likely. But it doesn't definitively tell us whether we're going to have principal liability. Likewise, did the employer have knowledge that the employee would perform the act? That makes it much more likely. It is, again, not definitive. These are all questions that we would want to think about. None of them are actually definitive. It's a holistic list. Now, if I had to pick one that is most important, it would definitely be, was it for the employer's benefit? And I would also warn you against thinking too much about were they authorized. Again, just because I told you not to do it doesn't mean I'm not liable for you doing it when I am the principal and you are my employee. Course and scope. Course and scope asks those basic questions that we saw on the previous slide. But we have different questions asked in different jurisdictions. So we have two basic tests that states use. One is the motivation or interest test, which most closely aligns with, was I doing this as an agent to benefit my employer, my principal? And the second and much less popular test or tests are the outgrowth or work-related tests. So the motivational test, also known as the traditional rule, because most states use it and it's been around for a long time, asks that starred question. Was the employee's action-- and here, it's really the agent's action-- motivated in whole or even in part by a desire to serve the employer's interests? Did I do this because I knew it would be good for my boss, good for my employer? This is contrasted very sharply with the outgrowth or work-related tests. The outgrowth test says, was this generally foreseeable, given what they are supposed to do on the job? And the even greater much more composting work-related test, which says basically, were you were at work? Was this during work time in a workplace? So you could imagine someone at their job at their desk watching videos of cats on YouTube and making prank calls. That is not benefiting the employer. It's not really or shouldn't be a foreseeable or natural incident of employment. But in some states, just because the person was at work during that time, they may be liable for, let's say, a prank call gone awry and some type of emotional distress damages. So those are the two basic states. As I said, many states have different rules or variations of those three-- or two, if we want to group those minority states together-- rules. Some states are very different. Texas is a great example of that. Texas, again, is a very employer-centric state. It is very protective of employers, and much less so employees. Texas is probably our exact opposite. But in Texas, we have a very narrow scope of employment. It's a three-part test that one starts with that basic motivation test. Was this action in furtherance of my employer's business? That's pretty basic, and is the traditional rule. But we narrow it in Texas. We ask then, was it within the general authority given to him or her? So was this within the general permissive set of actions I could do on the job? And then we narrow it even further and ask, was this the object for which I was employed? Was I doing something that I was actually asked to do when this tort was committed? So if, by example, I-- someone who teaches business law-- decided, you know what, I saw at the grocery store this really great sale on toilet paper. And you know who uses a lot of toilet paper? Rice University. I should buy some. So I did it because I thought it would benefit my employer. And within my general authority, I have the authority to contract on Rice's behalf. Generally, this is for things like research materials or conferences, that I have permission to buy things. But it doesn't specifically say I can't buy toilet paper. But number three, the object for which I was employed. I am not in the procurement department. I am not in janitorial. I am supposed to research and I am supposed to teach. And so it would fail. So if while out buying toilet paper I was involved in a car accident, someone might in the discovery phase of a lawsuit against me say, oh, you were working for Rice? Oh, you were buying toilet paper for Rice at the time of this accident? Hmm, we should sue Rice, who has much deeper pockets than this poor professor. In Texas, that would be a no go, because that's not what I'm supposed to be doing. But in many other states, if you think back to the general rules, yes, I was doing it to help my employer. Yes, I was within the general authority that I have. Yes, it was perhaps within the time and space of employment-- not place, but the time and space. And was it an outgrowth of what I normally would be expected to do? That's squishy, right? I have the authority to contract for some things. I'm not sure this would be within that. But the majority of states would say, this is furtherance of employer's business. She wasn't authorized to do it, but that doesn't matter. So course and scope exceptions. One course and scope exception is known as the coming and going rule. So because in my scenario, I left Rice during the day to go buy this toilet paper that I heard about on sale-- because it is during the work day, that is not coming and going. Coming and going is when I am getting to work for the first time in the day or when I am leaving at the end of the night, or whatever my work hours might be. So if I have a car wreck before I get to Rice's parking lot, no one can sue Rice, even though I was only on that road because I was going to work. The other big exception is what is known as the dual purpose mission rule, also sometimes known as the detours rule. So if my dean said, Leanne, we're out of toilet paper. Could you go get some for us? Sure, dean. I can do that. So I have been actually asked. It is now clearly within course and scope. It is a weird blip on my object of employment, But, I am now on the task for Rice. And I'm out on the roads of Houston, and I run over someone's dog. If that's the case, no question, Rice is going to be liable. But if when the dean asked me to run out and get toilet paper, I decide, you know what's on the way to Costco? It's Starbucks. I'm just going to run through the drive-through and get a latte, and then I'll get the toilet paper. That is a slight detour. And as long as it is a slight detour, and the main reason I was out on the road was to get the toilet paper for Rice, Rice is still going to be on the hook. If it is more than a slight detour-- and this is one of my favorite legal terms. If it is a frolic-- if I am out frolicking, going way out of my way. If I decide to visit the water park and then get back to the toilet paper and then get back to the business line, that means no liability for Rice. So minor detours or minor exceptions, where I'm doing a little bit for myself, but also I'm doing something for my employer, vicarious liability probably attaches. But frolics, not so much. Not frolic. All right, liability for principals violations of law-- almost never. Almost never can we expect or would we expect someone to commit a crime for the benefit of their employer. That said, there are some exceptions. Some regulatory violations, like EPA and FDA rules come to mind, because those are strict liability rules. And it's not really the intent that creates the liability in the first place. So we make exceptions there. Likewise, things like the dram shop liabilities. If you know you're not supposed to sell to a minor, the minor could have a great looking fake ID, they could lie to your face, and it doesn't matter. Both the bartender and the employee are going to be liable for those violations. Agency and contractual liability-- we've already looked at one side of this flow chart. We've looked at vicarious liability for a principle when an agent commits a tort. Now we're going to ask, if that same agent signs a contract in the principal's name, is the principal actually bound? And the key question here is, did the agent have authority? It is not just the key question. It's really the only question. That below, did the agent have authority on this flowchart, answer a different question, which is, might the agent be responsible for the contract also? We'll talk about that later. For now, we want to concentrate on authority of an agent to contract and bind its principal. So three types of authority will subject a principal to binding contract made by an agent, actual or implied authority that comes from the principal to the agent and this other outlier here, apparent authority. And by its name, it suggests, and it is true, that this is not real authority. It just appears to be. And this requires one other element, and that is a third party. If a principal leads a third party to believe an agent has authority that it doesn't actually possess, that's good enough in the eyes of the law. We will pretend that the actual authority existed. So let's look at each of the three types, and see if we can understand a bit better what they really mean. Actual authority-- actual authority is authentic authority. It is an objective manifestation by the principal. That could be in words. It could be a look. If that look can be understood, and it is the agent's reasonable interpretation of that manifestation. If I say, go dig a hole, that is a clear, actual authority to go dig a hole. If the agent believes me to mean, go dig a hole behind the building, and I really meant in front of the building, but given the circumstances, behind the building was reasonable, then he had authority to dig the hole behind the building. And it also includes that which the agent believes it is authorized to do. When we deal with actual authority, it is slightly larger than the actual words spoken. Not a whole lot larger-- when we get to a whole lot larger, we get to implied authority. It kind of fills in the gaps between what I have been told to do and what is necessary to get that done. So if I say, go dig a hole, there might be questions about where that hole should be dug. But there also might be questions about, can I go out and buy a spade and a bucket in order to dig this hole? So if I tell you, and I have not supplied the necessary equipment, but I tell you, go dig a hole, you may have implied authority to buy the equipment necessary. And then, remember, one of my duties as principal would be to reimburse you for those out-of-pocket expenses. Another way implied authority can exist, though, is that conferred by custom in your industry or even in your particular firm and that inferred from the position the agent occupies. So it might be that, when interacting with third parties, every VP in this particular company has always had the authority to contract up to $50,000. That's custom, and the third parties know and understand this. So when a new VP is promoted, they just assume and can reasonably assume, because of the custom of the firm, that this VP will have the same authorization. It could be that the third party infers that from the position. This one is very tricky, right? So if we have a president/CEO, president/CEO can basically do anything besides sell the company or completely change the industry in which the company works. Those big kind of high-level decisions would have to be made with the blessing of the board of directors. But they can contract, they can hire, they can fire, they can make decisions in marketing, finance, et cetera. And we believe that they have the authority of that just based on the knowledge that they are president and CEO. But as soon as you drop down from that highest level, it becomes precarious to assume that because of a position, people have specialized authority. So a VP in one company may have much greater authority than a VP in another company. So once you infer from position, you do so at your own risk, especially when you get down the managerial ladder to very low-level employees. In that case, you really want to make sure you have something in writing signed, preferably, by the secretary of the board that says, yes, this person really can bind the principal. Lastly, we have apparent authority. Apparent authority, again, requires a third party. It requires a third party that the principal has had contact with. So either by word or action, they have caused this third party to reasonably believe the agent is working for them. So this might be saying, this is my partner. And perhaps I meant, this is my life partner. But what I said is, this is my partner. And in a business context, that might lead a third party to agree or to believe that, oh, this person has the ability to contract in the name of the other person that I just met. It might be seeing someone wearing a Best Buy shirt that you know not to be a Best Buy employee and thinking, oh, free labor. But then, when that third party interacts contractually with another third party, this fake agent, you may actually be liable for the contracts because you saw it, you didn't do anything to stop it, and through your actions or lack of actions, you have led other people to believe this is your agent. So especially with apparent authority, you need to understand that the power to bind a principal to contract is much larger than the right to bind a principal. To have the right to bind a principal to a contract, I must have actual or implied authority. But with apparent authority, that authority is expanded to what a third party believes I have the right to do. Again, just as in tort, just because I tell my employee, don't dig any holes, if my employee goes out and digs holes because they think it's for the company's benefit and someone falls into it and breaks their ankle, company is probably going to be vicariously liable for that tort even though it was unauthorized. Likewise, if a rogue agent who has apparent authority because of something the principal said to that third party with whom they contracted goes out and makes a bad, bad contract, there is going to be liability on that contract even though that agent should not have ever signed it. So apparent authority is the power or the appearance, and it ends up having the same force and effect as true authority. Authority is authority. These are three different kinds of authority that we can find, that we can put a name or a label on. But ultimately, courts do not distinguish between them. There is nothing special about apparent authority versus implied authority versus actual authority. It's all authority, and that's all that's necessary for a binding contract on the principal. So we don't care what type. We just care about finding a type of authority if we want to bind the principal. So in addition to our normal ways of creating a binding contract with principal via agent, there are some extraordinary events that can also lead to a bound principal. One is ratification. If I have an unauthorized rogue agent signing contracts in my name, I can disaffirm them. No, this person had no authority. I refuse to be bound. Totally appropriate, although, it must be done in a timely fashion. But I might say, OK, you had no business, no authority to sign this, but, oh, my gosh, this is a good contract. I want to be engaged with this third party. I can ratify. As principal, I have the authority to say, I give retroactive power to this agent to make a binding contract with me and third party. Agents also have extraordinary powers in cases of emergency. So again, back to my toilet paper at Rice example. There is usually not a toilet paper emergency at Rice, but there could be something like a flooding emergency at Rice. And I could realize that, even though I am not hired to move computer equipment, that if I don't get computer equipment up to the third floor of the business school, it's going to be inundated with water. I might have the right to hire movers in that case to help me move stuff up to the higher floor if I'm the only one there. Normally, that would not be within my objective employment, and I would not be able to bind myself or Rice to those contracts. But in cases of emergency, I could. Undisclosed and Partially Disclosed Principals. You will remember that I said the key to principal's liability on a contract hinges absolutely on authority, was the contract authorized or within the scope of authority given by the principal to the agent? I want to point out a particular area that we need to talk about, it sometimes confuses people and causes them to not ask the authority question, but to ask the was the principal disclosed question when trying to determine principal liability on a contract. If I make a contract with you on behalf of an undisclosed third party, I am acting for this third party, but you don't know that I am acting for the third party. My third party principal will nonetheless be bound to any contract you enter, that is, you and someone you don't know will be in a contract, even if you think you've entered into the contract with me. Many people think this reeks of fraud. But there is an exception to the fraud principle that allows for undisclosed principals to contract via agent. So this creates an immense amount of power for a principal. If, for instance, in this Telegraph article people in New York knew that a Russian billionaire wanted to buy up a whole block of their homes to tear them down and make a mega mansion, they probably would have asked for more money. Quote, "had they known who it was and what he planned on doing, they would have asked for a lot more money." So the ability to have an independent, what we used to call a straw man or a straw person, ask individual homeowners to sell their homes without divulging the name of a super wealthy principal allows the principal to buy at market rates rather than at much higher profit-gouging rates. This is how Disney bought up all the land for what is now Disney World in Orlando, through many individual straw person buyers. That way they kept the prices down and were able to amass everything without any holdouts. So agent's liability for the principal's contracts. We know the principal is bound if the agent had authority, and we know the third party is bound. But what about the agent itself? The agent might be bound, and this does hinge on that disclosed or undisclosed question. So we have three types of principals in an agency contract situation, that is, when an agent is contracting with a third party on behalf of a principal. The principal might be disclosed, that is, known to the third party. They might be undisclosed, that is, the third party has no idea they're not actually contracting with the person sitting in front of them. Or they might be partially disclosed, that is, I might say, I'm not doing this for me. I'm doing it for someone else, but I'm not going to tell you who that someone else is. It depends on what jurisdiction you are in and what type of principal-- disclosed, partially disclosed, or undisclosed-- you have whether, as an agent, you, too, are bound on your principal's contract. So let's take a closer look at this. For authorized acts where there is a disclosed principal, an example of that might be-- I work for ABC Inc., and in that capacity-- So I'm clearly saying I am an agent, I am not the principal. And I am telling you exactly who the principal is. If I am authorized, the principal is bound to the third party because I am acting within the scope of my authority. And I, as agent, have no liability. I've made it clear I am not acting in a personal capacity. I am standing in the shoes of my principal, and you know who that principal is. A partially disclosed principal is very, very different, especially in some jurisdictions. This is where, as an agent, I might say, I work for someone and that someone might like to buy your property. And in my capacity as an agent for undisclosed principal, I would like to buy your land. In that case, my principal is bound. In all instances, the principal is bound as long as we have an agent acting with authority. The only question is whether the agent is also bound. And in this case, the agent might be or might not be. It depends on your jurisdiction. So, for instance, in Texas, a partially disclosed principal will cause both the principal and agent to be bound to the contract. So let's think about that for a moment. If I am acting in a representative capacity, and I am buying real estate for my principal, and I sign my name, even though the other side of this contract knows that it's not for me personally, it's for someone else, and then that someone else, my principal, decides not to go through with the deal, backs out of it, files for bankruptcy protection, flees the jurisdiction and cannot be found, I am stuck because I have bound myself along with the principal to that contract. So you want to be sure that you have a very tight contract with your principal, perhaps money has already been put in escrow, perhaps you have other types of insurance to make sure that if you are stuck with this contract that you entered into on behalf of your principal that you don't have to pay out of your personal assets. Last but not least, we have undisclosed principals. So if I am working on behalf of a principal and I just introduce myself as Bob, I'm Bob, and I would like to buy your property, just as in the Disney example or in the Russian billionaire example, that is liability for the agent. Your third party with whom you are contracting, even though in your mind you know you're doing it for your principal and not yourself, they only know you. If they want to sue anyone, you are the only person they are able to find. And you might say, well, then once they find me, I can say, no, I was doing it on behalf of X, and so only X should be liable. That makes some sense, but that is not the way the law looks at this situation. You will be liable, as will your principal. So hopefully, they will go after the principal who has deeper pockets, but until that judgment is paid, you are jointly and separably liable too. Now, there are some exceptions. The principal is not liable at all on undisclosed principal contract if the principal is expressly excluded. So I might know, as a landowner, that someone is trying to buy up property, and I don't want Disney to move into my neighborhood, let's say. And so I specifically say, I will sell you my land, Bob, but you have to agree you're not working for Disney, and that you will not sell this to Disney, and that Disney is not an undisclosed principal in this relationship somewhere. If I have expressly excluded them, then only Bob is bound. Likewise, if the contract is a negotiable instrument, we have a specific law that excludes undisclosed principals from negotiating instruments-- checks, drafts, et cetera-- and if the agent's performance is personal. So, for example, if I hire Beyoncé to sing at my child's birthday party, and then some random person named Bob shows up, and he says, oh, yes, Beyoncé's an undisclosed agent of mine, but really she was contracting on my behalf, I'm going to be miffed because I expected Beyoncé, I didn't expect Bob. So if we have personal performance, things like singing, dancing, painting someone's picture, things that require artistic expertise, we are not going to allow for undisclosed principals to pop in at the last moment. So to avoid liability as an agent, as an employee who's making contracts on behalf of your employer, you need to act with authority, inform the other party that you are acting as an agent, and make sure they know the actual identity of your principal. The fact that they could figure it out, the fact that you thought they knew, none of those buy you any, any bit of room in a lawsuit. You must know, at the time of contracting, that you have told the other side who your principal is. So let's try to think through, in a factual scenario, what this might look like, the types of problems we might see. So here we have Mr. Mosley who is a coal buyer. He works for a coal company. He buys coal for them. That is what he is authorized to do contractually. But instead, he buys land from Mr. Wiley, our third party. There are two possible outcomes to this scenario. Scenario one, the land is worth much less than what he purchased it for, and his employer is going to be rather unhappy. Mr. Wiley is going to be thrilled. He's going to want to enforce the contract. In scenario two, we have the land worth a lot more. Mr. Mosley made a really good buy. His employer is thrilled. But the third party, when he realizes that he has entered into a bad contract, is going to look for ways to get out from underneath it. So let's think about what might possibly happen here from the principal's point of view, from the third party's point of view, from the agent's point of view. So from the principal's perspective, this is an unauthorized contract. They are not bound. That is our only key concern, our only concern, period. For principal liability is, was this an authorized act of the agent? That said, if we have an unauthorized act, the principal still has some options. So if the coal company, who had a disclosed principal, agent with no authority issue, in this situation, the contract is viewed legally as an unaccepted offer from Wiley. Let's think about that. It looks like we have a contract. It's been signed by both parties. Both parties, at least the agent and Wiley, believe they have a deal. Wiley has clearly manifested his intent to enter into this agreement. But because the agent did not have authority, the principal hasn't. So we treat it as an unaccepted offer. Wiley is clearly willing, we want to know if the principal is too. So he has a short period of time, once he becomes aware of this-- and remember that his agent has a duty of notification. He needs to come back and say, hey, I entered into this contract where I bought land instead of coal-- so at that point, he can either ratify, that is, the principal can say, you didn't have authority, but I'm going to pretend like you did. I'm going to give it my stamp of approval. Or he can repudiate, that is, he can say, there is no way I want this land. In either case, he needs to communicate that promptly to the third party, especially with repudiations. Because at this point, Wiley thinks he has a contract. And if we are going to decide he doesn't have a contract, he needs to be aware of that promptly so that he can make other decisions. So promptly notify third parties of repudiation or ratification. But you can't just sit back and wait to see, oh, does this look like it's going to be a good deal or not? You don't have the luxury of time if you are a principal whose unauthorized agent has made a contract in your name. So let's think about, on the other side, the agent. So this agent was disclosed. This agent did not have authority. So we don't have, in theory, a binding contract on the principal. And so we don't have the oh, well, if he's disclosed, there is no problem, or if he's undisclosed, the agent is definitely liable, because we don't have a contract at all, quite possibly. If it's ratified, there is really no concern because Wiley's happy and clearly, the principal is happy. But if the principal repudiates this contract, Wiley is going to be very upset. And because the agent was disclosed and he is not a party to the contract, it might seem like the third party does not have any way of getting damages out of this agent. And that's where the implied warranty of authority comes in. As an agent, when I say, I am a disclosed agent working for ABC Corp., what I am really saying to third parties is, I have authority to contract on behalf of these people. I have warranted, I have promised you that I have authority. And if I breach that implied warranty-- and by implied it means I don't have to tell you that. It's just inherent when I say I am authorized, or I can, or I represent some other third party. That's the implied part of the warranty of authority when I enter into an agreement with a third party, I promise that I can do so. So if I didn't, I am liable for damages. I am liable unless the principal ratifies, or the agent gives notice that hey, I have no authority to do this, but I think they're probably going to ratify it. Or if the third party knows that the agent doesn't have actual authority, he can't come back later and say, well, I knew he didn't have authority, but he never said it. But in general, the agent will be responsible for any damages incurred by the third party due to the lack of ratification of this unauthorized contract. What might that look like? Well, if Wiley had agreed to sell for $100,000, and the principal realized this is a bad deal, I'm not going to ratify it, he repudiates the contract, and the next best offer that Wiley can find is only for $80,000, then he's lost $20,000. And that would be the amount of damages available to him through a breach of implied warranty of authority suit against Mr. Mosley. In addition, Mr. Mosley has another problem, which is he breaches fiduciary duty to his principal. Quite often for morale reasons, employers don't really sue their employees a whole lot. This typically only happens after an employee has been terminated, and even then, in rare situations. It's hard to hire quality employees if word gets around that you fire people and then sue them. But in this situation, if it's a big enough problem, it's always available. And that is the principal can sue for a breach of fiduciary duty, that is, he did not work within his authority, that is a lack of obedience. If there was delay in notification, that could possibly be a breach too. That will also allow for actual damages. Termination of Agency. All good things must come to an end, and even agency relationships usually do. This can be done in a number of ways-- expressly, through implication, or even by operation of law. So expressly, we can end an agency by the terms of the agreement. We may have agreed orally. We may have a written contract that says you will work for me for x years. When x years is over, contract is over. Agency is over. Likewise, a principal can revoke, or an agent can renunciate. This can happen even if we still have a term of years left on a contract. It's breach of contract, but it still terminates the agency. There could be circumstances by which we just assume-- and a reasonable party would also assume-- that the relationship should not continue. If I have hired someone to act as my agent in order to accomplish a feat, like repainting a house, and that house burns down, clearly I don't need that agent anymore. It can also happen by operation of law. So if one party dies or becomes incompetent or what they were going to do becomes illegal, all those kill the agency. The one thing I do want to point out when it comes to termination of agency, however, is that we have something known as lingering authority. So if you have fired someone but third parties have understood this person to have authority-- that is, they had actual or implied or even apparent authority while they were an agent-- until you notify the third parties with whom that agent had relations, they are reasonably going to believe that that agent still has authority. So when someone quits who has had close contact with clients and who you think might try to continue to have close contacts with your clients, you should immediately notify those third parties that the agent no longer has authority to transact on your behalf. Business entities. Business entities go by many names, or at least this area of the law. Some call it business forms. To me, that sounds like a piece of paper I might fill out. Business associations, but there are actual associations that are business types, and that doesn't feel like it can encompass enough. Business organization, that sounds great except the abbreviation BO makes me not favor that one. It's partly corporate governance, how we run a business is based on how we structure a business. But bottom line when we talk about business entity choice or how we form or how we associate or how we organize, we are talking about how groups of people can do stuff to make money rather than one individual. How can I diversify labor get more done in a shorter period of time, and what does that mean for me, for other owners, for the people that work for me for the tax man? So, why we choose the business entity form that we choose depends a lot on this, asset protection. If we care about asset protection, and we should, then we want to choose a limited liability form for our business entity. If we are so rich that we don't care if our fortune is wiped out because we'll just make another one, really doesn't matter, because a lot of business entity informed choice comes down to limiting liability. We limit liability for owners in the corporate form, in the limited liability company for. Certain people are limited in the limited partnership where all are in limited liability limited partnerships and limited liability partnerships, not so much for sole proprietorships or general partnerships as we will see. So there are some good choices, there are some bad choices when it comes to business entity form. As I said, liability is probably our top concern and the one that we will address most, liability for contracts, liability for torts and crimes. But we also worry about tax liability and how much tax and in what form we will pay it, who can control the entity once it's created, how complex the governance is, and how liquid our ownership interest might be. These all come into play. From a lawyer's perspective, from a business law perspective, liability is our big focus. But from a business person's perspective, especially from the CFO's office, taxation plays a big role. From the owner's perspective, control and how complex it is to run this business and can I cash out become really important concerns. So we will look at each of them in the space of looking at the different entity forms and how these five concerns differ depending on the entity choice we choose. Sole Proprietors. Sole proprietorship is the simplest form of business. The owner is the business. That's it. You report your business income on your personal income tax. You are legally responsible for all the debts of the business and all the benefits of the business. It is as easy as saying, I am now a business owner. I am going to sell things. And you have become a sole proprietor. This is problematic in almost every way. Liability-- again, the business lawyer's ultimate concern. I am going to do this slowly for emphasis. Sole proprietors enjoy no protection-- none whatsoever-- from the debts and liabilities of the business. Drive that home-- sole proprietors are completely liable, your personal assets, anytime the business or any business employee does something that causes a third-party damage. It is untenable long term if you worry at all or you have any assets that you might be worried about being taken away in a lawsuit. In terms of the other choice concerns, taxation-- it's simple. It's pass-through taxation. Control-- you are the sole owner. You have complete control. Complexity is incredibly low. You're the only person you have to worry about. You don't have to ask anyone else when you're making decisions. And liquidity-- it is also low. You have to find the right person that might want to buy it, but again, you have complete control over whether you sell or you don't. The big drawback to sole proprietors is this full, personal liability for the debts of the business and for the damages incurred on the business' behalf. Bad idea. General partnerships-- general partnerships involve multiple people owning a business as a sole proprietor would. That is, they share the profits and losses. They share joint ownership. They have equal rights in the management. It's as though we have one owner with three heads, or a hundred heads, or as many partners as you'd like to bring in. It is different than sole proprietorship, though, in that a partnership becomes an independent entity. So it's like a third person. If you remember discussing agency, and I said in the state of Texas, spouses are statutorily defined to be fiduciaries or agents of the other spouse. And I noted that in a community property state, there are three parties to a marriage, the two spouses and the community itself. That's what a partnership is like. A marriage is a partnership. And a partnership is a partnership between the partners and the partnership entity itself. That said, the agents of the partnership can be sued if they commit a tortious act. The partners can be sued vicariously for an agent's tortious act. And the partnership itself and the assets it holds can be sued. So we have multiple deep pockets that a victim may pursue when trying to become compensated for damages. Like a sole proprietorship, this is passed through income and loss. That is, all partners' income is reported on their personal taxes. All losses also can be used to offset income. Understand that when we have a partnership, all partners are principals. All partners are general agents of the partnership. It's a lot of liability. You're liable for what those employees do. You're liable for what your other partners do. And you're liable for the debts of the partnership itself. Joint ventures are a type of partnership. Typically, they are of limited duration, typically between two companies and for a single project. But they have a legal status that is similar to partnerships. So those can be tricky to maneuver also if you don't think ahead of time and devise a carefully crafted contract. The other thing to worry about partnership is while it is formed by agreement, that agreement does not have to be in writing. It doesn't have to be filed anywhere with the Secretary of State's office. It can be an oral agreement. It can be let's shake hands and become partners in this business deal. And it can be formed by estoppel. Estoppel is a lot like a parent agency authority. That is, if you create the belief in third parties, the reasonable belief in third parties, that you are in partnership with the person or persons, the law will treat you as if you are partners with that person or persons. Now, liability in a traditional general partnership-- again, like sole partners. That is, they enjoy no protection from debts and liabilities of the business. All of your personal assets are up for grabs if something bad happens in the partnership, or to one of the partners while in the course and scope of partnership business. It's a dangerous position to be in. Limiting liability by business entity choice-- we want limited liability, not full exposure to the debts and damages incurred by our entity form. I often think that when we think about how we want to form a business, we can think about it as going in to Nordstrom's to buy a suit. They all kind of look the same, especially men's suits, but they're all slightly different. If we choose as our business entity form from that rack sole proprietorship, that is like pulling out a clown suit. If we pull off of that rack general partnership, it's like somehow pulling out an entire clown car full of clowns. What we want is something businesslike and that protects us, that maybe has a little hidden suit of armor underneath. And clown suits don't do that. We want limited liability. Liability is limited for the owners, of course, not the firm itself. The firm can be sued. The firm will be sued if something bad happens. But the owners cannot be sued personally for the debts or other torts or crimes of the company. So it is protection from all debts. That is, you can lose your entire investment. All the capital you have can be gone. But you can't lose more than that. That said, if you are a tortfeasor, you are still always responsible for your own tort. So if you're directly involved in the activity that leads to the liability for the firm, you can be personally sued. Or if you had supervisory authority or you had notice of and failed to do anything to stop these things from happening, you can also have direct liability. That is not the vicarious liability that limited liability protection protects you from. So where do we find this complete liability shield? Well, nowhere. So it's limited liability, and that "limited" really means something. There are still times that a shareholder or owner or member or limited partner can still have their personal assets reached, even when we have a good corporation or limited liability entity to protect us. What are those situations? Well, one is if you have acquired watered stock. That is, you paid less than the actual value. You might have some limited liability up to the amount you received preferentially. That doesn't happen very much. One that does happen, however, is sometimes non-payment of taxes. If you are strapped for cash, you may think, well, I don't really need to submit those employment withholding taxes this time. Or maybe the IRS will not notice that I didn't file a return this year, and I can use that to pay my employees their actual salaries this month. That might sound like a dandy short-term remedy. But understand that non-payment of taxes will enable your state entity operator-- typically secretary of state-- to forfeit your entity status. That means you will go from being a corporation or an LLC to being a sole proprietorship or a general partnership. And then you are back into the same situation that you would have been if you had never established a chosen entity. And that is, you and every other member or owner or even manager will be liable for all the debts of the corporation. So you have to pay your taxes. The other instance in which the liability shield is not very good is in cases, typically, of fraud. But we call this "piercing the corporate veil." We say, yes, you have a limited liability shield, but we're going to disregard it because you've done something untoward. So in general, most states have a veil-piercing rule that looks like the rule announced in Hubbard Industries by the Fifth Circuit in 2004. In 2004, the Fifth Circuit announced that under Texas law, there are three broad categories in which a court may pierce the corporate veil. So this is a federal district court announcing what they believe Texas law to be. And what they believe Texas law to be is the general common law that we see in most states across the nation. And that is, we pierce the corporate veil when the owners or shareholders are really just an alter ego of the corporation. That is a situation where perhaps the owners don't segregate the income from the corporation and their own income, where they use the cash register at the store as their own personal pocketbook, where we cannot really tell where the expenses and income of the individual and the corporation begin or end. They have blurred, often through sloppy bookkeeping, any distinction between the two. Number two is when the corporation is used for illegal purposes. If it's something you don't want to do because you could go to jail, you can't form a corporation and do it and not expect to also go to jail. They will pierce the corporate veil and find you personally liable. And last, when a corporation is used as a sham to perpetrate a fraud-- so it may not be technically illegal or criminal, but it may be a fraudulent tort that you're using the corporate shell as a shield against personal liability. And the court will disregard it in that situation. Now I made a slight big deal about the fact that this was a Fifth Circuit case and they announced Texas law. Texas did not like this announcement. They said that's not our law. And so two years later, Texas-- their legislature-- enacted their own veil-piercing statute. Most jurisdictions-- veil piercing is a common law concept. It's been developed through the years through many, many court decisions. But Texas directly in response to the Fifth Circuit, in their belief, not understanding actual Texas law made their own. And that is veil piercing is very, very limited in Texas. Only with actual fraud can the veil be pierced. Again, Texas is very pro-business. It is very pro-employer. And so it makes it much harder in Texas to pierce the corporate veil than I believe in any other jurisdiction. Now where do we find limited liability? Where do we not wear the clown suit to work? Well, that would be in corporates. That could be a professional corporation; in some jurisdictions, a professional association-- that's often limited to the medical professions; or even public benefit corporations, which we'll talk about later; limited liability companies; limited liability limited partnerships; limited liability partnerships; and for the limited partners in limited partnerships, we have this shield. If you don't have the double L or the corporation, you need to be wary. I note here that asterisk. That asterisk reminds us to look at the fact that limited partnerships doesn't have a double L. It has a single L. And that's because limited partnerships have to have at least one general partner that has full and expansive personal liability. We'll talk more about them later. Limited liability companies-- limited liability companies are a creation of statute. This is something that we dreamed up-- or, more correctly, the state of Wyoming dreamed up, and then every other state copied. This is the idea that maybe I don't want to be a corporation. Maybe I don't want to be a partnership. Maybe I want to be a smaller company, but still enjoy limited liability. So let's see what a limited liability company might look like compared to our different partnership forms. If we look at a general partnership that is organized with limited liability, we might think that looks a lot like what is known as a member-managed LLC. That is an LLC. The owners of an LLC are called members. They can collectively agree to all manage together, much like a general partnership, but still enjoy limited liability. We can also have manager-managed LLCs. And that is, we can have part of the owners, like in a limited liability partnership-- I'm sorry, in a limited liability limited partnership. Or we can hire outsiders to be managers, much like in a corporation. The great and most innovative part of the LLC statute, though, is this. We can have a single-member LLC. In all of the other entity choices we've looked at, besides corporation, which is big and hairy and complex and too much for many people, the only option for a single-person owner would be sole proprietorship, which leaves us hanging out in the wind as far as liability is concerned. General partnerships and limited partnerships, in their limited liability forms, require us to be in business with another co-owner. The LLC gives the option, now in every state, to be a single-member LLC and to manage as you prefer. That is why I love the LLC. For many companies, especially small companies starting out, it is a very good choice. There is no limit on the number of members. As we will see when we get to S corps, what used to be the best alternative to C corp for a single owner, there are limits to how many owners we can have. Not so with the LLC. Taxation-- whereas partnerships are taxed as a pass-through entity-- that is, it goes on your personal income tax, the amount of profit or loss you have enjoyed-- in the tax realm for LLCs, you can choose. You can choose to be taxed as a partnership, pass-through, on your own personal income tax, or you can choose to be taxed like a corporation. You may think, why would I want to be taxed like a corporation? The whole point of not being a corporation is avoiding double taxation. We'll talk about that in a bit. But it's nice to have that option. And it can be really meaningful. Again, management-- it's members' choice. In a general partnership, everyone managers. In a corporation, the owners usually don't manage, at least if it's a big publicly-held corporation. You have outside people doing that. We can do all of those within the LLC form. Allocations and distributions, how much we hold back in retained earnings-- all of that can be decided by the members themselves. And we have many fewer formalities than we would with a corporate form. Things like corporate meetings and reports, et cetera, just don't apply to the LLC. And of course, we have the limited liability shield that we like so much and makes this so much better than a sole proprietorship might be. So LLC sounds great. Could we make it better? Yes. Maybe we could. We can kind of do the micro mini size, which is the single-member LLC. It does have some drawbacks that we're going to talk about in a bit. Or we can kind of super size our LLC into what is known as a series LLC. And we'll talk about that now. A series LLC goes by a few different names depending on where you are. It could be called a series. It could be called a master. It could be called a cell LLC. But it's generally a way of forming multiple LLCs within one master LLC unit. So each separate cell could have its own members, its own managers, its own membership interests. And its liabilities and benefits would be segregated from the other sub-units within the series. That sounds like a lot. So let's look at a picture of what a series LLC might look like. Imagine that you are a real estate investor. And you have a number of rental units that you own. You do not want to own them in your own name, because you do not want slip and fall, premises liability, toxic mold scare, whatever. Any type of potential liability-- you want it to not be able to affect your personal assets. So you might put all of your rental units into an LLC. This would be great, except if one bad thing happens at rental unit A, you may have to liquidate rental units B, C, and D to pay off that judgment. You could put each of those rental units into a separate LLC. But that's a lot of extra paperwork that you have to keep track of. Even if you are doing a pass-through taxation, you may still have to file an informational return. And you don't want to have to do that on the hundreds of rental units you own. So with a series LLC, you could create one LLC with individual cells that own one property each. And if something bad happens at property A, only the assets within that sub-cell can be used to satisfy the judgment. So you might have to sell property A in order to satisfy it. But they can't reach properties B, C, or D. It sounds like a great way to segregate assets and to protect assets. And it might be. The problem is, many states have allowed series LLCs, but not all states have. And in those states, they treat the series LLC differently for tax purposes. In a state like Texas, Texas allows us to treat the parent LLC as a single entity. We file one franchise tax return. But at the federal level, the IRS still requires a separate tax return for each component cell. So it's pretty messy still. It's pretty new. We also have single-member LLCs, which sound great and definitely better than being a sole proprietor. But we do have some concerns in the veil piercing area. If you recall that in most of the country, the requirements for veil piercing look to, are you the alter ego? Is this really just you, and you're using the corporate form to protect your assets? We call that unity of interest. And in a single-member LLC, it looks like that would be easy to do. I'm just using the LLC to shield my personal assets, especially if I'm commingling funds or I'm doing something fraudulent or unjust. So in many jurisdictions, single-member LLC veils are disregarded at a pretty high rate, because it looks like it's just an individual claiming limited liability that they would not otherwise be allowed to have. We have other problems with LLCs, too-- single-member LLCs-- such as reverse veil piercing. So veil piercing is typically looking past the corporate form, which may be under-capitalized, to reach the personal assets of the owner. But sometimes we may be looking at a debtor who has a personal judgment against them. Perhaps they were in a car wreck and severely injured another party. And they have very few assets in their own name. But they have a lot of assets held in a single-member LLC entity. We have seen courts that will pierce the LLC's veil to reach those business assets to satisfy the personal judgments of an owner. And we've also seen problems in the bankruptcy realm, where a member has filed for bankruptcy and the trustee has chosen to become a substitute member of the LLC itself, depriving that bankrupt member of our ownership and decision-making criteria. So LLCs are great. There are some problems with the newer versions-- the single-member LLC and also the series LLC, in particular. The wheels of justice turn very, very slowly. So we have had LLCs for a long time-- decades, at this point. And states and courts are still working through those issues. So you must be wary, but a general LLC is still a very good option for many small businesses. "Corporations." Corporations are probably the best-known limited liability form. Most people understand what a corporation is. Most people understand the ownership structure-- that is shareholders own, managers manage, board of directors makes the big decisions. One thing that most people also know about a C-corp is income is double taxed. It is taxed when it's distributed to the owners, but it's taxed first at the corporate level. And many people find this to be distasteful because they feel like it's going to be much more expensive to be a C-corp. That is not always the case. There are many benefits to the corporate taxing structure. And this is why, as an LLC, you may choose sometimes to be taxed as a corporation would be while enjoying the other relaxed benefits of the LLC form. So retained earnings and employee benefits, not taxable to the corporation. Salaries and interest rate on capital loans can be deducted from taxable income. These are things that are not available in a pass-through entity taxation state. The only thing that you really lose in terms of taxation is that losses cannot be deducted by shareholders. Whereas losses when held by a general partner, or limited partner, or an LLC member, those can be used to offset other income. So when we think about being an LLC versus a C-corp, or even an S-corp-- which we'll talk about in a second-- there are many benefits for a small company with no plans of real big expansion to be an LLC. It's easy to set up. You get that pass-through taxation with the option of corporate taxation. And there's a lot less record keeping and other requirements. On the flip side, as a corporation, you have a lot more requirements than you would. A lot more paperwork that has to be filed. If however, you plan to go big, you want to bring in big outside investment, especially for an outside investment, or even some type of venture capital, most will want you to be a C-corp before they feel comfortable investing. And most would want you to be a Delaware a C-corp, as Delaware does the most corporate business in the country. They get it. They have specialized corporate law. They have a specialized Chancery Court that does nothing but business cases. And busy firms don't want to learn 50 different sets of corporate law. They want to learn one set, and they know Delaware's. So if you plan to be big, even if you think you might want to be big someday, a C-corp might be a good choice. Because while you can convert from general partnership, or LLLP, or LLC to C-corp later, it is messy and difficult. So choosing the right form from the beginning can be really, really helpful. So I promised S-corp. S-corp is not as relevant today as it used to be. With the advent, as I said, of the LLC and its widespread acceptance, S-corps are less useful. But still, if you think I'm little now but my plan is to be really big, I would like to be a C-corp without all the C-corp hassle, S-corp might be for you. And S-corp is a C-corp. As far as the state, which is where you would incorporate, is concerned, you are a C-corp. S-corp is really only an election with the IRS. It is just saying, I want to be taxed in a different way. That is I want to be taxed like a partnership. So you get the easy benefits at the outset, and you can easily convert to regular C-corp status later. The drawbacks to being an S-corp are many, however, because there are a lot of restrictions. It has to be a domestic corporation that is in the US. It has no more than 100 shareholders allowed. It can only have one class of stock. And you can't have people who aren't residents or citizens of the United States as owners. As long as those restrictions aren't too much, it's a good way to have basically a BBC corp from the beginning. Benefit corporations. We've talked about C-corps and even S-corps. Both of these follow what is known as the profit maximization rule. That is businesses organized to primarily work towards making a profit for their shareholders. Many entrepreneurs, however, don't want to be just making money. They want to be doing good. Right. So on one hand, an entrepreneur may wish to raise growth capital. He wants to bring in outside investors. Those outside investors want an equity stake. But bringing in outside people with other ideas and other opinions on how much money should be spent making more money and how much money should be spent towards societal goods can be problematic. So on one hand, we want that money. On the other hand, we fear losing control of the business. And in particular, we fear losing the ability to use our corporation to make the world a better place while making a profit. So the solution to this control problem is what we might term a sixth category of entity choice. And that is social concerns. That is where we bring in the public benefit corporation. So our newest type of corporate entity is the public benefit corporation. It's been around in the US since April of 2010 when Maryland introduced it and since then it has caught on like wildfire in 35 states. I include DC and Puerto Rico in that number but 35 states, including our big ones-- New York, California, Illinois, Delaware, even my home state of Texas. What is the public benefit corporation you ask. Well, it is both a corporation and a social entity. So one, we have a public benefit corporation. We know that it's going to have to include public benefit corporation in its name. All limited liability entities must include the language that signifies their limited liability status. So the public knows if I am interacting with this entity, the owners are not personally liable. And a public benefit corporation is no different. So we know it's going to have the PBC at the end. But what really makes it different is it must have either a very broad or very specific public purpose. It might be working to clean the oceans or it might be working to benefit a specific discriminated against group. Anything that qualifies as helpful in the environmental, or social, or educational sphere will work. And we must have accountability as working towards that purpose as well as working in the for profit corporate realm. That is we will show our shareholders not only that we are making money but that we are doing good with some of that money. And those accountability standards, which are certified by a third party entity-- we'll talk more about that later. Those accountability reports must be transparent. That is in most states, the public will get to see just how much good you are doing. And in all states, at least your shareholders will have to see not only what are your profit and losses looking like but how you're doing on the social accountability scale. Now when I talk about third party certification, what most people know when they think of third party certifiers for benefit corps is B Lab. B Lab offers an independent seal of approval to companies that are Certified B corporations. That is B Lab has come in and looked and said, yes, you are striving to promote a social purpose within your corporation or your LLC or your limited partnership. This is not the same thing as being a public benefit corporation. Public benefit corporation status is a legal status, like being a C-corp or being an LLC. B Lab is a third party certifier. They will come in and say, yes, you have met accountability standards in this area. But they are not a legal entity themselves. And they don't confer upon you any special legal status. So what is the benefit of being a public benefit corporation? Well, it allows corporations to have ethics. They are not driven just to maximize profits. They may use some of the profits that otherwise would have gone to shareholders to do good for communities or select groups of communities. And this may allow them to build a distinctive brand. That is they can signal to consumers, to employees, to suppliers, to the community around that they are there to do good. And that may help them reputationally. It's also a commitment device and serves as a clear legal guidance. Right? I may make profit. I am still a for profit corporation. But I am committed to serving the public and the public good. That means pure profit maximization is out the window. And shareholders who otherwise would have complained cannot complain anymore. It protects that social entrepreneur by allowing him to incur more equity or to sell more equity and incur more capitalization without loss of control in that social way. Weekly wrap-up. Let's see we've covered so far-- tort and criminal law, and now agency and business entities. That means next week, we start contracts. And through it all, we've seen how remedies and liability law interplay with all of the subject areas we've covered. Specifically when we're talking about agency relationships, we ask the following questions. Are the parties in an agency relationship, or are they perhaps independent contractors? We ask, do the principals have control? That is a key question for any agency. If there is an agency, what is the potential liability for the principal, often the employer or the firm? That depends in large part whether it's tort or contractual. The same goes for the liability of the agent. Tort depends on whether an agent was acting within the course and scope for principal liability, but we know that a tortfeasor is always liable for their own torts. For contractual liability on a principle by acts of an agent, we ask, did the agent act with authority? If so, the principal will be bound. If the agent is disclosed as acting as an agent, they will not bear any legal responsibility on a signed contract in a representative capacity for their principal. But if they are undisclosed or even partially disclosed, they may bear the same joint and several liability with their principal on that contract. So if there is liability because someone worked in unauthorized manner or was working within the course and scope, but against authorizations, we also worry about indemnification. Should the agent have to pay the principal back, or vise versa? As far as entity choice concerns, we talked about five, maybe six issues that we need to think about when we make the important decision of how we should form our business. As a business attorney, my focus is always on potential liability and how we can reduce it through using a limited liability form. But for the businessperson, you also need to think about, how will I be taxed? How will I personally be taxed? How will the entity be taxed? How much control am I willing to give up to other owners or to my shareholders? Would a public benefit corporation be a good choice given my social responsibility? How complex do I want this entity to be? Can I handle all the paperwork? Do I have the assets to hire accountants and lawyers to take care of it for me? And if I want to get out, how liquid is my ownership interest? If I own shares in a publicly traded company, it's easy to get out. If I am in a general partnership, I typically need the agreement of my other partners in order to sell my shares. So these are all things that we want to concern ourselves with when choosing an entity for our corporate form.