Do It Yourself

Agency is a legal relationship that is crucial to any common law legal system because most of the work in the world is done by agents working for their principal. The law of agency covers both personal activities and business activities. You don’t need the formalities of a contract or consideration in order to have an agency relationship, though they are very often present. For instance, in many states, the family errand doctrine says that a parent can be found liable for the negligence of a child who they send on an errand. Under agency principles, many states will say that the child is an agent for the parent on family business.

Most of the work of the world is done by agents working for principals. Agency is a conductor of liability. Plaintiffs’ lawyers are always looking for financially solvent parties who are reachable. What is an agency? Agency is an agreement by one person (an agent) to act for a principal at the principal’s direction and control. We have established the definition of agency that we’ll work with: now let’s look at the three subdivisions of agency: (1) the servant-agent, (2) the non-servant agent, and (3) the non-agent.

The servant-agent

The servant-agent means precisely the same thing as “common law employee”. If the principal has legal power to control the agent’s time allocation as well as how and when the agent works, then the person is a servant-agent. So where does this come up? It comes up in tax and other statutes that refer to the word “employee”. Both of the Supreme Court cases we read for today get into this issue. Also, respondeat superior depends on this distinction.

In the corporate scheme of things, how do board members fit? If a person is a director and only a director, then that person is not any type of agent. How come? An agent is one who agrees to act for the principal and at the principal’s control and direction. This definition doesn’t fit a director qua director, because they are the ones who determine the principal’s policies! This has practical ramifications: there is no wage withholding from the pay of directors. They get a check from the company and they have to pay by declaration of estimated tax. Furthermore, in almost all states, a person who is a director and only a director is not covered by Workers’ Compensation or Equal Employment statutes. It’s the same way with a partner in a general partnership. The partners, acting together, determine the partnership policy. Thus, a partner of a partnership is not an employee of the partnership and has no wage withholding.

There are two statutory “curlicues” for this. In Ohio, and a number of other states, partners in general partnerships can elect to participate in Workers’ Comp. Few people choose to do this, but Shipman thinks that’s a mistake: this is a great tax deal! In California and several other states, by statute, directors are included in Workers’ Comp. But that’s very rare. A third “curlicue” or oddity: in Maryland and a couple of other states, in a closely held corporation, even if a person is both an officer and a director, there can be an opting out of Workers’ Comp (but that’s almost always a stupid thing to do).

Is the top officer of a corporation a servant-agent? Yes. If you carefully go through the definition, you’ll find that the principal is the board of directors in this case. They have the legal power to allocate the time of the president. The president of a corporation is a servant-agent. The president’s salary is withheld, and the president is covered by Workers’ Comp and Equal Employment statutes.

The non-servant agent

Respondeat superior is built upon the premise that where there is a servant-agent over whom the principal has the legal power over their physical activities, the principal is liable whether or not he is negligent in hiring and training that agent. On the other hand, respondeat superior doesn’t apply to a non-servant agent, though some other theory like negligent hiring may apply. Officers of corporations are servant-agents, but directors or outside law firms are not servant-agents. So we have defined agency. It can be personal or business-related. It can be contractual or not. It need not be in writing, usually.

In California and Ohio, by statute, if you ask your agent to sign a real estate brokerage contract on your behalf, the broker, in order to hold you, will have to show a signed power of attorney from you to your agent. That is not true in many other states. Under the Uniform Commercial Code, if goods are involved, you will find many requirements for a signed writing. But in most cases, you don’t need it. You need to satisfy the general statute of frauds, and also it’s just prudent to have a signed writing.

Consequences of agency

One of the most crucial consequences is that any agency relationship creates heavy fiduciary duties running both ways. In Russ v. TRW, an Ohio Supreme Court case post-1980, a contractor was doing work for the Defense Department. Russ was a young accountant assigned to calculate the cost figure in “cost plus”. He came up with figure “x”, and went to his boss, who said “this figure is too small”. He was told to change the figure to “5x”. The Defense Department finally figured out the scam. There are lots of fraud statutes on the books. An investigation uncovers the young accountant, who is taken into the FBI Headquarters and “scared shitless”. Russ had a nervous breakdown and he went to see a psychiatrist. The company fired him, saying it was his fault. Russ sued under a section of the Restatement of Agency saying the following: “If the principal knows that what the principal is ordering the agent to do is criminal, the principal must tell the agent up front that what the agent is being told to do is a crime.” The Ohio Supreme Court held that this fiduciary duty was violated. They granted punitive damages (and in Ohio, when you get punitive damages, you also get attorney’s fees). The big test on punitive damages in Ohio is Zoppo, from 1995. In order to get punitive damages, you must show “spite”, “actual express malice”, “terrible insult”, or “conscious disregard of the rights of others”. In Ohio, mere recklessness will not get you punitive damages. One of the defenses offered was the Workers’ Comp immunity, which usually shields the employer from suit when they are hurt on the job. The injury here was psychological. That’s the fiduciary duty running from the principal to the agent.

A major fiduciary duty running from the agent to the principal is a duty to promptly and accurately account and disclose. Here’s a hypo: you’re hired as a debt collector, and you’re dealing with very poor people. You collect in cash. At the end of each day, you must write out a report on what you’ve collected and turn it over. That’s a fiduciary duty. In the corporate area, directors, officers, all employees, promoters, and controlling persons owe a heavy fiduciary duty to the corporation, and in some cases they also owe the duty to the minority shareholders. The law of fiduciary duty is a big part of this course.

The agent’s lien

A lien is a charge upon, or interest in, property. Speaking poetically, it is a rough form of co-ownership. How do we know that? We read the Graham memo on attorney’s liens. Your attorney is your non-servant agent. You can’t tell him how to do his job. You can control the result, but not the exact process. A general rule is that an agent not paid what the principal promises to pay him may (emphasis on may) have a lien on property of the principal in his possession. Graham discusses how in the personal injury context, if you go to a lawyer and retain him for a one-third contingent fee, and he drafts an engagement letter with strong attorney’s lien language in it, and the attorney for the defendant knows of that lien, and the defendant settles with your client without your knowledge, cuts the check solely to your client, the defendant is going to have to pay twice as to your one-third. Why? If you had the lien through the right language in the contract and the defendant knew about it, you, as a lawyer have a “hard-core” property interest in that cause of action. It can be settled without liability to the defendant only with two signatures: yours and the defendant’s. If an insurance company has a subrogation right to the settlement, there may need to be three signatures on the settlement agreement. Liens are important!!!

Liens of agents are crucial, and attorney’s liens are one of the most important. Graham’s memo also develops the concept of subrogation. An insurance company would have a lien on the settlement of the personal injury claim by way of subrogation.

Here’s another hypo: there’s both a first and second mortgage on property. The mortgagor missed a mortgage payment and the first mortgage forecloses. Under the law in most states, the second mortgage will lose its in rem rights against the property with the foreclosure of the first mortgage. It won’t lose the in personam rights on the note. Therefore, when a first mortgage is foreclosed, very often the second mortgagee, to protect themselves, will buy in at the foreclosure sale (will be the high bidder). Braunstein can tell us why this is so, but Shipman doesn’t know. When the second mortgagee buys the first mortgagee’s interest, most courts hold that the second mortgagee gets all of the rights of the first mortgagee, and that can be crucial.

Notice

Notice to a sufficiently important agent of a principal is notice to the principal itself at common law. In the U.S. Supreme Court, post-1990, Chief Justice Rehnquist wrote an opinion regarding an EEOC proceeding where the plaintiff lost at the administrative agency level. The statute says that a losing claimant may appeal within 30 days of notice to him. The lawyer tried the case, went on a European vacation, and didn’t leave the memo with his secretary of what to do if things happen during your absence. That’s malpractice per se. The lawyer was in Europe, and, let’s say, on July 1^st, the case was decided and the administrative law judge sent him a copy of the opinion. The secretary got it in his absence. The lawyer is in Europe for a long time, and then on July 15^th, the administrative law judge sends a copy to the plaintiff. On August 3^rd, the lawyer returns from Europe and promptly files a notice of appeal. If you measured the 30 days from when the plaintiff got notice, then this appeal is timely. But if you measure from July 1^st, then the appeal is not timely. Rehnquist found that the secretary was the agent of the lawyer, the secretary got it on July 1^st, notice to the secretary is notice to the lawyer under the law of agency, and the client is kicked out of court. However, the client has a good malpractice cause of action against the lawyer.

There’s an exception in Article I of the Uniform Commercial Code that tries to reverse the common law rule. If you want to get fast notice, and you’re dealing with an organization, give notice not only to the local guy but also to the president in New York and the general counsel of the company in New York. Explain why you’re doing it. But this is perfectly okay, and you better do this if you want to “start the clock running”. Keep in mind that provision of the Uniform Commercial Code.

Corporate and partnership law draw heavily on agency law and the law of insurance. The Perl case involves insurance in the context of a law firm. We do quite a bit in this course with law firms.

Respondeat superior

Respondeat superior – “Let the master answer.” What is this doctrine? If you have (1) a servant-agent, (2) acting within the scope of employment, (3) who commits a tort, the actor is liable, but, in addition, the master (the principal) is liable even if the master is without fault. That’s an agency doctrine. The related tort doctrine says that if the principal was negligent in hiring, training, or failing to fire the agent, then you can sue the principal in tort. Respondeat superior is much more worrisome.

In any organization of any size, there will be the agents doing the work at the bottom, and in the middle and toward the top there will be several layers of managing agents like foremen, plant superintendents, and finally the president up at the top. Does respondeat superior apply to those managing agents so as to make them, in addition to the principal (the corporation) liable without fault? The answer is no, but under Rest.2d Agency, followed by Ohio, here’s the deal as to the managing agent: he can, without liability, reasonably delegate, but his initial delegation must be reasonable and there must be reasonable supervision thereafter. If he fails either one of these tests, he can be liable to the third party.

Note the Holy Trinity of agency law: (1) P – the principal, (2) A – the agent, and (3) TP – for the third party. It’s like a troika! They’re tied together.

Let’s go over these rules carefully. With a few exceptions, noted tomorrow, the principal found liable under respondeat superior has a good cause of action in indemnification (that’s one way to look at it) or in subrogation (another way) against the bus driver. Let’s stop and think about this: the subrogation theory is probably the more obvious one. In paying off the parents of the deceased baby, under duress (that is, a legal judgment) the principal becomes subrogated to the baby’s rights against the bus driver. But there’s a big, important exception: if the principal has an insurance policy covering both him and the agent, then the principal cannot go against the agent because the insurance company is covering both of them and if the insurance company went against the agent, the insurance company would have to pay off what they won against the agent and there is a big legal principle involved: where this is a pure circuity of action, the courts will not entertain the matter.

What’s a pure circuity of action? If A sues B in court and A wins, B has, as a matter of law, a mirror-image cause of action against A in the same amount. But the courts won’t entertain it! Also, under the Federal Tort Claims Act, the Supreme Court has held that the United States is liable for the negligence of one of its agents. The common law principle allowing the principal to go against the agent does not exist. Douglas says that the statute didn’t give them this right! But this decision could have gone just the other way. In Ohio, this is handled more by statute. By negligence, it will be the same situation. If all you’re alleging is negligence, you generally have to go against the state of Ohio alone, and you can’t join the state employer. However, if you’re alleging something worse than negligence, you can sue both the state of Ohio and the individual.

But caution: you may have to bring one action in the Court of Claims, and bring simultaneously the second one in the Court of Common Pleas. Likewise, the Ohio Supreme Court has held, generally speaking, that only the Ohio Court of Claims can determine whether an employee was in the scope of employment. In addition, with both the Ohio and Federal Courts of Claims, they have no equity jurisdiction and no restitution jurisdiction. Only a Federal District Court or a state Court of Common Pleas can sit in equity. When you sue the government, you often have to file two parallel suits!

Agency in the contract setting

We’ve looked at agency in the tort setting; now we’ll look at three prototypical agency cases in the contract setting. Say you have X, Inc., and Ms. Jones, president of the company. Say Ms. Jones enters into a large but not extraordinary construction contract. When you get to extraordinary items, you’ll have to have the approval of the board of directors. That’s why we presume the contract is not extraordinary. The contract is in writing and is described in the first paragraph as a contract between TP (Third Party) and X, Inc. Then at the signature block at the bottom, we find it set up as follows: “X, INC., by: Jane Jones, Pres.” TP will sign above. Jane Jones signs on the dotted line. That means that Jones has signed in her corporate capacity.

If there is (1) actual authority on the part of the agent, (2) the contract describes itself as a contract between TP and X, Inc. and (3) the signature block reads properly (agency capacity) then there is a valid contract between TP and X, Inc. and Jones has no personal liability on such a contract, with the exception of fraud, in which case TP may sue Jones and clearly sue X, Inc. for rescission and, in some states, TP can sue X, Inc. for damages. If TP wants Jones to have personal liability, there will have to be material below the line reading: “I, Jane Jones, in my individual capacity, do hereby guarantee the performance and payment of this contract.” Then she’ll sign again, just simply as “Jane Jones” with nothing under the signature. That is not present in our example here. If there is actual authority, the fact that the third party does not believe there is actual authority is totally irrelevant. Usually the third party will believe it, but if, in fact, TP didn’t really believe it, it doesn’t matter.

Actual authority

It comes in two flavors: (1) express and (2) implied. Either flavor suffices. The difference between the two goes back to McCullough v. Maryland and Chief Justice Marshall’s opinion dealing with the Bank of the United States. He said: “Let the end be legitimate and proper and all powers necessary to reach that end are implied.” That’s a Constitutional Law principle. Conceptually, actual authority results from manifestations by the principal to the agent that she has such authority. These manifestations can come in various ways: (1) in the charter, (2) in the regulations, (3) in the resolutions of the board of directors, or (4) if the principal has ratified similar transactions by the agent in the past.

If you are dealing with a big corporation that is heavy on paperwork, on a big transaction, supplies will sometimes require a purchase order or a board of directors resolution up front because they don’t want to get into litigation. The flip side is that if you are the third party and you’re dealing with the president, and you submit the bill to the corporate treasury for payment, the treasurer may ask the president where the purchase order or board of directors resolution can be found. That is a practical matter. In addition, a sophisticated supplier not under pressure in a big transaction will request the signed, written opinion of the outside counsel to the corporation because this will get everyone in gear to make sure the paperwork is clear.

What about powers of attorney? A power of attorney is a written instrument creating agency. You’ll have a serious operation, for example, with a lot of bad medicine for six weeks. You would stop and fill out a power of attorney to your spouse, parent, or close friend, sign it, and give it to them. Powers of attorney come in two flavors: (1) general power of attorney, and (2) special power of attorney, which is more limited.

There is an old Third Circuit case from the 1940’s called Von Wedel. In New York City, there was a married couple where the wife was a United States citizen and the husband had a Green Card but was a German citizen. It was 1940, 18 months before the United States entered the war. The husband decided he had to go back to Germany and fight. Before he left, he made out a power of attorney to his friend X with the broadest possible general powers in it. X can do anything that husband was allowed to do. X thought the husband’s assets were about to be seized by the United States government. X uses the power of attorney to transfer all of the husband’s assets to the wife. The United States Department of Justice challenged the transfer, and the Third Circuit found that gifts of all assets were so unusual that it could not be done under even the most general power of attorney. What should the husband have done? He should have transferred the assets himself before he left, because that would have been unchallenged.

Today we deal with something similar to special power of attorney. We’re dealing with the actions of partners, directors, or high officers of business associations. Take the facts of the example above, and let’s say that in the articles of incorporation of X, Inc. is a provision that says “no officer or employee shall cause a corporate contract to be entered into for more than $5,000, unless the board of directors first authorizes.” Let us say for the sake of argument that the contract in question is for $50,000. In the past three years, Jones, as president, on behalf of X with respect to everyone she’s dealt with, she has signed contracts for $50,000 or $100,000 and the parties have been paid. This shows apparent though not actual authority.

Apparent authority

Let’s say more specifically that TP is unaware of the $5,000 limit in the articles of incorporation. The goods are delivered to X, Inc. and the invoice is sent to the treasurer of X. He gets a nasty letter back with a certified copy of the provision of the articles of incorporation. Under these facts, TP can hold X to the contract because a type of reliance has been proven by TP. TP has shown that it did not know of the restriction on actual authority. Thus, apparent authority kicks in. X is liable on the contract, and has, in theory, a cause of action against Jones for any damages they can prove. The cause of action of X, Inc. against Jones will disappear if the board of directors of X, Inc. expressly, implicitly, or by conduct ratifies or adopts the contract. This action will make it as if there was actual authority from the beginning. But if the board of directors does not ratify, TP has a cause of action in restitution against X, Inc. There may also be hardcore estoppel, fraud, and so on. The tricky thing is that TP has an action against Jones for breach of the implied warranty or implied representation of authority. An agent signing impliedly represents or warrants that he or she has authority (in some states, this is watered down to “reasonably believes he or she has authority”).

On the other hand, let’s change the facts such that TP is aware of the $5,000 limit in the articles of incorporation. TP went to the statehouse and read X’s charter before dealing with Jane Jones. There is no apparent authority in Jones in this case, because TP cannot make out an apparent authority case if TP knows there is no actual authority.

Along the same lines of the agent’s liability, under the UCC, if you sign a negotiable instrument as an agent and you do not bind the principal, under the UCC, you as agent have total, automatic liability. Furthermore, in about four states, if an agent signs as an agent and doesn’t bind the principal, then it’s automatic personal liability. But that’s a minority view.

If you’re dealing with federal, state, or local government, the agent you’re dealing with must have actual authority, or none at all. There is no such thing as apparent authority when it comes to government. Obviously, however, restitution may be available against a government. If the government commits fraud, you must check the Federal Tort Claims Act, which tends to negate fraud. It has numerous exceptions, including acts by the United States government abroad. If you’re in France, for example, and a United States government army truck runs you over negligently, you probably have no claim under the FTCA. When your back is to the wall, don’t forget the possibilities of restitution and true estoppel (where the principal has held out and you have relied to your detriment).

Consider the case of Maglica v. Maglica. Maglica started Mag-Lite in his garage 35 years ago. He had been married and divorced. He met a woman about his age who had also been married and divorced. The woman became active in the business for 20 or 25 years. One day, he booted her out. She sued under various theories including restitution (benefits conferred). The business was worth about $600 million at the time, and she sued for $300 million. The jury came back with a verdict for hundreds of millions of dollars. The Court of Appeals sent it back for a new trial because they said the instructions were insufficient. Restitution is the smaller of the work you put out versus the reasonable value of the benefits conferred. She settled for $30 million.

There was also Marvin v. Marvin. A young woman moved in with Lee Marvin. Later, he booted her out and there was a suit for the reasonable value of services. This opinion lays out the issues nicely. The first issue is whether it is the transaction is more or less prostitution and thus against public policy. They found that she could recover something. But in many other states, it’s a complete non-starter. In Virginia, by statute or constitutional amendment, they recently prohibited Marvin v. Marvin kinds of lawsuits.

So first you consider whether you have the approval of the board of directors. In the cases we’re dealing with today, we are assuming that these are instances where you don’t need the board’s approval. In a close corporation, the standards can vary, either tighter or looser. Shipman has seen cases going both ways. In a tearjerker of a case, Brandywine Racing in the Delaware Court of Chancery in the 1940’s, a group of guys got together, deciding that Delaware needed a new racetrack. To build a racetrack, you need approval from the racing commission. To get the racing commission’s approval, you need good architects’ plans. The company was formed, and a couple of the directors went to the architect, asking if he would expedite the drafting of the plans. The board of directors did not formally act. The two people who negotiated with the architect did not own a substantial percentage of the company. The architect delivered the plans on time and the racing commission delivered permission for the track. Sounds good so far.

But “who knows what evil lurks in the hearts of men”? The architect sends a bill to the company. The two directors didn’t have the actual authority to make the deal! The company tells the architect that they will get nothing! A lawsuit was brought, and it went to a bench trial. The court holds that there was no actual or apparent authority for the directors to do the deal with the architect. The lawyer says to the court: “Give us the same amount under restitution: benefits conferred!” The judge got the complaint out and found there was no count two for restitution. The architect is screwed! The moral of the story is, always put in count two for restitution! The law firm committed malpractice! Always look at all of you theories, because the typical case today will have five or six different causes of action.

Consider a Pennsylvania case from the late 1940’s involving a close corporation. The war broke out in late 1941, and a lot of people did a lot of patriotic things. A top officer at this close corporation circulated a memo to the plant workers and told them that those who wanted to enlist and serve would be given a check for the difference between their military pay and their civilian pay at the plant. Many employees did enlist, and most came back and did not submit the claim for reimbursement. The plaintiff did and was fired! (Today, that would be an abusive discharge under Ohio law.) There was a big trial in which the court decided that the offer was so momentous that only the board of directors could have authorized it. The board of directors never formally took up the proposal. But the court held, however, that since it’s a close corporation and two directors knew about it, there was implied ratification or adoption.

National Biscuit Co. v. Stroud – Here we have a 50-50 two man partnership running a grocery store. The first partner said: “Don’t buy from X.” The second partner continued to buy from X, who knew about the dispute. There could be no apparent authority. They read § 18 of the Uniform Partnership Act, which says that when you have a deadlock among partners on this particular issue, any partner has actual authority for any typical transaction. Substantially the same result would have been reached under restitution. But the court upheld the contract.

Smith v. Dixon – Under § 9, limits are imposed on partnership. If you’re a bank making a loan to a law firm that will be a business loan, cognovit clauses will be used by the bank. That’s okay for a business transaction in Ohio. But there’s a surprise in § 9…you’ll have to have the signature of every partner! It’s the same for an arbitration agreement, the sale of all assets, or the sale of goodwill. The law firm will handle this by getting a power of attorney from each new partner as they are admitted for limited purposes such as those specifically mentioned in § 9. The senior partner will sign once for himself, and then once for each other partner, with an asterisk indicating that he’s using the power of attorney he got earlier.

Here we have a family farming partnership in Arkansas. Various members of the family are partners. They met one Sunday and authorized the old man to sell the farm. But they told him not to go below $230,000. The old man signs for the partnership at $210,000. It is binding on the partnership and the other partners? Applying our catechisms, there was no actual authority because the partnership assembled and under § 18 gave him binding instructions not to go under $230,000. However, as the court held, there was apparent authority and the third party did not know of the secret limitation on the price. “Apparent authority makes the world go round!” Therefore, there was a valid contract binding on everyone.

In the Matter of Drive-In Development Corp. – P, Inc. owned 100% of S, Inc. P, Inc. is borrowing money from a bank. P, Inc. happens to be in pretty bad shape itself, while the subsidiary, S, happens to be in good financial shape. The bank wants what is known as an “upstream written guaranty” by S, Inc. of S’s liability to the bank. The corporate secretary for S, Inc. fills out a certificate and delivers it to the bank stating that S’s board of directors has duly met and has unanimously approved the S guaranty. Based on that, S’s president has signed the guaranty on behalf of S, Inc. Later, there is a bankruptcy and the bank files its claim both against P, Inc. and S, Inc. There are two touchy issues: (1) It just so happened that the board of directors of S, Inc. didn’t actually meet, and an upstream guaranty is so unusual that only the board of directors could approve it. S, Inc. says “Sorry, the board didn’t meet, despite what the corporate secretary did. Without a board meeting, we’re not liable on the guaranty!” On the agency issue, the court holds that there is apparent authority. The notes indicate some contrary authority. In the later case, a reasonable person would have been put on notice if the secretary was lying. (2) There also were the fraudulent conveyance statutes. Here, the attorney for S did not properly raise the issue in the bankruptcy court. In a big 1990’s Third Circuit case, upstream guaranties were said not to be per se fraudulent.

Black v. Harrison Home Co. – Here we have a closely held corporation buying land to sell lot by lot. As you come to the last lots, you’re selling substantially all of your assets. Does that mean that the company must have board of directors and shareholders’ approval for the last lots? When a land company contemplates that they’ll sell off the lots one by one, the officers themselves can do it. In the bylaws of the company, it said that there had to be two officers’ signatures on a contract for it to be valid. The parents started dying off and the daughter was effectively the only owner and the only officer. She signed a contract on behalf of the company for the sale of the last lot. Then she dies. Her estate has not yet been probated. The court held that there was no actual authority for her to sell with one signature and that therefore the company could not be bound. The case is clearly wrong on modern standards because though she did not have actual authority, she did have apparent authority because the third party had no reason to know of the unusual bylaw with the two signature requirement. The plaintiff’s last theory was that the corporate fiction should be disregarded because the daughter owned all the stock and it would be silly to talk about lack of authority as an officer. The court said that would be true if her estate is solvent enough to pay off all her creditors. But the plaintiff’s counsel neglected to allege that to be the case, and the court won’t go along with them.

Lee v. Jenkins Bros. – Here we have a closely held corporation where the president orally assured a guy of a pension if he would switch employers. He worked for twenty years, after which he was laid off without a pension. He sues the company. There are two defenses: (1) statute of frauds, and (2) no authority on the part of the president to make this contract. The district judge held that in Connecticut at that time the statute of frauds was a complete defense. He did not reach the authority issue. Then it goes to the Second Circuit which held that the authority issue ought to be looked at too. In Ohio and in a number of states, very substantial partial performance will take you out of the statute of frauds. In terms of authority, lifetime contracts and contracts for a pension are viewed with much suspicion by courts. In Ohio and in a number of states, if you’re an employee, you’re better off with a limited but long-term contract (10 or 20 years). Many states will say that a lifetime contract is “too rich” and “too indefinite”. The case has a good discussion of apparent and actual authority. The court makes the point that if the board of directors ratifies similar transactions, that can create actual authority in that it’s a signal to the agent that he has the authority. It can also create apparent authority to the world at large. The employee should have gotten the promise in writing, and he should have gotten the board of directors to approve! Since the president owned most of the stock, in a number of states, they would go with the employee on the agency issue and it would help on the statute of frauds issue.

Davis v. Sheerin – Here we have despicable conduct on the part of the majority shareholder. The majority shareholder claims that the minority shareholder isn’t a shareholder at all! The minority shareholder brings an action for oppression. Since what the majority shareholder was doing was arguably oppressive, the minority shareholder claims that the court should enter an order forcing the majority shareholder to buy the minority shareholder’s shares at market value without a minority discount. The problem was that until five years before, Texas had a statute authorizing this remedy. The statute was modeled after Michigan and California. (Ohio is silent on this issue right now.) The Texas legislature had repealed the statute. The court held that as a court of equity they have inherent jurisdiction under judge-made law to enter the order. The order will cause a sale of several hundred thousand dollars. In Ohio, you would have to hook up with Crosby v. Beam. You would have a pretty good chance, in Shipman’s view. The notes after this case discuss oppression, which is a post-1960 buzzword. Just what is oppressive, though? You don’t need violence or fraud in order to have oppression. There was a Minnesota case where the majority shareholder ran the place and the minority shareholder was simply ignored. That was seen to be oppressive.

All agents are fiduciaries to their principals. No fiduciary, including an agent or a director, may, by contract with a third party limit his fiduciary duties to the beneficiary of that fiduciary relationship. The case that sets out this rule is ConAgra v. Cargill from the Nebraska Supreme Court from the 1980’s. The Delaware Supreme Court agrees with this case. X, Inc. was approached by Z, Inc., which said to the board of X, Inc. that they wanted to buy all or substantially all of their assets. They proposed to assume all of their disclosed, noncontingent, and uncontested liabilities. In many states, that might be considered a de facto merger, but Delaware does not recognize de facto mergers. We also don’t have to worry about that because it was a cash offer. The federal securities laws and state Blue Sky laws are inapplicable, at least as far as the Securities Act of 1933 goes, because it’s an all-cash offer in U.S. dollars. Could the officers themselves approve such a thing? The statutes in all states on this transaction specify a two-step transaction. The directors of the selling corporation must approve and call a special shareholders’ meeting and a specified majority or supermajority of all the shareholders must approve.

The directors of X, Inc. met with the people from Z, Inc. and said: “Let’s go!” They approved the contract offered by Z, Inc. But notice that the contract is in limbo and not effective until the shareholders of X, Inc. approve it at a meeting. The contract included language saying that the directors of X, Inc. agreed to put the matter before the shareholders of X, Inc. and “support [the offer], if consistent with the fiduciary duties of the directors of X, Inc.” Now, a second suitor, B, Inc., comes along and talks to the directors of X, Inc., saying that it will offer what it thinks is a better deal by a cash tender offer to all shareholders of X, Inc. B says: “How’s about it?” The directors did so, and of course, it screwed up the shareholders’ meeting called to approve the Z, Inc. offer. Z, Inc. brings an action against both B, Inc. and all directors of X that in effect says: “I’ve been unjustly used as a ‘stalking horse’! I’ve been used to make the main horse run faster! The directors backed out of their word! Give us money and/or an injunction!” The case should have gone off on contract principles. The language phoned in to the X directors to put in the contract was standard and it says: “if the fiduciary duties of the X, Inc. directors cause them to change their mind, they can do so legally.”

Why? Here’s a big deal: the Nebraska Supreme Court chose not to go by contract but rather by an agency principal. They said that if the X, Inc. directors collectively held all or nearly all of the stock of X, Inc., the principal would not buy because substantially all stock would have consented to an alternate arrangement. (Note that creditors have nothing to fear.) The Delaware courts have picked this up in the case of Paramount from 1994, where Delaware expressly approved ConAgra v. Cargill. So what’s a lock-up? It’s unclear in Delaware exactly what you can do for a lock-up. Probably you can have a clause saying that if the deal doesn’t go through, Z, Inc. will be reimbursed for its legal, accounting, investment banking and similar expenses. That is called a “modest breakup fee” clause. In states other than Delaware, such a clause is valid. Some people have tried to go further and include “massive breakup fees”. In one recent case, there was a merger involving $50-60 billion where the breakup fee was to the tune of $4-5 billion. It was paid, and there was no suit over it.

The Z, Inc.-type businesses of the world can negotiate an option to purchase X, Inc.’s stock at the current market price. The Delaware court said that this can be done within limits, but you can’t allow the person to make a killing. If the stock is at 30, you can grant Z an option for 20% of the stock, except if the stock of X goes over, for example, 40, then you can’t allow them that particular benefit. In 2003 in the Omnicare case, there was a decision that boggles the mind! It was from the Delaware Supreme Court. You had a situation where about three shareholders of X, Inc. owned, collectively, 60%. The vote in Delaware to approve a transaction is only a simple majority of all outstanding shares. In Ohio, this often goes up to 2/3rds. Z, Inc. contracted with the three directors who held 60% and got a promise from them in their individual capacity that they would vote to approve the deal. B, Inc. entered and made a much better offer. Z brought an action against the directors in their individual and corporate capacities. The Delaware Supreme Court held that even though these three people were contracting in their individual capacity concerning their stock, it still was an impermissible lock-up under Delaware law. It was a 3-2 decision. The opinion said that if the directors, in their individual capacity, had put the language in similar to what the Houston lawyer put in as in ConAgra v. Cargill, that is, that they would vote as shareholders to support consistent with their fiduciary duties as directors, then it probably would have been okay. There is a Minnesota case that followed the Delaware case that was not as picky on lock-ups. We have no idea what the situation would be here in Ohio.

Here’s another big agency and fiduciary principle: no fiduciary may unreasonably delegate. Within a law firm, for example, a senior partner conducts an interview and assures the potential client that they will be treated right. They will be introduced to the associates and told up front that the associates will do most of the work under his supervision. If he is a noted trial lawyer but he isn’t going to try the case, you put that into writing early on. If your firm takes a case and you want the assistance of an outside law firm, you must first clear that with the client in writing.

A Seventh Circuit case from Indiana involves an Indiana insurance company. The company had entered into a 15-year contract with C, whereby C was going to run everything. The company went insolvent. When an insurance company goes insolvent, the state insurance commissioner goes to a state court and they take over the company’s assets. Creditors file claims. A claim was filed by C for compensation for the future under the contract. This did not involve past, paid compensation. The past compensation was reasonable. There was no fraud. C had been doing his job. The Seventh Circuit held that this was a highly unreasonable delegation by the board of directors of its functions, and therefore the future portion of the contract was unenforceable and C would take nothing. Today, if you’re going to have a contract like this, the lawyer will (1) research carefully and keep the contract reasonable in length, (2) reword it to say: “I, C, will give advice to the board of directors, which advice they may or may not take in their own discretion”.

All participants in the study group must always follow the BSL Honor Code.