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Agency, Partnerships, and Limited Liability Entities: Cases and Materials on Unincorporated Business Associations--6th Edition

Foundation Press has announced that the 6th edition of Agency, Partnerships, and Limited Liability Entities: Cases and Materials on Unincorporated Business Associations is now available for pre-orders.

This book is a collection of edited cases, original text, questions, and problems designed for use in a law school level course on agency, partnerships, and limited liability entities. A key feature of this casebook is the extensive coverage of limited liability entities, especially unincorporated limited liability companies (LLCs). The authors include cases on such LLC topics as formation, interpretation of the operating agreement, piercing the LLC "veil," fiduciary obligation, expulsion of an LLC member, and dissolution. Also included is a section on the question of whether membership interests in LLCs and limited partnerships are a security. This edition has been meticulously updated with important new cases and rules.

In this edition, I am joined by two new coauthors: James Park (UCLA) and Usha Rodrigues (Georgia). I was delighted that these two outstanding corporate law scholars wanted to work with me and our partnership went very well. I think the new book is even better than ever thanks to their contributions.

 

Harvard Law School Business Associations Exams from 1871

Harvard Law School Agency Law exam from 1871 (h/t @OrinKerr) pic.twitter.com/VVIjoq7heu

— Steve Bainbridge (@PrawfBainbridge) October 9, 2024

Harvard Law School Partnership Exam from 1871 pic.twitter.com/hjuUoVaD1X

— Steve Bainbridge (@PrawfBainbridge) October 9, 2024

Harvard Law School Corporations Exam from 1871 pic.twitter.com/tD6yOKzfCP

— Steve Bainbridge (@PrawfBainbridge) October 9, 2024

The Distinction Between a Principal’s Liability for Torts of an Independent Contractor with Respect to Inherently Dangerous Activities and Ultra-Hazardous Activities: An Explainer

I gave this to my class today and thought it might be of interest to some readers.

The principal can be held liable where the contractor’s performance involves an inherently dangerous activity. In the Majestic case, for example, the Parking Authority of the City of Paterson hired Toti Contracting to demolish a building adjacent to one owned by Majestic Realty.[1] A wrecking ball operated by a Toti employee knocked a section of wall onto the Majestic building’s roof, causing extensive damage. Humorously, the Toti employee explained: “I goofed.”[2] Majestic sued the Authority. The trial court held that Toti was an independent contractor and, accordingly, that the Authority could not be held liable. The New Jersey supreme court reversed, adopting:

[A] rule which would impose liability upon the landowner who engages an independent contractor to do work which he should recognize as necessarily requiring the creation during its progress of a condition involving a peculiar risk of harm to others unless special precautions are taken, if the contractor is negligent in failing to take those precautions. Such work may be said to be inherently dangerous, i.e., an activity which can be carried on safely only by the exercise of special skill and care, and which involves grave risk of danger to persons or property if negligently done.[3]

Demolition was just such an activity, according to the court.[4]

In a classic article, Professor Sykes explained that:

Vicarious liability is clearly efficient for many inherently dangerous activities. In cases where the agent’s activity requires particular, ex ante precautions the principal can require those precautions in the agency agreement, and provide that failure to undertake the precautions will result in loss of the agent’s fee in a one-period agency, discharge or demotion in a multiperiod agency, or some other adequately severe penalty. The enforcement costs of this simple agreement are low if the desired precautions are cheaply observable—opportunities for inexpensive observation of precautions arise in many inherently dangerous activities. Vicarious liability is unambiguously efficient under these conditions.[5]

Majestic distinguished inherently dangerous activities from ultra-hazardous ones.[6] Under Majestic, the principal is liable with respect to both types of activities. The difference is that the principal is vicariously liable with respect to liable ultra-hazardous activities without regard to the negligence of the contractor. As the Majestic court put it, the principal’s “liability is absolute where the work is ultra-hazardous, but it is contingent on proof of negligence in cases of inherently dangerous activity.”[7]

Judge Posner advanced an economic justification for the ultra-hazardous exception—which he called the “abnormally dangerous” activity exception—in Anderson v. Marathon Petroleum Co.[8] In general, Posner argued, a principal does not directly supervise the independent contractor’s work. Accordingly, the principal typically has little ability to prevent negligence on the part of the independent contractor (or the latter’s employees). Where an activity is abnormally dangerous, however, it is by definition one that “might very well result in injury even if conducted with all due skill and caution.”[9] With respect to such activities, Posner argued:

[I]t is important not only that the people engaged in it use the highest practicable degree of skill and caution, but also—since even if they do so, accidents may well result—that the people who have authorized the activity consider the possibility of preventing some accidents by curtailing the activity or even eliminating it altogether. . . . The fact that a very high degree of care is cost-justified implies that the principal should be induced to wrack his brain, as well as the independent contractor his own brain, for ways of minimizing the danger posed by the activity. And the fact that the only feasible method of accident prevention may be to reduce the amount of the activity or substitute another activity argues for placing liability on the principal, who makes the decision whether to undertake the activity in the first place.[10]

Note that this analysis seemingly would not justify an exception to the no liability rule where the conduct is merely inherently dangerous. Because inherently dangerous activities by definition can be conducted safely with special care and precautions, there seems less justification for requiring the principal to “wrack his brain” for precautions.[11]

Fourth Edition of my Mini-treatise Agency, Partnerships & LLCs is Now Available

The Fourth Edition of my book Agency, Partnerships & LLCs (Concepts and Insights) is now available via Amazon.  This thoroughly-updated edition provides a comprehensive guide to the law of agency relationships, partnerships, and limited liability companies. In addition to detailed treatment of the key legal issues, the text also provides balanced analyses of the policies underlying the law. The reader thus comes away not only with a knowledge of the law but also an understanding of why courts and legislatures chose those rules. The text incorporates frequent references to the most up-to-date sources of the law, including those most frequently encountered in law school courses, such as the Restatement (Third) of Agency, the Uniform Partnership Act, and the Uniform Limited Liability Company Act. In addition, to account for the increasing dominance of Delaware as the state in which limited liability companies are formed, the new edition pays considerable attention to the Delaware Limited Liability Company Act.

Kentucky Attorney General Holds ESG and Stakeholder Capitalism to be Inconsistent with Kentucky Law in Fiduciary Duties

Kentucky Attorney General Opinion OAG 22-05 notes the "increasing trend among some investment management firms to use money in public and state employee pension plans—that is, other people’s money—to push their own political agendas and force social change." The Attorney General is also concerned "that politically biased investment strategies have real costs and worsen outcomes for pensioners."

The Attorney General therefore addresses the following question:

Whether “stakeholder capitalism” and “environmental, social, and governance” investment practices in connection with the investment of public pensions funds are consistent with Kentucky law governing fiduciary duties.

The opinion reviews both ERISA and Kentucky statutes to conclude that:

While asset owners may pursue a social purpose or “sacrifice some performance on their investments to achieve an ESG goal,” investment managers entrusted to make financial investments for Kentucky’s public pension systems must be single-minded in their motivation and actions and their decisions must be “[s]olely in the interest of the members and beneficiaries [and for] the exclusive purpose of providing benefits to members and beneficiaries” .... In sum, politics has no place in Kentucky’s public pensions. Therefore, it is the opinion of this Office that “stakeholder capitalism” and “environmental, social, and governance” investment practices that introduce mixed motivations to investment decisions are inconsistent with Kentucky law governing fiduciary duties owed by investment management firms to Kentucky’s public pension plans. (Emphasis in original.)

I certainly agree that politics has no place in investment management. I have frequently written about that issue in connection with divestment campaigns, most notably in Those Divesting Presbyterians.

As I will be discussing in my forthcoming book, The Profit Motive: In Defense of Shareholder Value Maximization, I am also deeply skeptical that there is a business case for ESG and stakeholder capitalism.

Having said that, however, note that the Kentucky Attorney general's opinion has a gap; namely, it fails to address the question of whether there is a business case for ESG and stakeholder capitalism.

Proponents of ESG argue investing in employee welfare generates higher employee satisfaction and, as a result, productivity gains.[1] Improved corporate governance will discourage managers from actions that benefit themselves at the expense of shareholders and/or stakeholders. Likewise, investing in environmental enhancements will reduce long-term costs from climate change. And so on.[2]

Proponents will therefore argue that they are using ESG metrics in making investment decisions precisely for the required "purpose of providing benefits to members and beneficiaries." 

As I explain in The Profit Motive, I don't buy the proponents' argument. To the contrary, ESG is mostly about politics. 

But the Kentucky Attorney General's opinion basically ignores this critical issue. It says there is "some suggestion" that ESG's costs outweigh its benefits. In support of that rather weak claim, the opinion cites one op-ed from Barron's. This omission significantly weakens the opinion. As such, the opinion does the objection to ESG little good.

Fifth Edition of Agency, Partnerships, and Limited Liability Entities is Now Out

It's here. Agency, Partnerships, and Limited Liability Entities: Cases and Materials on Unincorporated Business Associations https://t.co/0H8lqjSdPu pic.twitter.com/PVWeGDPDAv

— Steve Bainbridge (@PrawfBainbridge) April 12, 2022

Look what came in today's mail: The 11th edition of my Business Associations casebook

Longtime users will notice a major change to the cover of this edition. My friends and coauthors Bill Klein and Mark Ramseyer have decided to retire from working on our books. It has been an honor and privilege to work with them these many years. Going forward, I will be solely responsible for editing the books.

I do not plan any significant changes to the editorial style. In editing this book, I will continue to follow the six basic but apparently widely ignored principles that have informed the book since Bill’s first edition. Each principle is one that I think helps produce a book that teaches students the gist of the law they need to know; that trains them to apply it; and that (perish the thought) almost makes them enjoy the process.

States with Limited Liability Limited Partnership Statutes as of 2021

The 11th Edition of what is now Bainbridge's Business Association's casebook is now available for Spring 2022 adoptions

Foundation Press today announced that the 11th edition of my Business Associations casebook is now available for Spring 2022 adoptions. Go here to order.

The Restatement (Second) of Agency is Still Alive and Kicking

According to a Westlaw search I conducted this morning, in the last three years there were 506 cases that cited to the Restatement (Second) of Agency. In that same period, there were 630 cases that cited to the Restatement (Third). Ignoring the fact that some cases cited both, that means over 44.5% of cases in the last three years cited a 63 year old Restatement instead of citing a 15 year old Restatement.  I assume that a large part of the persistence of the Restatement (Second) is driven by lower courts following older higher court precedents that embraced the Restatement (Second). Eyeballing the results seems to confirm that. Yet, there were a fair number of state supreme court cases citing the Restatement (Second).

It might be interesting for someone with a lot of time on their hands to drill down into these results to see if there are doctrinal reasons courts are sticking with the Restatement (Second).

It also suggests that my fellow teachers of agency law cannot yet throw the Restatement (Second) into the dustbin of history.

Collins v. Lewis cafeteria eventually opened but finally closed in 2014

Collins v. Lewis was a staple of Klein, Ramseyer & Bainbridge Business Associations casebook for many years. A friend sent along this article that tells something of the backstory.

Greenwood: "The goal of liberalism should not be individual self-determination but the freedom to live together in peace, prosperity and justice"

I really enjoyed reading Daniel Greenwood's new article, which sits at an interesting intersection of political theory, Jewish law, and partnership law:

Liberal political theory has long relied on a metaphor of contract: autonomous adults coming together to agree, by unanimous consent, on the basic structure of a just society. But contract is a strange metaphor with which to explain society. Contract law is based on a morality of strangers acting at arms-length. In contrast, decent societies and the governments they set for themselves must be based on a commitment of mutual responsibility. What makes us fellow citizens—fellows of any variety—is accepting that we are all in this together.

Jewish legal and midrashic traditions can be a useful corrective to the atomistic metaphors underlying most liberal political theory. The Jewish tradition has never had the luxury of imagining self-sufficiency, that government itself is the primary source of unjust power, or that individuals could be free in a state of nature. We too can no longer ignore that a solitary human being is a dead human being, that we need government to make spaces in which we can be free from want, resist oppression by non-governmental power, reverse the destruction of the natural commons on which we depend, and engage in the communal activities that make life meaningful.

The partnership metaphor, I argue, can make visible the mutual concern and collective effort that must characterize decent and just governments in an age of economic challenges and ecological crises. The goal of liberalism should not be individual self-determination but the freedom to live together in peace, prosperity and justice.

Greenwood, Daniel J.H., Partnership, Democracy, and Self-Rule in Jewish Law (May 3, 2021). Touro Law Review, Vol. 36, No. 959, 2021, Available at SSRN: https://ssrn.com/abstract=3838904

What is the scope of a CEO's authority with respect to corporate mergers?

Over on Twitter my friend David Skeel posed an interesting question:

Helpful thread by @PrawfBainbridge on the NRA corporate authority issue. One question: I assume the Board that while the Board could auth the CEO to sign a merger agreement, it couldn't auth her to decide whether and when to propose a merger on behalf of the Bd? https://t.co/yBEccXGnrF

— David Skeel @ Penn (@daskeel) April 12, 2021

I discuss the general authority of corporate CEOs in my book Corporate Law (Concepts and Insights). In it, I observe that:

Corporate employees, especially officers, are agents of the corporation.[1] As such, they can have authority or apparent authority. Actual authority exists when the agent reasonably believes the principal has consented to a particular course of conduct.[2]

Actual authority can be express, as where the principal instructs the agent to “sell Whiteacre on my behalf.” In the corporate context, express actual authority is usually vested in officers by a resolution of the board and/or a description of the officer’s duties set forth in the bylaws.[3] Actual authority can also be implied, however, if the principal’s acts or conduct are such the agent can reasonably infer the requisite consent.

Apparent authority exists where words or conduct of the principal lead the third party to reasonably believe that the agent has authority to make the contract.[4] Of particular importance with respect to the authority of corporate officers is the concept of apparent authority implied by custom. If it is customary for officers holding the position in question to have authority to make the contract in question, it would be reasonable for a third party to believe this officer has that authority.

Most of the case law on the apparent authority of corporate officers relates to the powers of presidents. Corporate presidents are regarded as general agents of the corporation vested with considerable managerial powers. Accordingly, contracts that are executed by the president on the corporation’s behalf and arise out of the ordinary course of business matters are binding on the corporation.^[5]

An important line of cases limits the implied actual and the apparent authority of corporate officers—of whatever rank—to matters arising in the ordinary course of business.^[6]

There is no bright line between ordinary and extraordinary acts. It seems reasonable to assume, however, that acts consigned by statute to the board of directors will be deemed extraordinary.[7] The Model Business Corporation Act provides that the following decisions may not be delegated to a committee of the board, but rather must be made by the board as a whole: (1) Authorize dividends or other distributions, except according to a formula or method, or within limits, prescribed by the board of directors. (2) Approve or propose to shareholders action that the statute requires be approved by shareholders. (3) Fill vacancies on the board of directors or, in general, on any of its committees. (4) Adopt, amend, or repeal bylaws.[8] DGCL § 141(c) is similar. Certainly, if those decisions may not be delegated to a board committee they may not be delegated to officers.

This is critical for our purposes, because approval of a merger requires approval by both the board of directors and the shareholders. Hence, it seems clear a CEO would lack both implied actual and apparent authority to bind the corporation to a merger.

Obviously, however, the board of directors could delegate substantial authority with respect to a merger to a CEO and thereby vest the CEO with express actual authority. The board doubtless can (and usually does) authorize the CEO to hire legal and financial advisors, negotiate with potential merger partners, and negotiate the terms of the merger agreement.[9] The board also could authorize the CEO to explore alternative transactions.[10] Once the board of directors has approved the agreement and plan of merger, the board doubtless could (and usually does) delegate authority to the CEO to sign the merger agreement on the corporation’s behalf.[11]

Could the board thus authorize the CEO to decide whether and when to contact a potential target or buyer? I think this would be valid. It differs in degree but not in kind from the things we know a CEO can be given actual authority to do. While I haven’t found a case on point, I note that in the famous Trans Union case, CEO Van Gorkom initiated the sale of the company without first getting any authorization from the board to do so and, while that may have been unwise, the court did not use that fact to invalidate the deal.[12]

New Video on the Parable of the Talents

Ownership Piercing by Lécia Vicente: Recommended Reading

I am reading a very interesting paper by Lécia Vicente, which argues that:

In this article, I develop the concept of "ownership piercing." I use the expression to suggest that courts engage in a process of evaluative reasoning to clarify who owns property rights and controls the limited liability company. I show under what circumstances courts should do that. Ownership piercing entails investigating the reality of the company's governance and tracing the real ownership profile of the company. It means defining who materially controls the company (i.e., managers or members?) and how "tamed" or, in other words, restricted the members' property rights are considering the consensual agreements the members and other stakeholders entered into. The idea that there may be situations in which courts should ownership pierce rests on the substance over form principle, which maintains that the economic substance of transactions rather than their legal form be disclosed.

Vicente, Lécia, Ownership Piercing (February 21, 2021). Available at SSRN: https://ssrn.com/abstract=3790108 or http://dx.doi.org/10.2139/ssrn.3790108.

She explains that:

Ownership piercing is not the same as the company's veil piercing. I define ownership piercing as a process of evaluative reasoning that courts undertake to complement the material participation test. Ownership piercing may also shed light on the level of control and the manager's decision-making role. Ownership piercing may help courts understand if an agent occupies a control or decision-making role despite acting under the control of a principal who has the final decision-making authority. In other words, ownership piercing helps understand who exercises ultimate control in the LLC.

I think she is very much on to something here. In particular, I think her work will do much to inform our analysis of cases like AG Resource Holdings, LLC, et al. v. Terral and Focus Financial Partners v. Holsopple. In both of those cases, the question of status as an owner or employee matter a great deal. Ownership piercing gives us a starting point for parsing them out.

Professor Vicente uses Metro Storage International LLC v. Harron to frame her analysis. (I commend to your attention Francis Pileggi's blog post on the case.) On one level, Harron is a constitutional law/civil procedure case, as the question before the court was whether a Delaware court had personal jurisdiction under 18-109(a) of the Delaware code, which implies consent to jurisdiction on the part of both de jury and de facto managers of an LLC. As Professor Vicente points out, however, deciding those issues required the court to parse out what it means to own and control an LLC.

Those who own are not always in control. Therefore, those who control should be held accountable like the owners would if they were in control. ... I am dealing with situations where standard contractual terms give the managers exclusive decision-making power. The role of an acting manager who had that type of exclusive power was analyzed by the Delaware Chancery Court ("Court") in Metro Storage International LLC v. Harron (“Harron”). In light of the company's contractual framework, members are peculiarly vulnerable since they cannot remove the managers, nor is it easy for them to sell their units. I suggest that, under these circumstances, courts may be less willing to give managers the benefit of the doubt as it is done through the application of the business judgment rule.

The first thing that sprang to mind when I read that was Martin Petrin's work on the responsible corporate officer doctrine, which is an analogy I encourage Prof. Vicente to pursue. 

In any case, she poses the question "What does it mean to participate materially in the management of the company?" In doing so, she does a deep dive into there hybrid property and contractual nature of LLC member's rights.

I was interested by her attempt to use the biological concept of pleiotropy to understand legal rights. It's an ambitious attempt at intellectual arbitrage. I'm not 100% convinced, but I admire her scholarly ambition and the modesty that prompts her to forthrightly acknowledge that "legal pleiotropy needs to be continuously studied, particularly to determine the applicable contractual clauses' scope and depth."

There's a digression into some empirical research she did into the UK equivalent of LLCs, which I'm not sure advances the ball. I would urge her to tie it more throughly into the argument throughout. (Or to dump it.)

At page 27, we come to her detailed exposition of how ownership piercing would solve the problems laid out in the preceding sections. What I would encourage her to develop in this section is a clearer statement of how ownership piercing would work. Set out a practical test that a judge could adopt and apply. In particular, it strikes me that she could adapt the veil piercing standard to say something like:

1. Does this individual have de facto managerial control whether by contract or otherwise?
   1. The laundry list of factors used in veil piercing cases could be adapted to ask whether this LLC has de facto allowed this individual to take over the members' control of the company and effect a separation of ownership and control.
2. Would not treating this individual as a controller lead to inequitable results?

Obviously, I'm shooting from the hip here but I think it would be helpful for her to flesh out what it means when she says "Ownership piercing means that the courts engage in a qualified process of evaluative reasoning." How does the court go about unveiling "the company's real owners, that is, the managers."

In sum, I think Prof. Vicente's article has the potential to make a very substantial contribution to an important area of the law that has not been well served by courts or commentators to date.

 

I also note with amusement that my friend Joshua Fershee will be pleased by Prof. Vicente's admonition that "THE LLC IS NOT A BERLE-MEANS CORPORATION." As Josh has often pointed out, much confusion has resulted from courts' failure to understand that point. 

Prof. Vicente draws three points from that distinction:

1. The LLC consists of autonomous individuals and the individualistic aspects of the LLC "do not favor weaker members." The cases in which courts have validated "predatory competition" within LLCs (with appropriate fiduciary duty waivers) come to mind here.
2. The principal-agent problem takes a different form that is "exacerbated by majority rules, the power of controlling or activist members, and the benefit of hindsight of the knowledgeable manager acting opportunistically."
3. The "common understanding in the literature that in LLCs, members are usually part of the management" is simply not true in manager-managed LLCs, where members "grant the managers autonomy, but in the process, become dependent on them to the point that unclear property rights in the units are not sufficient to overcome self-dealing by the management. Hence, without self-motivated investors minding the company's business, managers' effective constraints are small."