Agency, Partnership, and the LLC: The Law of Unincorporated Business Enterprises

Seventh Edition
Professor Mark Lowenstein
Spring, 2011

Chapter 1: The Agency Relationship; The Ambiguous Principal Problem; Sub-agency

I. The Agency Relationship

 Agency relationship = when one person (the agent) consents to act on behalf of and subject to the control of another (the
principal).
o 1) Consent
o 2) Acting on behalf of
o 3) Subject to the control of
 The principle is responsible for the tortious conduct of his agent.
 The principle liable to third parties for contracts made by agent for the principle.
 “Agency is the fiduciary relation that arises when one person (a “principal”) manifests assent to another person (“an agent”)
that the agent shall act on the principal’s behalf and subject to the principal’s control, and the agent manifests assent or
otherwise consents so to act.” Restatement 3d §1.10

Carrier v. McLlarky, 693 A.2d 76 (Supreme Court of New Hampshire, 1997)

 Facts: D installed a replacement water heater in P’s house and told him he would try to exchange the old water heater
with the manufacturer for credit b/c he thought it was still under warranty.
 Proc. Hist: P sued D in small claims court for the replacement value of the water heater and assorted costs. The district
court rendered judgment in favor of the plaintiff. D appeals.
 Issue: Was there an agency relationship b/w P and D? Holding: yes.
 Rule: An agency relationship is created when a principal gives authority to another to act on his/her behalf and the agent
consents to do so. The granting of authority and consent to act need not be written, but may be implied from the parties
conduct or other evidence of intent.
 Reasoning: This was a factual decision for the trial court to make, and the Supreme Court of NH will not overturn a
factual finding unless it was unsupported by the evidence. Not the case here.
 Issue: Was there a breach? Holding: No.
 Rule: Agents have a duty to conduct the affairs of the principal with a certain level of diligence, skill, and competence.
 Rule: Under ordinary circumstances, the promise to act as an agent is interpreted as being a promise only to make
reasonable efforts to accomplish the directed result.
 Reasoning: D made a reasonable attempt to obtain a refund for P. He returned the old water heater for credit, but did
not receive credit. He never guaranteed he would receive credit, only that he would make reasonable efforts to do so.
 Class Notes: Since this is a tort claim for negligence we need to ask is whether there is a duty. Yes! Because the
plumber was an agent and an agent owes a duty of care to the principle. Could the homeowner sue under a breach of
contract theory? No. Because there was no consideration given by the homeowner. This was a promise without
consideration. But isn’t consideration necessary for the agreement to act as the agent of the homeowner? NO! The
court makes clear that there is no requirement of consideration before an official agent relationship.
 Green Checkmarks = (1) Agency relationship can come about even in the absence of consideration. (2) The level
of control does not need to be great. (3) The courts tend to focus on one or another of the elements of agency in
identifying an agent relationship.
Note:
 A person does not become the agent of another simply by offering to help or making a suggestion.

M.D. & Associates v. Sears, Roebuck & Co.. 749 S.W.2d 454 (Court of Appeals of Missouri, 1988)
 Facts: Landlord company sued Sears, as tenant, claiming unlawful possession of the leasehold following termination of
the lease. Sears mailed an extension of the lease letter to Paul Hogg with a request for receipt. Paula Fraley, who worked
with Mr. Hogg, signed the receipt. The person who first received the notice gave it to an agent for the landlord (Hogg).
Hogg was an agent for the leasing company, Fraley was an agent of Hogg.
 Issue: Did the landlord company ACTUALLY receive the letter through the agent of an agent? (Was Mrs. Fraley an
agent of Mr. Hogg and if so, was Mr. Hogg on notice of the extension, and if so was the landlord on notice?) Holding:
Yes.
 Rule: The existence of agency and the authority of an agent can be implied by proof of facts, circumstances, words,
acts, and the conduct of the party to be charged with the agency. The prior conduct of the parties is a factor to be taken
into account if such conduct is a part of the circumstances surrounding the transaction.
 Reasoning: Ms. Fraley had been picking up Mr. Hogg’s mail for months prior to the notice from Sears, and if not
expressly, than by acquiescence, she was authorized to do so.
Three Elements of the Agency Relationship: Restatement Second §1
1. On Behalf Of: The acting party must be acting “on behalf of” the principal (“for the benefit of”).
 Risk? Look at who has the risk in the relationship. If the principle has the risk, likely an agency relationship. If the
acting party is acting on its own behalf, it is not a fiduciary, nor is it fair to subject the other party to the burdens of being
a principal.
 Be careful though. Merely benefiting another by one’s conduct is not enough the agent must be acting primarily for the
benefit of the principal. (i.e. in Clapp v. Skewer, Skewer was benefited by Clapp’s regulations of the mall b/c he got a %
of the profits)

2. Control: element of subservience. In Cargill, the court lists a number of factors:

 At a minimum, Control means the agent must respond to the directions of the principal.
 “Element of subservience”
 Control is defined in different ways depending on the nature of the liability being asserted against the principal.

3. Consent: An agency relationship must be created by mutual agreement. One party in invitum cannot create it.
 consent can exist even where the parties involved fail to recognize that they have created an agency relation or explicitly
avoid creating an agency. Cargill
 consent can be implied as well as express (Sears)
o Assent can be found in nonverbal action (i.e. shaking head) or failure to object when action taken previously in
an agency capacity is again proposed.

4. Fiduciary Relationship: Ask whether or not the agent has a fiduciary duty to the principle. If no, not likely to be an agency
relationship.
 They would have to exercise their agency with due care, and if they breach that due care and a third party is injured, the
principal is responsible.
 Helpful also to ask that isf the agent is negligent (i.e. a retailer is negligent in setting up their store and a third party is
injured), would that third party be able to go after the principal?

A. Agent or Seller? = Title is key.

 If a distributor holds title to the goods and can set its own price with the retailers = likely seller, not agent.
 “Whether distributor is an agent or a buyer depends on whether his duty is to act primarily for the benefit of the one
delivering the goods to him or to act primarily for his own benefit.”
 Important elements = who holds title? Who sets the price?
o When the owner retains title, sets the prices, and gives the person selling the goods (consignee) return privileges
for unsold goods = agency.
o Title is important because whoever has the title is likely to be acting on own behalf, AND take the risk of
ownership.
 It is possible that a buyer has title to the goods and still be deemed an agent. So the courts will then look to the control
element. (i.e. GE)
 Rule: One who contracts to acquire property from a third person and convey it to another is the agent of the other only if
it is agreed that he is to act primarily for the benefit of the other and not for himself. Factors that one is a supplier,
rather than an agent, are:
o (1) that he is to receive a fixed price for the property irrespective of price paid by him. This is the most
importsnt.
o (2) that he acts in his own name and receives the title to the property which he thereafter is to transfer.
o (3) that he has an independent business in buying and selling similar property.

 Hunter Mining Laboratories, Inc. v. Management Assistance, Inc., 763 P.2d 350 (Supreme Court of Nevada, 1988)
o Facts: Hubco agreed to sell to Hunter Basic Four computer equipment, and install it for him. They did not
finish the instillation so Hunter hired Data Doctors to install it. They did not finish it either. Both Hubco and
Data Doctors were authorized resellers of Basic Four computer equipment. Hunter sued the manufacturer of
Basic Four computer equipment. The trial court found for D b/c they did not find any evidence that an agency
relationship between D and the two installers existed.
o Issue: Was there an agency relationship b/w Data Doctors and/or Hubco and (D)? Holding: No. Affirmed.
o Rule: In an agency relationship, the principal possesses the right to control the agent’s conduct. When the
owner retains title, sets the prices, and gives the person selling the goods (consignee) return privileges for
unsold goods = agency.
o Reasoning: Just because D was able to control some portions of how the installers re-sold its product, they did
not retain the power to control their business expenditures, fix rates, demand share in profits, etc.
 Additionally, there was no “acting on behalf of” element because the installers were not acting primarily for
the benefit of D – they acted independently and in their own names.
o Class Notes: Courts will look if the purported agent acted on behalf of, with consent of, and in control of the
purported principal. Here, the court looks to the fact that the buyer took ultimate title to the goods and could
resell them at any price they want. However, just because someone has title doesn’t end the inquiry. See G.E.
below.

 United States v. General Electric Co., 272 US. 476 (Supreme Court of the United States, 1926)
o Facts: Gov’t argued that GE was breaking anti-trust laws by fixing the prices of their products that were being
sold by 21,000 distributors. GE claimed they were selling the products through agents, and not requiring
resellers to sell at a certain price.
o Issue: Were the 21,000 distributors agents or buyers? Holding: They were agents. GE wins.
o Reasoning: The 21,000 distributors were not getting the title to the products, and they did not buy the
products from GE, they were basically receiving the products on consignment from the company to hold in
their custody until they could sell them. They were a way for GE to deal directly with the customer.
o Class Notes: What were the government’s best arguments? How could this be characterized as NOT an agency
relationship?
 Control? How these distributors sell the lamps, as far as where they sell them, how the store is laid
out, how they are displayed, etc., was not under the control of GE. There were a lot of aspects of the
retailer’s business, besides the fixing of the price, that were not subject to the control of the
manufacturer.
 Consent? The retailer consented to sell GE lamps, but did they consent to be their agent? Consent to
be controlled by GE in all aspects of their business? Consent to act on behalf of GE, or were they
acting on their own behalf?
 On behalf of? Who had the risk? The resellers were paying for these lamps right?
o Bottom line: Other cases involving similar fact situations (manufacturer tries to fix prices by characterizing
retailer as its agent) have met with mixed success. It turns on the elements we have just gone through (above).

B. Agency or Debtor-Creditor Relationship?

 If the debtor’s control over the debtor’s business is substantial (particularly if it is affirmative in nature and includes the
right to initiate transactions) the creditor may be classified as a principal with the debtor its agent.
 Cargill = agency found without the right to initiate (primarily because of right of first refusal on grain  had a grain
source = on behalf), bue PLo says probably wrong.
 A. Gay Jenson Farms Co. v. Cargill, Inc., 309 N.W.2d 285 (Supreme Court of Minnesota, 1981)
o Facts: Warren borrowed money from Cargill to grow his business. Cargill gave Warren money, but in return
was appointed as its grain agent and had a right of first refusal to purchase market grain sold by Warren.
Warren was required to provide Cargill with annual financial statements. Cargill was given the right to access
to Warren’s books for inspection. Also, Cargill had to first approve any improvements in excess of $5,000.
Warren went under when their checks to farmers were not clearing and after an audit it was found that they
were more than 5.6 million in debt to Cargill and farmers. Farmers brought suit against Warren and Cargill
under principle-agent theory.
o Proc. Hist: The jury found that Cargill’s conduct b/w 1973 and 1977 had made it Warren’s principal making
Cargill liable to the plaintiffs.
o Issue: Was the relationship b/w Cargill and Warren that of principle-agent, or a creditor-debtor relationship?
Holding: Principle agent.
o Rule: “An agreement may result in the creation of an agency relationship although the parties did not call it an
agency and did not intend the legal consequences of the relation to follow. The existence of the agency may be
proved by circumstantial evidence, which shows a course of dealing b/w the two parties.
o Rule: A creditor who assumes control of his debtor’s business may turn into a principal for the acts of the
debtor in connection with the business.
o Rule: If creditor takes over the management of the business and directs what contracts may or may not be made,
he becomes a principal. The point at which the creditor becomes a principal is that at which he assumes de facto
control over the conduct of his debtor,whatever the terms of the formal contract with his debtor may be.
o Reasoning: By directing Warren to implement its recommendations, Cargill manifested its consent that
Warren would be its agent. Warren acted on Cargill’s behalf in procuring grain for Cargill as the part of its
normal operations, which were totally financed by Cargill. Further, and agency relationship was established by
Cargill’s interference with the internal affairs of Warren, which constituted de facto control of the elevator.
o All portions of Warren’s property were financed by Cargill thus there was no independent business. Cargill
thought that Warren owed a duty to them. The decisions made by Warren were not independent of Cargill’s
interest OR it’s control. Cargill exercised its control over Warren through (elements of factors of control):
 constant recommendations
  right of first refusal
 requiring approval before Warren could incur more debt
 right of entry onto Warren premises
 correspondence and criticism
 Class Notes: In this case, as the debtor got sloppier and lost money, the lender became concerned and ratcheted up its
control in order to protect itself. When the debtor went bankrupt, plaintiffs looked for deep pockets. Their theory was
that any Ks the Warren entered into, were Ks on behalf of Cargill because Warren was acting as Cargill’s agents.
 The court here agreed making Cargill liable for all of the liabilities of its debtor(/agent), Warren. This is important b/c
every bank lender who enters into an extensive loan agreement with a debtor has to be concerned about the fact “have I
gone too far with the control element that I’ll be deemed a principal and my debtor will be deemed an agent?”
 Was the court right here? Cargill’s arguments make a good case that the court was wrong – there was no agency
relationship:
o The grain elevator owned the grain, seeds, could resell at any price they wanted to. Even though Cargill owned
rights of first refusal still meant they could sell at any price they wanted to.
o Also, just because they were in debt to Cargill and any profit they made was going to go to Cargill, thus
benefiting Cargill, they were still operating their own business, and trying to dig themselves out of the deep hole
they had dug.
 Elements of factors of control the court found (p. 32):
1. Cargill’s constant recommendations to Warren by telephone;
2. Cargill’s right of first refusal on grain;
3. Warren’s inability to enter into mortgages, purchase stock or pay dividends w/out Cargill’s approval;
4. Cargill’s right of entry onto Warren’s premises to carry on checks and audits;
5. Cargill’s correspondence and criticism of Warren’s finances, salaries, inventory;
6. Cargill’s determination that Warren needed “strong paternal guidance”;
7. Provision of drafts and forms to Warren upon which Cargill’s name was imprinted;
8. Financing of all Warren’s purchases of grain and operating expenses;
9. Cargill’s power to discontinue the financing of Warren’s operations.
 Lowenstein thinks it’s a wrong decision. Thinks the court got it wrong.

E. Agent or Escrow Holder and Third Party Beneficiaries

 Escrow = holder of an escrow contracts to hold money, a deed, or some other asset until the occurrence or nonoccurrence
of a specified event before a specified date. The escrow contract states the holder’s duties to deliver or return the escrow
upon the occurrence or nonoccurrence of the specified event. The escrowed deed or other property is beyond the control of
the parties to a transaction for a specified time and the escrow contract determines when the holder may properly make
delivery. An escrow holder is not an agent during escrow period but becomes one if escrow succeeds or fails.
 Duty of escrow holder = to adhere to the terms of the escrow agreement. Failure to do so will make the escrow holder liable
to parties for whose benefit the escrow was created for loss caused by the holder’s failure to adhere to the terms of the
agreement.
 King v. First National Bank, 647 P.2d 596 (Supreme Court of Alaska, 1982)
o Facts: Olsons held land subject to payment of the full purchase price to the state of Alaska. When the Kings
purchased it, an escrow agreement was signed by the Olsons designating D as the escrow holder, stating that the
Kings were to make payments to D who were to in turn make the payments to the state of Alaska. The remainder
was to go to the Olsons. The Olsons subsequently modified this escrow agreement so that all the money from the
King’s payments were sent to the Olsons. None was sent to the state of Alaska. The Kings had thought they had
paid off their land when the state of Alaska informed them that they had not received any payments from them in
quite some time and were thus repossessing the land.
o Issue: Was D an agent or a “escrow holder”? Holding: Agent.
o Rule: If a principal delivers property to agent, with a command to deliver to T upon performance, he is an agent for
the principal only and no liability of agent to T. But the agent may be liable under 3rd party beneficiary when: (1) K
between Principal and A is intended to benefit T or (2) K between principal and A is for discharge of a single
obligation.
o Reasoning: Since the Olsons were the only ones to sign the escrow agreement, there was no escrow and they could
change the agreement whenever they wanted.
o Issue: Is the bank liable to the Kings as third party beneficiaries? Holding: Yes.
o Rule: When an agent’s employment is for the benefit of a particular person or for the performance of a single
obligation by the principal, it may be found that the agreement with the principal was a contract for the benefit of
the donee or obligee. If so, the agent is responsible to such person for his non-performance or misperformance.
o Rule: An agent acting on behalf of one person may be held liable to a third person for failure to perform a contract
intended to benefit the third person. The third party is justified in relying on the contract and it may not be changed
w/out his consent.
 o Reasoning: The original escrow instructions were drafted by the Kings’ attorney with particular sections intended
to protect the Kings’ interest so it is possible they were third party beneficiaries.
o Rule w/r/t third party beneficiaries: Traditionally, an agent is not liable for injuries to third persons resulting
solely from a mere breach of duty, which he owes to his principal, unless at the same time the agent owes a separate
duty to the third party. In order for a third party to enforce a contract, it must be shown that there was a contractual
intent to benefit the third person, or, in other words, that the third party was the direct and intended beneficiary of
the contract.
o Notes: In construction contracts, the lender wants to make sure that as the project is being built, all the contractors
are being paid because the bank doesn’t want there to be a mechanics lien that would take priority over its own
mortgage on the property.
o Mechanics lien = statutory provision that allows those who improve real property to have a prior lien for the worker
materials that they provided.
o So banks will not disperse money to a general contractor unless they receive lien waivers from the subcontractors (a
certificate that they’ve been paid). What happens in a lot of cases is the general contractor will say that the subs
have been paid, will receive a disbursement of money, and will not pay the subs with that money. The subs say that
the money shouldn’t have been disbursed b/c they weren’t paid and this contract was for their benefit (they’re third
party beneficiaries). The subs normally fail on both the escrow and third party beneficiary arguments b/c the
subs are not the intended beneficiary of the contract b/c the bank usually convinces the court that the
contract was entered into for it’s own protection.

F. Agency Distinguished From Other Relationships.

1. The Franchise Relationship:

Franchise = a license from the owner of a trademark or trade name [the franchisor] permitting another [the franchisee] to sell a product
or service under that name or mark.”
 It usually includes an exclusive right to sell the product in a specified territory.
 Technically though, an agreement between a franchisor and franchisee does not create an agency relationship. These
agreements usually give the franchisor a significant amount of control over the franchisee.
 Some courts tend to look at the indicia of control and say that there was an agency relationship. Most courts however
will honor the parties intent to create a franchise relationship, not an agency or partnership agreement.

While there is no agency b/w franchisor and franchisee, there are a number of cases that have held the franchisor liable for the
franchisee’s actions because it APPEARED to a third party that there was an agency relationship. In this theory, what matters is
what a third party perceived, NOT the elements of agency.

2. The Marriage Relationship

 A marriage relationship does not in itself create an agency between husband and wife. This is because in particular
transactions it is not necessarily the case that the one spouse is acting on behalf of and subject to the control of the other
spouse.
 But could create great weight toward the finding of an agency relationship if other factors present.

3. Property Relationships
a. Co-ownership = this relationship does not in itself establish agency b/c one cannot fairly infer that one co-owner
consents to another acting on his behalf merely from the fact that they are joint owners of property.
b. Landlord-Tenant – in general, this relationship in itself does not involve agency.
 nature of the lease could establish an agency relationship when the lessee was required to make
improvements.

4. Corporate Relationships
a. Directors
 It’s a common misperception that directors of a corporation are agents of a corporation.
 Directors don’t act on behalf of the corporation, but have general oversight of the corporation. Also, nobody
has the authority to tell the directors what to do.
 Also, directors have no authority to act on behalf of the corporation individually; they can only act as a group.
They can however, agree to appoint one of the members to be an agent of the corporation for a number of
different purposes (i.e. acquiring property, etc.). For this purpose, the director would be an agent, but only for
that particular circumstance.
b. Officers of the corporation
 Officers though clearly ARE agents b/c subject to control by board of directors.
c. Employees of the corporation
 Employees are almost always agents of the corporation.
  Some employees, like doctors, cannot be told what to do, because of their expertise.
d. Multiple Corporations:
 Subsidiaries = i.e. one business entity (corporation, LLC, etc.) owns another business entity. Quite often, the
subsidiary will incur liability that it can’t pay (tort liability, contractual, etc.). The plaintiff will bring a claim
against the parent corporation looking for deep pockets. If the subsidiary is acting as an agent for the
parent, obviously the parent will be liable.
 This relationship has a lot of the indicia of the agency relationship.
o The parent controls the subsidiary b/c it owns it.
o Acting on behalf of. The whole purpose of this entity is to increase profits for the owner.
o Consent? This is problematic because corporations many times create these subsidiaries for the sole
purpose of avoiding liability! So these two are at odds. So in order to solve this, the courts have
required more than the existence of a parent-subsidiary relationship before finding an agency
relationship. Many times courts will require a finding that the parent exercises so much control that
there really is no separate business.
 In order to avoid liability, the parent company should allow the subsidiary to operate
independently.
 Subsidiaries are assumed to not be agents unless the alter-ego rule is applied.
 Alter-ego/instrumentality doctrine =

5. Agent distinguished from middleman

H. Subagency = agents acting for other agents.

 Subagency exists when an agent is authorized expressly or (more commonly) implicitly by the principal to appoint another
person to perform all or part of the actions the agent agreed to perform on behalf of the principal. If A remains
responsible to P for the actions taken, B is a subagent and A is both an agent to P and a Principal to B.
o B is an agent of P as well as A, which underscores the importance of P’s express or implied consent to this
relationship.
 Implied authority comes from: (1) type of work to be done; (2) circumstances; (3) type of agency.
 Sub-agency must be distinguished from co-agency, where two agents both act for one principal.
o A would want to make B a co-agent, not a subagent, avoiding the burdens of being B’s principal.
 Remote Principal = original principal. P in the example above is the remote principal.
 Rule: Consent. In order to establish subagency, a principal must know or have reason to know that the agent will hire
someone else to act on behalf of the principal and consent, expressly or impliedly, to such arrangement. If there is no
knowledge, or knowledge and no consent and no estoppel to deny consent, the actor is an agent’s agent, not a subagent, and
has no indemnity rights against the remote principal.
 Listing Contracts = a common example of subagency (Stortroen): K authorizes broker to offer % of commission to other
brokers if they find a buyer. Upon acceptance 2nd broker has power to bind principal to K, unless principal actually notifies
2nd broker of termination before she binds.
 Stortroen v. Beneficial Finance Co., 736 P.2d 391 (Supreme Court of Colorado, 1987)
o Facts: P wanted to sell and listed with agent Panio who was to find them a new home. Panio consulted a multiple
listing service and found them home owned by D who had an exclusive listing with Olthoff. Panio helped Ps
make offer contingent upon sale of their home. D rejected offer and prepped counter-offer given to Olthoff and then
Panio. Meanwhile Carelli made an offer of $112K (higher) that D wanted to accept. D directed Olthoff to withdraw
the offer to P and Olthoff left a messages with Panio withdrawing the offer. Panio got Ps to agree to counter Ds
counteroffer before Olthoff sent the message attempting to withdraw.
o Proc. Hist: District Court held that a principal-agent relationship existed b/w the purchasers and the selling
broker (Olthoff) in connection w/ the sale and that the purchasers’ act of notifying the selling broker’s associate of
the acceptance of the seller’s counteroffer did not constitute notice to the sellers of the acceptance.
o Issue: Is there a subagency relationship b/w the seller of a home and a multiple listing service? Holding: Yes.
o Rule: Notice to an agent given in the course of a transaction, which is within the scope of the agency, is notice to
the principal. Notice to a subagent who is under a duty to communicate the notice to the agent is effective to the
same extent as if notice had been given to the agent.
o Rule: Under traditional agency principles, a listing contract which authorizes the listing broker to list the property
with a multiple listing service permits the listing broker to create a subagency with other members of the
multiple listing service. The listing broker’s act of listing the property with the multiple listing service constitutes
an offer of subagency by the listing broker to other multiple listing service members to procure a buyer in
exchange for a percentage of the sales commission.
o Rule: Notice of termination of subagency is not effective until receipt.
 Chapter 2: Rights and Duties Between Principal and Agent

A. Duties of Principal to Agent – are these fiduciary duties or something else?

Common law duties a principal owes its agent:
1. to indemnify for losses and liabilities resulting from authorized, good faith performances of the agency;
2. to deal with the agent fairly and in good faith.
**These are default terms. Operate if not otherwise expressly agreed to. All of these duties can be altered or negated by express
agreement b/w principal and agent with the possible exception of the duties of good faith and care.

1. Duty of Exoneration and Indemnification

 Agent has a right to reimbursement for expense reasonably incurred during the course of agency, including cost of defending
a frivolous suit grounded upon acts performed on behalf of Principal’s business (Admiral Oriental)
 Indemnity
o Not entitled to recover for losses that are solely Agent’s fault – i.e. mere negligence, illegal acts, or other wrongful
conduct.
o Policy underlying this is explained in Admiral Oriental Line by Judge Learned Hand:
 the venture and the profits are the principal’s so should be the expenses.
o Agent’s right to indemnity depends on reasonable inferences drawn from the circumstances.
 customs of the business
 nature of the relationship
 i.e. real estate brokers are, by trade custom, generally expected to bear advertising costs.
o Subagent is entitled to indemnity from both the immediate principal and remote principal. If subagent obtains
indemnity from immediate principal, the immediate principal can obtain indemnity from the remote principal.
Restatement Third §8.14, Comment b.
 Exoneration = an agent may sue Principal before he suffers a loss where Agent would have a right to indemnification.
Equitable doctrine available to agent.
o Can be used to avoid the expenditure of personal resources under circumstances in which the principal should bear
the loss.
 Rule: An agent has a duty to notify the principal of a claim against the agent and give the principal the opportunity to defend
the claim. If the principal and the agent are co-defendants represented by separate counsel, “the agent may not obtain
reimbursement for his or her separate defense costs unless it is shown that joint representation would have left the agent’s
interests unprotected.

Admiral Oriental Line v. United States, 86 F.2d 201 (United States Court of Appeals 2nd Circuit, 1936)
 Facts: Admiral Line (Line Co.) was an agent of Atlantic Gulf and Oriental Co. They were charged with fitting out the
steamship the Elkton on a voyage. There was a typhoon on the voyage and the Elkton was lost. The people who owned the
cargo onboard the Elkton sued Admiral for their loss. Admiral won the lawsuit but was out the money it paid to defend itself.
Admiral (agent) in turn sued Atlantic Gulf (principal) to recover the money it spent on its defense. Atlantic Gulf attempted
to bring in the United States claiming that they were agents of the United States and that the United States (remote principal),
as principle of the whole venture, was responsible not only to them for expenses incurred, but also for any which it might be
compelled to pay to the subagent.
 Issue: Is the United States liable as the principle of the entire venture, for expenses their agent (Atlantic Gulf) is compelled
to pay to the subagent? Holding: Yes
 Rule: An agent, compelled to defend a baseless suit, grounded upon acts performed in his principal’s business, may recover
from the principal the expenses of his defense.
 Reasoning: The Shipping Board appointed the Atlantic Gulf as its Agent to manage, operate and conduct the business of
such vessel as it . . . may assign to the Agent,” and the company agreed to act as such “in accordance with the directions” of
the Board. Atlantic Gulf was to “man, equip, victual and supply” the vessels as the Board required, and to pay all expenses
and maintain them in seaworthy condition, all on the Board’s account. It was to issue all documents on the Board’s form,
appoint sub-agents, collect freights which it must deposit in a bank approved by the Board and in the Board’s name, and for
which it was to account on forms prescribed by the Board. For this the company was to be paid in percentages on the gross
receipts including salvage; out of these it was to bear its “administrative and general expenses of every nature,” not including
brokerage however, or commissions “for agency services rendered at foreign ports.” Atlantic Gulf was to furnish a bond for
faithful performance of its duties and was forbidden to profit in any way from the services rendered.
 For these reasons it is difficult to construe the agreement as anything other than that of a straight agency.
 It was the United States venture because they were the ones who had something to lose. They chose not to charter their
ships but to put them in trade on its own account, so they should be the ones who bear the hazard of defending
unwarranted suits.
 Issue 2: Is the United States is liable to Atlantic for Admiral’s defense fees even though Atlantic hadn’t paid anything yet?
Holding: Yes.
  Rule: Duty of exoneration. Before paying the debt a surety may call upon the principal to exonerate him by
discharging it; he is not obliged to make inroads into his own resources when the loss must in the end fall upon the principal.
 Indemnification = Admiral sued Atlantic for indemnification. Exonneration = Atlantic sued United States for
indemnification.
 Greencheckmark: The right to be reimbursed includes litigation expenses.
 Greencheckmark: This extends to subagents. Admiral was a subagent because they were an agent of an agent and their
appointment was contemplated and consented to by the main principal. The agent is also responsible for the subagent’s
expenses.
 Greencheckmark: The principal will indemnify the agent . . . so long as the agent isn’t at fault. This is a default term. If
the agent wants indemnification, even when they are at fault, they have to contract for that.

5. Duty to Deal Fairly and in Good Faith

 The principal is required to maintain a standard of conduct that will not harm the agent’s business reputation or
reasonable self-respect.
 Agent can terminate the relationship and to sue for breach of contract. (Cordis)
 Taylor v. Cordis Corp., 634 F. Supp. 1242 (United States District Court, Southern District of Mississippi, 1986)
o Facts: P was the agent of D, a medical supply company selling pace makers. He signed a non-competition
agreement. Became concerned about quality and marketability pace makers stemming from the frequency of
recalls. He had to send out notices to his clients regarding the quality of the products.
o Issue: Did the principal breach the implied duty of good faith and fair dealing that it owed to its agent, P, in failing
to timely provide P with material information relating to problems it had discovered in its pacemakers? Holding:
No.
o Rule: A principal has a duty to deal fairly and in good faith with an agent and to provide the agent with any
information that might subject the agent to physical or pecuniary loss in dealing with the product.
o Rule: The principal’s good faith duty to the agent also demands that the principal must maintain a standard of
conduct that will not harm the agent’s business reputation.
o Reasoning: Notwithstanding the above stated rules, the defendants in this case did not breach the duties they
owed to P because the duty cannot be interpreted to require the principal to distribute to the agent copies of
consumer complaints relating to product performance or to report the progress of all ongoing research into
product efficiency. D’s actions to identify and remedy problems with their pacemakers were reasonable under the
circumstances. The duty to inform P came about only when D, in the exercise of reasonable diligence, knew that
specific product defects posed a threat of harm to consumers and a concomitant threat to the professional reputation
of the sales agent. D fulfilled this duty.
o Class Notes: The fact that he is seeking to avoid a non-competition clause affects the outcome of the case. It puts
the plaintiff in a weaker position as it looks like he’s just griping about looking for a way to avoid the non-
competition agreement.

B. Duties of Agent to Principal – most of the duties run this way. This is because the principal is dependent on the agent.

1. Non-Fiduciary Duties of Agents

a. Duty of Good Conduct and to Obey
 Rule: An agent is subject to a duty not to act in a manner that makes continued friendly relations with the
principal impossible. Also, the agent must not bring disrepute to the principal.
 Rule: The agent must obey all reasonable directions of the principal but has no duty to perform illegal,
unethical or unreasonable acts.
b. Duty to Indemnify Principal for Loss Caused by Misconduct
 Rule: A principal has an action in tort or in contract against an agent who wrongfully causes it loss, as where
the agent negligently damages the property of the principal, or exceeds his authority, or by negligence or
fraud causes the principal to be liable to a third person, or violates a duty of loyalty owed the principal.
Thus, a servant is subject to a duty to indemnify the master for damages the master had to pay resulting from the
servant’s negligence while acting within the scope of employment.

2. The Fiduciary Duties of Agents

a. Commencement of Fiduciary Relationship

 Rule: An agent’s fiduciary duty is limited to actions occurring within the scope of his agency and the
creation of the agency relationship is not itself within that scope.

b. The Duty to Account

  Rule: “Unless otherwise agreed, an agent is subject to a duty to keep, and render to his principal, an account
of money or other things which he has received or paid out on behalf of the principal.” Restatement
Second §382, Comment a.
c. Duty of Care
 Subject to agreement, the duty of care includes the duty of a paid agent to act with the “care, competence, and
diligence normally exercised by agents in similar circumstances.” Restatement 3d §8.08.
 For unpaid agent = roughly the same but courts may be more linient. (Carrier says “a promise to act as an
agent is interpreted as a promise only to make reasonable e
 If an agent purports to have an even greater skill, he is held to that level.
 Parties can contract around this duty (only responsible for gross negligence  the lower partner standard).
 Carrier v. McLalarky, 693 A.2d 76 (Supreme Court of New Hampshire, 1997)
o Facts: See above. They have to do with the return of an old water heater that may or may not have
been under warranty.
o Issue: Did D breach his duty of care? Holding: No.
o Rule: Agents have a duty to conduct the affairs of the principal with a certain level of diligence,
skill, and competence.
o Rule: Under ordinary circumstances, the promise to act as an agent is interpreted as being a promise
only to make reasonable efforts to accomplish the directed result.
o Rule: The duties of an agent toward his principal are always to be determined by the scope of the
authority conferred.
o Rule: The degree of skill required by an agent in pursuit of the principal’s objective is limited to the
level of competence which is common among those engaged in like businesses or pursuits.
o Rule: An agent cannot be held liable to the principal simply because he failed to procure for him
something to which the latter is not entitled. 3 Am. Jur. 2d Agency §2154
o Reasoning: The invoices and work orders only provided that D promised to attempt to obtain a credit
from the manufacturer. He didn’t guarantee that he would get one. There was also a letter from the
supplier stating that the defendant “acted in a normal manner as any dealer would under these
circumstances,” and “was right to withhold credit . . . until the factory actually covered the unit.”

d. Duty of Disclosure
 Duty to inform the principal of all facts relevant to a transaction that the agent reasonably believes the
principal would want to know. R2d §381.
o Involves a duty of loyalty – to deal fairly with the principal. Most frequently litigated in the context
of “conflict of interest”.
o Conflict of interest– when agent is acting on behalf of a third party whose interest is adverse to that of
the principal.
o Self dealing – when agent is acting entirely or substantially for the agent’s own interest.
 Principal bears burden of proof that Agent was aware of the undisclosed fact, that the fact was material. If the
facts raise a conflict of interest the burden to prove full disclosure is on the Agent (Vail Associates)
o principal must first prove the issue of conflict of interst. If he doesn’t do so the burden of proof is still
on him to prove lack of full disclosure.
 Notes: If an agent acts as an adverse party with the principal’s consent he still has duty to deal fairly and
disclose all facts the agent should know would reasonably affect the Principal’s judgment. . Restatement
(Third) Agency §8.06

 Olsen v. Vail Associates Real Estate, Inc., 935 P.2d 975 (Supreme Court of Colorado, 1997)
o Facts: D’s, Vail Associates, introduced third party Lindholm to the Olsens, P,s who were trying to sell
land they inherited as well as the children’s adjacent property. After offers and counteroffers, the
Olsens decided not to include the children’s property in the sale and withdrew that parcel from the
negotiations. Because Lindholm wanted another piece of land besides the estate property (so he could
control development of the Lower Pine Valley), he inquired through Ds about the Rickstrew property.
Upon inquiry from D, the owner of the Rickstrew property informed Ds that he would not negotiate
through a real estate agent and demanded to negotiate one on one with the buyer, Lindholm. They
reached an agreement contingent on the closing of the estate property and both properties were
subsequently purchased by Lindholm for 2 mil for the Rickstreet prop and 8.75 mil for the estate
property. Olsens sued for breach of fiduciary duty.
o Issue: Was the information that D had regarding the sale of the Rickstrew property and the price
material information such that it was a breach of fiduciary duty to conceal this from Ps? Holding:
No. Judgment affirmed.
 o Rule: A breach of fiduciary duty occurs if the broker, as agent, conceals from the seller, as principal,
“material” information, i.e. “information that bears upon the transaction in question.”
o Rule: An agent is thus required to disclose to the principal any facts “which might reasonably affect
the principal’s decision.”
o Rule: The burden is on the principal to demonstrate that the agent was aware of the nondisclosed fact,
that the non disclosed fact is material, and that the agent breached his or her fiduciary duty.
o Rule: The matter is material if a reasonable person would attach importance to its existence or
nonexistence in determining his choice of action in the transaction in question. Restatement (Second)
Torts §538(2)(a)
o Reasoning: The knowledge of this information was not material because the plaintiffs did not meet
the burden of showing that it would have made any difference in their decision in this case. Testimony
that other potential buyers with Rickstrew had not caused the Olsen’s to alter their position in regartd
to the estate property.

e. Duty of Loyalty = must place principal’s interest ahead of his own; no self-dealing or conflict of interest through
adverst T. Even putting yourself in situation of conflict of interest is breach of loyalty. R2d §387
 No self dealing = no benefit to herself to the detrmiment of the P.
 No usurping the pringipal’s opportunity
 No secret profits = may not profit from doing business with employer w/out his full knowledge and consent.
(Gefland)
 These duties are default – can be changed by agreement.
 A clear breach of loyalty occurs when an agent takes a bribe from a third party while acting for the principal.
 Remedies of the principal:
o agent forfeits bribe and any compensation he would receive out of the transaction.
o forfeits compensation for agency during period of disloyalty (not a per se rule though);
o If the agent has made it possible for others to profit from his breach of loyalty he can be held
accountable for those profits whether or not he receives any part of them. This creates a windfall for
the suing principal but the principle is to deter the agent from this kind of conduct.
 (i) loyalty during the relationship
o Scope of fiduciary duty = varies with the position held by the agent.
 More trust placed in an agent = greater the discretion an agent has, the more demanding a
court will be about loyalty.
 Duty of loyalty applies to all employees.
o An agent has a duty
 (1) not to use property of the principal for the agent’s own purposes or those of a third party;
and
 (2) not to use or communicate confidential information of the principal for the agent’s own
purposes or those of a third party.
o Misusing information = duty of loyalty includes a duty not to compete with the principal w/out his
knowledge and consent. This includes using confidential information in competition with or to the
injury of the principal.
 “an agent has the duty not to use information acquired by him as agent of by
means of opportunities which he has as agent to acquire it, or acquired by him
through a breach of duty to the principal, for any purposes likely to cause his
principal harm or to interfere with his bueinsss, although hit is information not
connected with the subject matter of his agency.” Restatement Second §395
 This includes not only confidential information but information the agent should know the
principal would not want revealed to others or used in competition with him.
 This does not include matters of common knowledge.
o The duty not to compete is not violated if the principal knows or has reason to know that the agent
believes he is privileged to compete or self-deal.
o Gefland v. Horizon Corp., 675 F.2d 1108 (United States Court of Appeals, Tenth Circuit, 1982)
 Facts: Gefland, P, was working for Horizon Corp, making land deals to his wife and other
third parties and profiting off of the deals. D terminated P’s employment and withheld
commissions owed to P. P sued to get his commissions.
 Issue: Is D entitled to offset the commission owed to P for profits accruing directly to the P,
and/or for profits which accrued to third parties allied with the agent, P? Holding: Yes w/r/t
profits directly to P, no w/r/t 3d parties.
 Rule: An agent occupies a relationship in which trust and confidence is the standard. When
the agent places his own interests above those of the principal there is a breach of fiduciary
 duty to the principal. The fiduciary is duty bound to make a full, fair, and prompt disclosure
to his employer of all facts that threaten to affect the employer’s interests or to influence the
employee’s actions in relation to the subject matter of the employment.
 Rule: A broker is not entitled to compensation where he acts adversely to his principal’s
interest.
 Rule: A fiduciary will be held accountable for the profits reaped by a third party when, by
violating his obligation of loyalty, he has made it possible for third parties to make profits.
This is regardless of whether he has profited personally.
 Reasoning: (1) The court determines that there was an agency relationship in (2) the agent
did in fact breach his fiduciary duty. (3) The court next determines that the amount D owed to
P should be offset by the profit accrued to P’s wife, $20,000, because P was using his wife
indirectly to profit b/c the profit could not be given to him directly. (4) Finally the court
determines that while P should not be held accountable for the profits realized by third
parties. The purpose of the rule is both punitive and compensatory, and serves to deter the
fiduciary from disloyalty. This is because (1) Horizon did not have a policy forbidding land
purchases by employees or required disclosure in such situations. Even still, Horizon was
aware of the sale. (2) There is no evidence that the third parties were going to pay P back for
his favor. According to the court it was an isolated incident in a long term of useful service
by P to D.

Notes:
The middleman = allowed to work for both parties in a transaction w/out owing anyone a duty of full disclosure. He is a go between
and has nothing to do with negotiation and thus it is of no importance that both parties pay him.

Chapter 3. Vicarious Tort Liability

Terminology
 Three types of principle-agent relationship.
o Principal – Agent/Servant/Employee = If the principal’s control over the agent rises to the level of being able to
direct the agent on how he should discharge his responsibilities. The principal is also called employer or master.
Restatement (Third) introduces the terms employer/employee.
 this can arise even when someone is helping someone else out for free.
 This is the only type of relationship that has vicarious liability.
 Biedenbach v. Teague from the notes has a pretty good definition of employed = “the act of performing
services even w/out wages.”
o Principal – Agent Independent Contractor = principal has less control than that of agent/servant.
 Examples – attorney.
 These types of agents have a certain degree of independence.
o “Principal” – Non-Agent Independent Contractor = i.e. if someone is building an addition to your home, is that
building contractor your agent? He takes the plans and executes them but the builder is not your agent. So if the
builder commits a negligent act, the homeowner is not liable b/c the homeowner has no control over that enterprise.
Also this relationship is missing the consent element. Neither party would consent to being agents
o The contract b/w the parties can create agency authority.
 i.e. building contract clause that authorizes the contractor to purchase certain items for the owner. Can you
be an agent for one narrow purpose but not for another purpose? Even though there’s no case law on this,
Lowenstein thinks the answer is yes. (i.e. Texaco service station displaying credit card applications.)
 There are different consequences for the principal depending on which kind of above relationship. An
agent/servant/employee’s torts will be imputed to the principal. No imputation in the other types of
relationships. In other words, vicarious liability only comes about if the agent is also a servant.

A. The Master-Servant Relationship

1. The Concept
 Rule: When a principal has the right to control the manner and means of the agent’s performance, the principal is
strictly liable for the Agent’s tortious conduct towards 3rd parties.
o The agent will be directly liable to the third party for malfeasance, but not nonfeasance (unless 3rd party
beneficiary). But agent has a duty to indemnify principal for losses caused by the agent’s negligence/departure
from instructions  nonfeasance.
o Always look for direct tort action against principal: lack of due care in hiring or supervising agent.
 Presumption of right of control where employment is fulltime, even if no actual control exercised: staff doctor, in house
counsel, etc.
 Vicarious Liability = liability in addition to the liability of the employee, who remains personally liable for tortious
conduct.
 Jones v. Hart = “For whoever employs another is answerable for him, and undertakes for his care to all that make use of
him. The act of a servant is the act of his master, where he acts by authority of the master.”
 Notes:
o The Restatement (Third) Agency abandons the terms “master “ and “servant.” In their place, the new
Restatement uses the terms employer and employee. A principal though may be vicariously liable for the torts
of its agent wven if the agent is not, for other purposes, an employee of the principal.
o “Senior corporate officers, like captain of ships, may exercise great discretion in operating the enterprises
entrusted to them, just as skilled professionals exercise discretion in performing their work. Nonetheless, all
employers retain a right of control, however infrequently exercised.” Restatement (Third) §7.07
o so the president of GM is considered a servant for some purposes.
o Liability of employee = employee personally liable for affirmative acts of wrongdoing committed while acting
on behalf of the employer.
o Liability of employee for nonfeasance? Delaney v. Rochereau & Co. is a well known and frequently quoted
case that stands for the proposition that agents are not liable for failing to perform a duty owed to the principal,
such as a failure to repair certain property of the principal contrary to instructions, and a person is injured as a
result.

a. The History of Respondeat Superior Liability

(i) the Holmes thesis
 Respondeat superior came about in early Roman and German law dealing with the unlimited liability of
slaeholders for the torts of their slaves. These affected our common law. It was based on substantive
grounds of policy, not because “the act of the servant was the act of the master” (quoting Jones v. Hart).
 But once this was adopted it stood on its own and became a reason in itself for making the master
answerable.
(ii) the Wigmore rebuttal
 In Norman England, the concept of “se hoc non conscium esse,” (“this was not done with his knowledge”)
reappeared throughout the law. It made a difference for the purposes of liability whether or not the employer
knew about and consented to the acts of his servant. The master could exonerate himself by pleading that he
had not commanded or consented to the act.
 This concept became too cumbersome with the advent of industry. So Jones v. Hart adopted the current
version.

b. Is an Employment Relationship Necessary to Respondeat Superior Liability?

 Employer-employee relationship is not the threshold – a master could still be held responsible for the torts of his
servant even in the absence of paying that person i.e. gratuitous relationship.
 Heims v. Hanke, 93 N.W.2d 455 (Supreme Court of Wisconsin, 1958)
o Facts: Uncle and nephew were washing the uncle’s car on a cold day. The uncle was directing the nephew
to get water in a pail and bring it back to the car. The nephew was spilling water while bringing it back, the
water froze, and plaintiff slipped and fell on it as a result.
o Issue: Was there negligence? Holding: Yes. The nephew was negligent.
o Issue: Is the uncle responsible for the negligence of his nephew even though he was not paying him?
Holding: Yes because of respondeat superior.
o Rule: A servant is one employed to perform service for another in his affairs and who, with respect to his
phycisical conduct in the performance of the service, is subject to the other’s control or right to control.
o Rule: One volunteering service w/out any agreement for or expectation of reqard may be a servant of the
one accepting such services. Restatement, 1 Agency (2d), p. 497, sec. 225

 Class Notes: Only a lawyer would call this kid an employee. Why is the uncle liable here? Deep pockets theory.
Legal fiction that the agent and the principal are really one. Enterprise theory is that the uncle chose the agent and is
presumably in the best position to take steps to ensure the safety. He could watch what he does or have chosen a
better agent.
 Lowenstein says it seems like there’s a moral basis for justifying the principal’s liability for the acts of the agent.
The recently popular rationale drift away from the deep pockets, and there is a notion of a fairness responsibility
for the actions of the agent.

 Sandrock v. Taylor, 174 N.W.2d 186 (Supreme Court of Nebraska, 1970)

o Facts: D was driving the decedent (whose estate is the plaintiff) to get a part for a lawnmower on the
request of the decedent. The other D was driving a milk truck and crashed into them, killing the decedent.
 o Issue: Was D driver the agent of the decedent because the decedent asked him to drive him to town to get
the part for the lawnmower thus his negligence being imputed onto the decedent so he cannot recover?
Holding: No.
o Rule: Negligence of a driver is not imputable to a passenger except where the driver is the servant or agent
of the passenger, or where the driver and passenger are engaged in a joint enterprise or where the passenger
assumes to direct operation of the automobile and to exercise control over it.
o Reasoning: The only relationship b/w the driver and passenger was that of gratuitous social host and
guest, not that of agent/principal. This is because the passenger retained no right of control over the
vehicle. The mere fact that the trip was for the passenger’s benefit and that he happened to have a business
purpose does not make the driver a controlled agent and the passenger a controlled principal; and the
negligence of the driver is not ordinarily imputable to the passenger.
o Class Notes: Lacking was the degree of control b/w the driver of the car and Sandrock, who was just a
passenger in the car. Therefore, the driver’s negligence would not be imputed to Sandrock as it would be if
Sandrock was the principal. This refocuses our attention on the relationship b/w the principal and agent.
Secondly, this introduces us to the notion of imputation. Imputation – not only will an employer be liable
for tortious conduct of employee, but it will be impuyted onto the employer for certain purposes.

c. Rationale for Respondeat Superior

(i) Arguments questioning the theory
 Holmes = common sense says that one man shouldn’t have to pay for another man’s wrongs.
 Baty = Respondeat Superior was justified by the fact that the principal extended an invitation to the injured
third party to have confidence in the employee. This suddenly switched to the “course of employment”
losing the sense of the rule and the moral foundation on which it was based.
(ii) Arguments in favor of the theory
 Seavey = the fact that the one who is responsible for all consequences is more apt to take precautions to
prevent injurious consequences from arising. Also, it is difficult to prove negligence on the part of the
employer.
 Posner = under a negligence system, the courts would have to regulate the company’s method of selecting,
supervising, and disciplining employees. Strict liability is better b/c of this.
 Young B. Smith = Entrepreneur Theory. It is better to spread among a large group of people the inevitable
losses that come from running industry. The master should be made responsible not merely b/c he is better
able to pay, but because he is best able to effectuate the spreading and distribution of such losses.
o Economically the loss belongs to the employer b/c in reality most employers are businesses and
sell products or services. The business will adjust its price accordingly.
 Employers should be responsible b/c they initiate the activity, profit by it, and have the power to closely
supervise the work of their employees and thus can take the steps to minimize their exposure to liability.

d. Imputed Contributory Negligence = when a principal seeks to recover from TP for negligence (like in a car accident
where agent was driving), courts are split as to whether agent’s contributory negligence is imputed. if it is, principal is
liable for damages to TP and her own recovery is limited by amount of agent’s negligence.
 Rule: a master is barred from recovery against a third person who negligently caused a loss to the master if the
servant also was negligent in the accident giving rise to the loss. Restatement (Second) of Agency §317
 This has been rejected in many states.

e. Limitation to Losses Caused by Tortious Behavior

 Liability under respondeat superior is limited to the tortious acts of servants.

2. The Independent Contractor Exception =

a. The Concept
 Kane Furniture Corp. v. Miranda, 506 So. 2d 1061 (Court of Appeals of Florida, 1987)
o Facts: Kane sold its carpet installation business to Perrone who continued to install carpet for Kane.
Perrone hired other independent carpet installers to help him finish the jobs. One of these was Krause. On
one such occasion, Krause got drunk and drove home while taking one of his workers to Kane’s furniture
store after doing a job. Mrs. Miranda died in this accident, and her husband, Dr. Miranda, sued.
o Proc. Hist: Trial court entered summary judgment finding that Perrone was Kane’s employee and that
Kraus was Kane’s subemployee.
o Issue: Was Krause Kane’s subemployee or an independent contractor? Holding: Independent contractor.
o Rule: In determining whether one acting for another is a servant or an independent contractor, the
following matters of fact, among others, are considered:
(a) the extent of control which, by the agreement, the master may exercise over the details of the work;
 (b) whether or not the one employed is engaged in a distinct occupation or business;
(c) the kind of occupation, with reference to whether, in the locality, the work is usually done under the
direction of the employer or by a specialist without supervision;
(d) the skill required in the particular occupation;
(e) whether the employer or the workman supplies the instrumentalities, tools, and the place of work for
the person doing the work;
(f) the length of time for which the person is employed;
(g) the method of payment, whether by the time or by the job;
(h) whether or not the work is a part of the regular business of the employer;
(i) whether or not the parties believe they are creating the relationship of master and servant; and
(j) whether the principal is or is not in business.
o Reasoning: Perrone and Kraus had unbridled discretion in the physical performance of their tasks.
Perrone did not report to anyone at Kane and had absolute discretion in contracting out installation jobs.
o Carpet installing is a distinct occupation and each Kraus and Perrone had their own independent
businesses.
o They both did work on an “as needed” basis.
o There is a high degree of training and skill involved.
o Kraus and Perrone each supplied their own tools.
o They worked on an “as needed” basis and the time spent on each job varied.
o They were paid on a per yard basis, not hourly.
o Furthermore, while the court did find a couple factors that tended toward employee, i.e. the fact that the
work was part of the regular business of the employer, the court held that this factor alone was not
dispositive and alone is insufficient to sustain a holding that they are employees.
 Class Notes: LOWENSTEIN: DON’T SHY AWAY FROM THE RESTATEMENT FACTORS. WALK
THROUGH THESE ONE BY ONE FOR EACH PROBLEM.
 Contract not dispositive = if contract claims only Independent Contractor relationship, but if right of control over
manner means, right to fire, non-compete, etc. show master/servant, disregard what contract calls the relationship.
(Sandrock)
 The greater degree of control over a non-servant agent, the more likely they will be found to be an agent.
o A P will not have RS liability for non-servant agents.
o Non-agent IC = building contractor
o Agent IC / non-servant agent = “on your behalf” – lawyer – fiduciary duties but no Vic. Liab.
 Lazo v. Mak’s Trading Co., 644 N.E.2d 1350 (Court of Appeals of New York, 1994)
o Facts: P truck driver delivered a shipment of rice to D who hired three neighborhood guys to help him
unload it. One of the neighborhood guys assaulted P. P sues D on the theory of respondeat superior.
o Issue: Were the three neighborhood guys employees or independent contractors? Holding: Independent
Contractors.
o Reasoning: D did not exercise actual or constructive control over the performance and manner in
which the work of the unloaders was performed.
o Concurrence: There was probably control here on the part of D over the three neighborhood kids.
However liability should not be found on the part of the D. An employer can’t be held liable for assault
on behalf of his employee because the employee was not acting in the scope of his employment when he
assaulted P and he was not furthering the interests of his employer when he did it either.
o Rule: Although an employer is often held liable for the torts of employees, an employer cannot be held
liable for an employee’s assaultive acts where the tortious conduct was not undertaken within the scope
of employment, the employer did not authorize the violence and the use of force is not within the
discretionary authority afforded the employee.
 Notes:
o If a contract gives one party the right to inspect and supervise, this does not mean that party has the right to
control. If that party fails to exercise its right to supervise and inspect and injury occurs as a result, the
party cannot be held liable for the injury because there was not a legal duty to exercise that right. See
Wright v. United States, 537 F.Supp. 568 (N.D. Ill. 1982)
 Soderback v. Townsend, 57 Or.App. 366 (Court of Appeals of Oregon, 1982)
o Facts: D was retained by Quasar to negotiate gas leases. While D was driving to check on some of the
leases, he was involved in a car accident.
o Issue: Was D an agent of Quasar or independent contractor? Holding: Independent Contractor.
o Rule: A principal employing another to achieve a result but not controlling or having the right to control
the details of the physical movements is not responsible for incidental negligence while such person is
conducting the authorized transaction. . . It is only when the right to control physical details as to the
 manner of the performance is added to the principal agent relationship that the person in whose service the
act is done becomes subject to liability for the physical conduct of the actor.
o Reasoning: Quasar had no control over D’s actions. D was told generally the areas in which Quasar was
interested. Quasar placed maximum limits on D’s negotiating authority as to the price and duration of the
leases, but otherwise the manner and means by which he obtained leases were up to him. He set his own
work schedule and had no quotas. He did not contract for any specific piece of work and was paid a per
diem of $175 plus expenses and accounted to Quasar at two-week intervals.
 Hunter v. R.G. Watkins and Son, Inc., 110 N.H. 243 (Supreme Court of New Hampshire, 1970)
o Facts: A truck operated by Davis, an employee of D, broke down. Davis was instructed to pick up the part
needed to fix the truck and bring it back to the job site the next morning. He left in his own car at about
noon, stopping at his apartment and in Salem on the way there and back from getting the part to run
errands. The accident happened that day at about 5pm when Davis was on his way back to his apartment.
o Issue: Was Davis an employee of D or was he an independent contractor when he got in the accident?
Holding: Employee.
o Reasoning: The court recognized that the rule in New Hampshire at the time was that the employer was
not liable for this type of accident because he was not exercising any control over the employee’s in the
management and operation of the employee’s automobile. However, the court said that this was an
anomaly and that the majority of states do not have this rule. They decided to change it and lay out a new
rule following the Restatement (Second) Agency, which lists factors relevant in determining whether an
employer employee relationship exists. Because he was acting within the scope of his employment and
with the knowledge and permission of the employer, the employer should be liable.
o Rule: Control should not be overemphasized and is not a controlling factor. The court is usually
concerned with whether on all the facts the community would consider the person an employee.
o Rule: When a regular employee is sent upon a specific errand, using his own car with the knowledge and
permission of the employer, and it is agreed he was acting within the scope of his employment at the time
of the accident, the employer is liable for his acts whether it had control of his detailed operation of the
motor vehicle or not.
 Notes:
o Inferring the right of control: The fact that the employer did not exercise the right to control does not show
that it did not have the right of control, but it might be evidence of this. The right of control must be
determined by reasonable inferences shown by the evidence.
o The independent calling test: Professor Leidy in Salesmen as Independent Contractors, 28 Mich. L. Rev.
365, 370 (1930) laid out the alternative approach to identifying servant status. “The term independent
contractor has come to be used with special reference to one who, in pursuit of an independent business,
undertakes to do a specific piece of work for other persons, using his own means and methods, without
submitting to their control in respect of all its details . . . the true test of a “contractor” would seem to be
that he renders the services in the course of an independent occupation, representing the will of his
employer only as to the result of the work and not as to the means by which it is accomplished.”
 Sandrock v. Taylor, 174 N.W.2d 186 (Supreme Court of Nebraska, 1970)
o Facts: D Taylor was driving a milk truck. Passenger vehicle had a passenger and a driver. The issue in
this case in the previous chapter was whether or not the passenger was the agent of the driver. This part of
the claim involves the claim by the passenger against the co-op that had a contract with the driver of the
milk truck. This is a simple respondeat superior claim claiming the co-op is responsible for the driver’s
actions. D Co-op was joined on the allegation that D Taylor was its servant driving in the course of its
business. Also the Co-op owned the trucks Taylor used to deliver the milk with.
o Taylor did not own his own milk delivery business, and the Co-op was the only people Taylor delivered
milk for.
o Issue: Was D Taylor an independent contractor or a servant/agent/employee of D Co-op? Holding:
Employee.
o Reasoning: Despite the appearance of lack of control in the contract, it was purely illusory as the Co-op
had provisions in the contract allowing it to terminate w/in 30 days whenever they wanted as long as
they gave written notice, and they also stated that they would consider the payments Taylor made
toward the truck voided if he worked for anyone else.
o So he worked solely for Co-op.
o He wasn’t in business for himself.
o Co-op paid him by the delivery.
o Rule: An employer cannot insulate himself against the burdens of the employer-employee relationship by
a contract that leaves him with the control benefits of that relationship. Nor can he escape his liability
under the doctrine respondeat superior by a contract that expressly provides that the workman is an
independent contractor, if in fact, under the entire contract, the workman only possesses the same
independence that employees in general enjoy.
 o Class Notes: The key factors that caused the co-op to lose: they continued to give instructions to the
drivers, they had a non-compete clause with the “independent contractors” which is an odd thing in b/c
you expect independent contractors to work for as many people as they can handle, and the drivers were
bound to the co-op yearly while the co-op could terminate at any time w/30 days notice. This last one is
another indication of control b/c it means that the drivers were dependent on the co-op.

b. Limitation to the Independent Contractor Exception = a principal is liable for the torts of an independent contractor
only in 3 situations, but has indemnification (breach of K):
 1) Inherently dangerous activity = work itself and not one input creates peculiar risk of harm (Hixon)
 2) Non-delegable duty = usually originates in statute of K (landlord/tenant), from the special status of D (common
carrier), of b/c of gravity of public policy attached to farmed-out work (Rheingold = service of process is
nondelegable.)
 3) Negligence in selection of IC = direct tort liability; hard to prove b/c burden to check out IC only when aware of
facts lead to believe IC is not competent.
 Hixon v. Sherwin-Williams Co., 671 F.2d 1005 (United States Court of Appeals, Seventh Circuit, 1982)
o Facts: The Chess’s insurance company, American States Ins. Co., had to put in new floors in their home
b/c of water damage. They hired Hixon to put in new linoleum floors. Hixon in turn hired Sherwin
Williams who in turn hired Louie Benkovich who had been in the linoleum business for many years and
had a good reputation. Benkovich used a glue that was extremely flammable and did not read the warnings
on the bottle that said to ventilate the room and turn off the pilot light. As a result the glue exploded and
the Ins. Company had to pay $27,000 in additional damage to the Chess’s house.
o Proc. Hist: American States brought this lawsuit in a federal district court in Indiana against Sherwin
Williams . . . at the close of the plaintiff’s evidence the defendant moved for a directed verdict. The district
court granted the motion and dismissed the complaint on the merits. This appeal followed.
o Issue: Is Sherwin Williams liable for the negligence of Benkovich, who is not their employee but an
independent contractor, on the theory that Benkovich was engaged in an inherently dangerous activity?
Holding: This case does not fall w/in the hazardous activity exception. S-W is not liable under this
theory.
o Rule: The hazardous activity exception to the independent contractor rule = The more hazardous an
activity is, the higher is the cost-justified level of care; and if it is hazardous enough, the principal should
take his own precautions even though he does not supervise the details of the independent contractor’s
work.
o Issue 2: Is Sherwin Williams liable for the negligence of Benkovich who is not their employee but an
independent contractor, on the theory that they negligently selected him to perform the work? Holding:
No.
o Rule: A principal is liable for the consequences of negligently failing to select a competent contractor.
Reasoning: Benkovich had a good reputation as an installer and they didn’t have a duty to quiz him on
his experience laying linoleum with glue. Even if they were negligent, their negligence would not have
been the proximate cause of the accident because his lack of experience may have actually caused him to
look closer at the bottle of glue because he had never used it before.
o Notes:
 Rule: Inherently dangerous has been defined as work “which, in its nature, will create some
peculiar risk of injury to others unless special precautions are taken 0 as, for example, excavations
in or near a public highway.” Prosser and Keeton on Torts 472.
 Rule: Basically the only duty an employer has w/r/t choosing the independent contractor is to
look into his reputation. Courts have held that there is no duty to look into whether or not he is
insured, the adequacy of his equipment, or his personnel.
 Kleeman v. Rheingold, 614 N.E.2d 712 (Court of Appeals of New York, 1993)
o Facts: plaintiff retained law firm to sue doctor for malpractice. The doctor in turn retained Fischer’s
service agency to serve the papers on the doctor. The lawyer delivered the summons to Fischer 2 days
before the statute of limitations and told him to serve them immediately. Fischer in turn selected a licensed
process server to deliver the papers. Fischer’s process server delivered the papers on time but to the
wrong person, so the plaintiff was non-suited when the suit came before trial.
o Proc. Hist: The trial court determined that a process server is an “independent contractor” rather than an
agent of the employing attorney, since “the attorney does not have control over the manner in which
the task is performed” he can not be vicariously liable.
o Issue: Can an attorney be held vicariously liable to his or her client for the negligence of a process server
whom the attorney has hired on behalf of that client? Holding: Yes. It is a non-delegable duty.
Judgment reversed.
o Rule: The general rule is that a party who retains an independent contractor as distinguished from a mere
employee or servant is not liable for the independent contractor’s negligent acts.
 o Rule: The exceptions to this rule are:
 Negligence of the employer in selecting, instructing or supervising the contractor
 employment for work that is especially or “inherently” dangerous; and
 instances in which the employer is under a specific nondelegable duty.
o Rule: Nondelegable duties = requires the person upon whom it is imposed to answer for it that care is
exercised by anyone, even though he be an independent contractor, to whom the performance of the duty is
entrusted.”
o Rule: Nondelegable duty is when the responsibility is so important to the community that the employer
should not be permitted to transfer it to another.
o Sub-issue: Is the service of a summons a non-delegable duty? Holding: Yes.
o Rule: A duty will be deemed nondelegable when “the responsibility is so important to the community that
the employer should not be permitted to transfer it to another. Prosser and Keeton at 512.
o Reasoning: Service of process is a critically important duty that a lawyer undertakes when he is retained
to commence an action. i.e. when an individual retains an attorney, timeliness and accuracy or service of
process is an integral part of the task that the attorney undertakes. Service of process is also a critical
component of a lawyer’s overall responsibility. A lawyer shouldn’t be able to evade responsibility for
its careful performance by the simple expedient of “farming out” the task to independent contractors.
o Green checkmark = generally, the principal is not liable for injuries caused by independent contractors.
There are two exceptions that could be collapsed into one – if the independent contractor is engaged in an
ultrahazardous activity or engaged in a duty, which, for public policy reasons, is deemed to be a
nondelegable duty – then the employer of the independent contractor could be liable.

3. Borrowed Servants
 2 different kinds of loaned employees
1) Where the general employer is in the business of training and supervising the employees that it loans out
and typically loans them with some equipment.
 in this situation, if the loaned employee acts negligently, it depends on who was exercising control
at the time of the accident.
2) Where the general employer is only nominally an employer. They don’t provide any training or even hire
the employee that they are loaning. Rather, the special employer does all the interviewing, and picks an
employee, then tells general employer they want so and so. This is increasingly common in business in the
United States. These general employers provide payroll services and benefits to the employees.
 i.e. an off-site HR department. I think this is like AdminiStaff.
 the general employer is hardly ever liable in this business model, Charles v. Barrett, 135 N.E. 199
(Court of Appeals of New York, 1922)
 The general principal will remain liable for acts of borrowed servant so long as borrowed servant is furthering
business of general principal in rendering services to special principal. But if control is totally relinquished then no
longer servant of general principal and the special principal is vicariously liable for torts of borrowed servant.
Charles v. Barrett.

4. The Scope of Employment Limitation

a. Negligent Acts = a principal is liable for the negligent acts of its servant only when it is w/in the scope of employment.
 Detour = mere departure from assigned task. Remain intent to serve.
 Frolic = new and independent journey. Business of servant’s own. Morrison
 Restatement Second §228 factors:
o (1) Intent to serve the master – did business create necessity for detour or, if business had been dropped,
would journey have continued – Fioco – dominant purpose was not to serve master’s business
o (2) Conduct of the kind employed to perform - §229: must be same general nature as that authorized or
incidental to authorized; §230 forbidden acts may be w/in scope
o (3) Substantially within authorized time and space limits – de minimis departures not ‘frolics’
 Restatement Third §7.07 simiplifies the test: “an empllyee acts within the scope of employement when performing
work assigned by the employer or engaging in a course of conduct subject to the employer’s control. An
employee’s act is not within the scope of employment when it occurs within an independent course of conduct not
intended by the employer to serve any purpose of the employer.
 Acts of a personal nature (especially for intentional torts) = generally not within the scope of employment b/c
not done with intent to serve master and not kind of thing hired to do.
o Smoke/lunch break and commutinc not within (even if paid) b/c not hired to perform/course of conduct
subject to master’s control. Could make an argument if it is an assigned errand.
o May be w/in scope if negligent way of doing job (lighting cig. while driving) b/c incidental to
performance of assigned work.
 o May be w/in scope if employer exerts sufficient control over personal acts (i.e. tells employee where to
smoke).
o Going and coming rule = commuting to and from work is generally not within the scope b/c the benefit is
lacking.
 Re-entry = (1) once again near authorized time and space limits (route employee would have traveled without
frolic); (2) dominant purpose is once again to serve master’s purposes (Fioco, Clover)
o break b/w frolic and resumption of duties must be clear (no “divided loyalty”)
o Accident cannot be caused by forces set in motion by or during frolic.
 What is the difference between re-entry in Restatement Second and Third
o The Restatement Third focuses on intent of the employee. They say that if the course of conduct shows
that the employee was intending to serve the purpose of his employer, then he is acting within the scope
of his employment.
o Restatement Second looks at temporal and special limitations.
 Joel v. Morison, 172 Eng. Rep. 1338 (England, Nisi Prius Exchequer, 1834)
o Class Notes: This case introduces the notion of detour and frolic.
o If employee is only on a detour = employer remains liable
o If employee is on frolic of his or her own = employer is not responsible.
o Cases after this try to identify what is a frolic and what is a detour. Also, when an employee has been on a
frolic, when does the frolic end and new employment begin?
 Fiocco v. Carver, 137 N.E. 309 (Court of Appeals of New York, 1922)
o Class Notes: Facts say that he already had it in his mind to return back to work. Court says that having
started back does not put him back within the scope of employment.
o A presumption exists that the employee is acting within the scope of employment when he is using the
company vehicle.
o Cardozo seems to be saying that the greater the frolic, the more the court would require in order to
demonstrate return to the scope of employment.
o When you return to the scope of employment = depends on each case and underlying circumstances. This
rule is based on flexibility that turns on the degree of deviation from the scope of employment. And the
greater it is, the greater the court will require in order to show return. In this case, it was a complete
departure in that he was not where he was supposed to be, and what he was supposed to be doing. So he
had to shoe A LOT in order to overcome and show the return.
 Clover v. Snowbird Ski Resort, 808 P.2d 1037 (Supreme Court of Utah, 1991)
o Facts: Skier employee of the ski resort crashed. He settled with the injured party and all that is left is the
respondeat superior claim against the ski resort.
o Proc. Hist: Lower court granted summary judgment to the ski resort. The court of appeals reverses.
o Issue: Was employee acting in the scope of his employment at the time of the accident?
o Rule: Under the doctrine of respondeat superior, employers are held vicariously liable for the torts their
employees commit when the employees are acting within the scope of their employment.
o Rule: The acts within the scope of employment are “those acts which are so closely connected with
what the servant is employed to do, and so fairly and reasonably incidental to it, that they may be
regarded as methods, even though quite improper ones, of carrying out the objectives of the
employment.
o Rule: Test to figure out when employees are acting w/in the scope of employment:
 1) an employee’s conduct must be of the general kind of the employee is employed to perform.
In other words, the employee must be about the employer’s business and the duties assigned by
the employer, as opposed to being wholly involved in a personal endeavor.
 2) The employee’s conduct must occur substantially within the hours and ordinarily spatial
boundaries of the employment.
 3) The employee’s conduct must be motivated at least in part, by the purpose of serving the
employer’s interest.
o Reasoning: A jury could find that taking 4 runs is not a TOTAL abandonment of employment.
o Class Notes: Argument that he wasn’t acting w/in scope of employment? 1) he was told not to jump off
the jump that he took. This is clearly outside the scope of employment isn’t it? No. If the employee is
instructed not to do something, and does it anyway, it is not per se outside the scope of employment
doctrine starts from the premise that the employee may be violating the employer’s directions. If that were
the rule it would swallow up scope of employment. 2) He took extra runs. To fulfill his duty he just had
to go up and back down. Instead he took 4 more runs.
 Spencer v. V.I.P., 910 A.2d 366, 2006 ME 120 (Supreme Judicial Court of Maine. 2006)
o Class Notes: This is a going and coming case. The general rule in going and coming cass is that the
employer is not liable because the employee is serving her own purposes by coming. There are exceptions
 to the going and coming general rule i.e. when the employer has given the employee special instructions
w/r/t the vehicle in which the employee was driving.
o Dual Purpose Doctrine = Did the court create an exception to the going-and-coming rule?
o One of the rationales for non respondeat superior liability in the going and coming rule is that the employer
has no control over the way in which the employee is driving. Why not here? Theoritical control including
the power to specify where the employee drives.
o Court doesn’t use the term special errand. Marches through §228 factors. A mechanical application of
those factors is sufficient to find respondeat superior liability. The problem is that it would justify a
finding of liability in any going and coming case. This is what the dissent is arguing. Lowenstein thinks
this case needs to be narrowed, assume that it wasn’t intended to overrule the going and coming rule,
assume that his driving to and from this place on this occasion, he was actually on a special errand.

b. Intentional Torts – a P is not liable for the intehtional torts b/c it is rarely w/in the scope of employment.
 Various tests:
o Did the conduct further the interest jof the employers? Bremen (stold bank money – no VL)
 but maybe a bartender who overreacts there is intent to serve.
o Was it foreseeable? Is it fair to hold liable? BUshey (drunk sailor – VL)
o Was the tort engendered by employment? Lisa M. (assault during exam – no VL)
 watt her ea nexus b/w employment and the tort?
o R2d §219(2) = was A “aided in accomplishing the tort by existence of agency relationship? Costos
(manager of hotel raped guest – VL)
 was there but-for causation?
o Was there an implied contract where the plaintiff couldn’t leave? Nazareth (assaulted in ambulance)
 almost always restricted to common carriers.
o R3d §7.07 = simplifies the R2d §219(2)
o Under either test, always look for direct liability; negligent supervision, negligent hiring, etc.
 Bremen State Bank v. Hartford Accident & Indemnity Co., 427 F.2d 425 (United States Court of Appeals, Seventh
Circuit)
o Facts: Bank was moving locations. Bank employee accidentally put over $10k in a locker. Moving
company moved the locker and an employee found and stole the $10k. Bank is suing the moving company
to recover it on the theory that it is responsible for the misconduct of its employee.
o Issue: Is the moving company Bekins civilly liable for the loss occasioned by the criminal act of its
employee? Holding: No.
o Rule: The employer is liable for the negligent, willful, malicious, or criminal acts of its employees when
such acts are committed during the course of employment and in furtherance of the business of the
employer; but when the act is committed solely for the benefit of the employee, the employer is not liable
to the injured third party.
o Reasoning: there is no contention that the employee stole the money in furtherance of the business of his
employer. Neither the employer nor the bank gave him permission or even had knowledge that he had the
money.
o Note: The book lists a bunch of cases that concur with the result reached in this case, and they all have to
do with theft.
o Class Notes: What is the best argument the plaintiff can make for respondeat superior? He was where he
was supposed to be, during the time he was supposed to be there. But it fails here because the tortious
conduct wasn’t in furtherance of the employer’s purposes. This sinks almost all intentional torts. An
exception would be an overly aggressive bouncer. Even in the case of Scott Bertuzzi the Canucks could be
liable for. Even if the employer made it clear that the type of behavior was not going to be tolerated.
 Class Notes: The mere fact that the tort was intentional doesn’t necessarily mean that the employer won’t be liable.
o Restatement Third Rule = Motivation test = was the employee intending to serve the purpose of the
employer?
o Lisa M. Rule = employer might be liable even if employee wasn’t intending to serve the purposes of the
employer under certain explicit exceptions.

(i) The assault on Restatement Second §228(1)(c)

 Ira S. Bushey & Sons v. United States, 398 F.2d 167 (United States Court of Appeals, Second Circuit,
1968)
o Facts: A drunk coastguard shipman came back to the ship through the drydock and turned some
valves on the drydock. The valves he turned let water into the drydock causing it to rise. The ship
then slid off the drydock. The contract the Coast Guard had worked out with the drydock owner
called for the personnel of the ship to have access to the vessel at all times.
 o Proc. Hist: The drydock owner sought and was granted compensation by the District Court for
the Eastern District of New York in an amount to be determined. The district court judge
rejected §228(1)(c) instead focusing on the larger purposes respondeat superior is supposed to
serve concluding that §228(1)(c) did not serve these purposes.
o Issue: Is the Coast Guard liable for the drunken sailor’s drunken stupidity? Holding: Yes.
o Rule: §228 Motive Test = “Conduct of a servant is within the scope of employment if, but only
if: . . . (c) it is actuated, at least in part by a purpose to serve the master.” Restatement of Agency
2d §228(1)(c)
o If the court applied this rule the employer would not be liable because his actions were not in
furtherance of his employer’s purposes. The court here in Bushey rejects this test and instead
employs an Enterprise Test.
o The Enterprise Test = is it fair to impose this type of cost on a business engaged in this
enterprise? Note: When you’re dealing with an abstraction like fairness you could obviously
come out either way on it.
o Reasoning: The court rejects the motive test and finds liability on another ground. While the
sailor’s actions were not actuated by a purpose to serve the master, the court rejects the rule and
adopts a new rule of vicarious liability. It rejects the lower court’s policy arguments because
respondeat superior does not rest so much on policy grounds as it does in the sentiment that a
business enterprise cannot justly disclaim responsibility for accidents which may fairly be
said to be characteristic of its activities.
o Instead the court employs a foreseeability test. They said that the drunken sailor’s conduct was
not unforeseeable and thus the Coast Guard should be liable for his actions. The foreseeability in
the context of respondeat superior is different from the foreseeability in the context of negligence.
The rationale for using foreseeability is that the employer should be held to expect risks that arise
out of and in the course of his employment of labor. The risk that seamen going and coming from
the drydock might cause damage to the drydock is enough to make it fair that the enterprise bear
the loss.
o Rule: Foreseeability test = if the actions of the employee are reasonably foreseeable, the
employer shall be held liable.
o Rule: Ask the question, is this a deeply rooted sentiment that a business enterprise that cannot
justly disclaim responsibility for accidents which may fairly be said to be characteristic of its
activities?
o Note: The Restatement Third rejects the use of the foreseeability test. They do so because of the
confusion caused by the differences between negligence foreseeability and respondeat superior
foreseeability. Difficulty to apply, confusing, may generate outcomes that are less predictable
than intent-based formulations.
o Class Notes: Court is cognizant of the 228 test and said that prior precedent would take a place
like this and go out of its way to make it look like it served the interest of the employer.
According to Lowenstein one of the great things that the court does right is say that this type of
forced analysis is B.S. and dishonest. Judge Friendly says, “we’re not going there anymore.”
Now he has to embark on a different analysis. The underlying rationale he comes up with is
fairness. It seems fair because if you look at the nature of this enterprise, it’s not so startling that
this type of thing would happen. It was not unforeseeable that a sailor is going to get drunk.
o Wrap up = this case departs from §228 and for the most part from traditional tort analysis and
stakes out a really new test for liability. One that looks at the nature of the business enterprise
and the nature of the precise tort involved and makes a factual judgment as to whether imposing
liability on that enterprise for that particular tortious conduct would be fair or unfair.
 Lisa M. v. Henry Mayo Newhall Memorial Hospital, 907 P.2d 358 (Supreme Court of California, 1995)
o Facts: While getting an ultrasound from the defendant’s technician, a girl was sexually assaulted
by him under the auspices of necessity for the treatment.
o Proc. Hist: Plaintiff sued on a direct negligence theory and a respondeat superior theory. The
superior court granted the Hospital’s motion for summary judgment. The Court of Appeals
reversed. The court relied only on the theory of respondeat superior and expressly declined to
reach the question of direct negligence.
o Issue: Was the technician’s sexual battery of Lisa M. within the scope of his employment?
Holding: No but it may be directly liable. The judgment of the Court of Appeals is reversed to
try the issue of direct liability.
o Rule: an employee’s willful, malicious and even criminal torts may fall within the scope of his or
her employment for purposes of respondeat superior, even though the employer has not
authorized the employee to commit crimes or intentional torts.
o Rule: California does not use the motive test but the employee’s motive is still relevant.
 o Rule: Foreseeability test = While the employee thus need not have intended to further the
employer’s interests, the employer will not be held liable for an assault or other intentional
tort that did not have a causal nexus to the employee’s work. Carr
 this nexus is different than “but for” causation. That the employment brought tortfeasor
and victim together in time and place is not enough.
 varied language to describe the nature of the nexus = the incident leading to the injury
must be an “outgrowth” of the employment; the risk of tortious injury must be
“inherent in the working environment” or “typical of or broadly incidental to the
enterprise the employer has undertaken.
 Basically all this is saying is California courts are asking whether the tort was
foreseeable from the employee’s duties.
o Rule: The tortious occurrence must be a generally foreseeable consequence of the activity.
Foreseeability = in the context of the particular enterprise and employee’s conduct is not so
unusual or startling that it would seem unfair to include the loss resulting from it among other
costs of the employer’s business.
o Sub Issue 1: were the technician’s acts “engendered by” or an “outgrowth” of his employment?
Holding: No.
o Rule: vicarious liability has been deemed inappropriate where the misconduct does not arise
from the conduct of the employer’s enterprise but instead arises out of a personal dispute or is
the result of a personal compulsion.
o Rule: a sexual tort will not be considered engendered by the employment unless its motivating
emotions were fairly attributable to work-related events or conditions.
o Reasoning: he took advantage of the situation to commit the sexual tort for reasons unrelated to
his work. His work provided no occasion for any type of emotional involvement with the
patient. The circumstances of his work made the tort possible but the tort didn’t arise out of his
performance of his work. It was merely the result of propinquity and lust.
o Sub-issue2 = Was the sexual tort foreseeable? Holding: No.
o Rule: An intentional tort is foreseeable, for purposes of respondeat superior, only if in the
context of the particular enterprise and employee’s conduct is not so unusual or startling that it
would seem unfair to include the loss resulting from it among other costs of the employer’s
business. The question is one of a relationship b/w the nature of the work involved and the type of
tort committed. The employment must be such as predictably to create the risk employees will
commit intentional torts of the type for which liability is sought.
o Reasoning: What about the physically intimate nature of the work? The court says that this
alone is not sufficient to impose vicarious liability. There is no evidence of emotional
involvement arising from the medical relationship. Although the procedure involved physical
contact it was not the type expected to give rise to intense emotions on either side. This is not the
result of a mishandling of the feelings predictably created by the therapeutic relationship.
o Class Notes: Majority here holds that there is no liability for the employer here. Analyzes it in
terms of whether or not it is foreseeable and concludes that it is not. Uses some other constructs to
analyze the question that sound different, but Lowenstein thinks they are the same thing. –
o “engendered by, or is typical to the employment” = outgrowth of the employment, adds context to
the foreseeability test we saw in Bushey. Court says no.
o Dissent = let the jury decide. Shines a light on it because he basically says “the jury could come
out the other way.” With a hindsight bias it’s always going to appear that it could happen.
Basically if this is the test, give it to the jury.
 pg. 220 – New York Tribune deliveryman lost it and assaulted the person whose car he hit when he went to
get the license number of the driver. How would this come out under Bushey? Whose interest was the
driver serving at the time he hit the victim? His own. What is the Bushey test? In the course of
conducting the larger enterprise, could this happen? Yes of course, it DID happen! In the course of
delivering newspapers all over the city of New York, it could happen that a driver could get into an
accident.
 Bottom Line = it’s difficult to predict the outcome of these cases using the Bushey Enterprise test. It’s
too fuzzy and too unpredictable. Lowenstein thinks it all comes together in the Lisa M. case in the dissent
that says if this is the test, give it to the jury.
 It’s because of all these problems that the Restatement Third rejects this enterprise test and retains the
intent/motive based test.
 So there are two different camps. Either measure liability on either motivation/intent of the employee, or
you’re not. If you’re not, you’re basically going with the Enterprise test that focuses on fairness.

(ii) Restatement (Second) §219(2)(d) = aided in accomplishing by agency relationship.

  Costos v. Coconum Island Corp., 137 F.3d 46 (United States Court of Appeals, First circuit, 1998)
o Facts: The manager at a hotel in Maine let himself into the room where plaintiff was staying at and raped
her in her sleep.
o Proc. Hist: P sued the defendants in federal court, alleging the defendants were negligent and were
vicariously liable for its employee’s torts. Defendants moved for directed verdict. Denied. Defendants
appeal.
o Issue: Is the defendant owner of the hotel vicariously liable for the intentional tort of its employee?
Holding: Yes. Affirm.
o Rule: A master is not subject to liability for the torts of his servants acting outside the scope of their
employment, unless the servant purported to act or speak on behalf of the principal and there was reliance
upon apparent authority, or he was aided in accomplishing the tort by the existence of the agency relation.
Restatement (Second) of Agency §219(2)(d)
o Discussion: The defendants are trying to case the last part of §219(2)(d), the part that says “. . . or he was
aided in accomplishing the tort by the existence of the agency relation” as a reiteration of the prior
language in subpart (d). The court says that this is not the law in Maine, and that the last part of subpart
(d) can stand alone in finding liability for their agent’s actions even when acting outside the scope of
employment. In other words, the use of apparent authority is not required for such a finding. Even
though other courts have accepted defendant’s argument based on the fact that in all of these cases, there
will be some kind of supervisory authority that puts the tortfeasor employee in the proximity to and contact
with the victim also pointing to a narrowing comment in §209(2)(d) which states that an employer is liable
only if the tort “was accomplished by an instrumentality, or through conduct associated with the
agency status.” Restatement (Second) of Agency §219 cmt. e. The court says that even with this
narrowing comment, the employer here is still liable.
o Reasoning: The employer is liable because by virtue of his position at the hotel, that of manager, he had
keys to all the rooms and the information as to where Costas was staying. This put him in the position to
commit the tort.
o Notes: 5 years later, the Maine Supreme Court said this, “comment e to section 219(2)(d) acknowledges
that the section is limited in its application to cases within the apparent authority of the employee, or when
the employee’s conduct involves misrepresentation or deceit . . .
o See also Daniel M. Combs Colorado Law Review article from 2002 which states that “the limitations
contained in Comment e . . . prevent the aided-by-agency-relation basis for liability from potentially
swallowing agency law’s general scope of employment rule.”
o The Restatement Third does not embrace the use of §219(d)(2) reflected in the Costas case.
o Lowenstein says the Restatement was not referring to cases like this one. It was referring to agents who
defrauded people out of money and they were only able to defraud those people only because of their
agency status. Everything the agent will now give rise to respondeat superior liability because it is
basically a “but for” test.

(iii) Punitive damages

 There are two divergent lines of authority:
o 1) assessment of punitive damages is permitted in a case where the employer would be liable for
compensatory damages under respondeat superior.
o 2) majority rule = allows the imposition of punitive damages on the employer only on the basis of
culpability, i.e. authorizing or ratifying the tortious behavior.
o Since the rationale behind punitive damages is punishment and deterrence, the majority rule makes sense.
Shareholders and owners are blameless in cases where they did not authorize the wrongful behavior and
holding them responsible for them would be unfair.
 Restatement Second of Agency §217C = Complicity Rule. Employer is liable for punitive damages only when a
superior officer in the course of employment orders, participates in, or ratifies outrageous conduct.
o A superior officer = connotes more than an agent, more than “ordinary” officer, or employee vested with
some supervisory or decision-making responsibility. It must be a high level of managerial authority in
relation to the nature and operation of the employer’s business.
 Criminal liability? Sometimes but only in cases where the employee committed a crime of strict criminal liability.
Malum prohibitum v. Malum en se.
 Rule: A principal is not criminally liable for the criminal act of his agent unless he authorized, consented to,
advised, aided or encouraged the specific act. An exception to this rule is the doctrine of criminal liability without
fault which has been applied to criminal statutes enacted for public morals, health, peace and safety. In general,
such statutes deal with offenses of a regulatory nature and are enforceable irrespective of criminal intent or
criminal negligence.

Lowenstein’s game plan for going after independent contractor

  Establish they are agent or employee
 Negligent hiring
 Other exceptions is they are applicable

Chapter 4. Contractual Powers of Agents

A. Authority – the ability of A to affect the legal relations of P by acts done in accordance with P’s manifestation of consent to the
Agent. Authority may be either express or implied.
 We’re not talking about independent contractors here. However, be on the look out for independent contractors who have a
piece of agency in their independent contract. i.e. a limo driver on the way to pick you up and you ask him to stop by your
office to pick up your briefcase and you’ll pay him for his favor. The point being you can carve out principal agent
relationships out of principal-independent contractor relationships.
1. Express Authority
 King v. Bankerd, 303 Md. 98 (Court of Appeals of Maryland, 1985)
o Principal leaves power of attorney with his attorney that authorizes him to deal with some real property that
the principal, King, owned. The agent deeds the property to the estranged wife of the principal. The principal
comes back to claim property and finds out that his property has been conveyed to his estranged wife. He
doesn’t like this.
o The court says he has a claim for negligent breach of fiduciary duty. Lowenstein says it is plain and simple a
breach of contract b/c he had no authority under his relationship to convey the property to his estranged wife b/c
the contract did not give him the authority to gift the property. The principal does not benefit from this
transaction and if he wanted the agent to have that power he should have put it in the contract expressly.
o This case explores the interpretation of a power of attorney.
o Powers of attorney are interpreted narrowly.
 Lamb v. Scott, 643 So. 2d 972 (1994)
o Rule: Powers of attorney will be construed strictly, restricting the powers to those expressly granted.
o Rule: One who accepts a power of attorney covenants to use the power for the sole benefit of the one
conferring the power and to use it in a manner consistent with the purposes of the agency relationship created
by the power of attorney.

2. Implied Authority = agent’s reasonable interpretation of express instructions. “Reasonableness” = words, custom, relations.
R.2d §7
 Incidental Authority: unless otherwise agreed, an Agent has authority to do acts incidental to expressly authorized
transaction – necessary, usual, and proper. R.2d §35. E.g., authority to borrow = authority to execute promissory note
 Delegation of Authority = authority to delegate to subagent must be express or implied: may be implied from type of
work – two man job. UNLESS – emergency – cannot contact Principal, do work by himself, and reasonably necessary to
protect Principal’s interests

B. Apparent Authority
 Rule: A person who professedly acts as an agent has authority to bind the Pincipal, even if he is unauthorized if (1) P is
responsible for appearance of agency authority in A to TP AND (2) TP’s reliance is reasonable (Hansen & Jonhson). There
are three sorts of apparent authority:
o 1. Statements made by P to TP – i.e. P is liable for authority stated in a letter, even if given to A with instructions
not to diplay it.
 Lingering Apparent Authority
 It has to be reasonably interpreted by the third party based on representations by the principal.
 And must make the T believe that principal consents to having agent acting on his behalf.
 Smith v. Hansen, Hansen & Johnson, Inc., 818 P.2d 1127 (Court of Appeals of Washington, 1991)
o Glass wall purchased from a supposed agent of glass company begins to leak and building renovators sue glass
company.
o Business cards and office does not make someone an agent.

 Sauber v. Northland and Insurance Co., 251 Minn. 237 (Supreme Court of Minnesota, 1958)
o Sauber calls up insurance company over phone and girl on other end says he could transfer the policy.
o Rule: One who answers a business telephone has apparent authority to discuss matters relating to the business and
it is binding. This is a presumption that may be rebutted if evidence that P is not acting in good faith.
o Notes: P is bound by acts of those he leaves in charge of his business. Employer liable to retailer when retailer
receives authorization over the phone to extend credit to someone purporting to represent the principal.
  Foley v. Allard, 427 N.W.2d 647 (Supreme Court of Minnesota, 1988)
o Facts: A customer, Allard, is hanging out in a stock broker’s office. He tells the plaintiff that he can double her
money or guarantee that he can return her principal at least. She invests with him and loses everything. She sues the
stock broker’s office where this guy was hanging out.
o Cause of action = breach of K which is going to require some form of vicarious liability.
o The plaintiff will have to establish that Allard was an agent.
o Is Merill Lynch liable if one of their sales people defrauds a customer? While fraud might not be in the scope of
employment, investing money is so he was acting in the scope of employment in that sense. So, unless the plaintiff
acted unreasonably, the plaintiff should be able to maintain an action for respondeat superior liability against the
employer.
o The court holds however that there is no claim for respondeat superior of breach of contract here because he is no
agent. So court has to move to the theory of apparent agency. Court finds no apparent agency b/c to was
unreasonably for her to believe that he was an agent b/c if was fishy, she was sophisticated enough to realize that it
was fishy.
o RULE: the purported principal can be liable for the acts of someone who appears to be an agent. Theory = i.e.
negligence for not seeing who was on the floor of your store, walking up to customers, and soliciting their business,
etc. Theory = estoppel i.e. you’ve done something that had led me to believe that this person is your agent (i.e.
answering and transferring phone calls like in Foley) and so you should estopped fro denying that this person is your
agent.
 Herbert Construction Co. v. Continental Insurance Co., 931 F.2d 989 (United States Court of Appeals, Second Circuit, 1990)
o Lingering apparent authority. Agent had power of attorney revoked but he misled company into believing that he
had one by fixing it up AND company never told P that the agent could no longer issue bonds.
o The plaintiff seeks to hold an insurance company liable on a performance bond that it never issued. Their claim is
breach of contract, defendant says “I don’t have a contract with you.” The plaintiff response, “you should be
estopped to deny that you issued this bond since we reasonably believed that Dixon was your agent as a result of
actions you took to lead us to believe that Dixon was your agent and we relied on these actions.” Dixon did not
have the authority to issue bonds on behalf of Continental. He was an agent though because he had the authority
to do some things on behalf of Continental, but he exceeded scope of his authority. So this is an apparent authority
case.
o Issue = does the agent of an insurance company have the authority to bind the insurance company? What is the
apparent authority of an insurance agent?
o A customer who receives a policy from an agent might reasonably believe that the company is bound.
o In this case, there’s almost an assumption that in order to have a valid policy, it has to be signed by somebody and if
the person with the authority to sign it, the person who does sign it has to have the apparent authority.
o If a person was once an agent and a principal failed to notify third parties that that person is no longer an agent, then
the court will treat that person like an agent.
o So we start from the premise that in order to bind the insurance company, the agent needs the power of attorney
because almost as a matter of law, the agent doesn’t have the actual authority to do that.
 Continental Insurance Co. v. Gazaway, 453 S.E.2d 91 (Court of Appeals of Georgia, 1994)
o Facts: bond for $52,000 was filed in the probate court. Continental Insurance was named as the surety but it was
issued by George Robinson who did not have the authority to write bonds for Continental b/c his authority was
revoked. Continental says it was not liable even though the power was filed with the county clerk.
o Persons dealing with a limited agent have the duty to examine the agent’s authority. Especially when the bond was
not from Continental but from Transamerica Ins. Co. This court did not discuss its liability under apparent agency
and said that Principal did not hold agent out.
o Dissent = this was on file w/county cleak and could have been relied opon.
o Notes: It costs a lot to take away power and these things are all over the place and often not relied upon. Agency
costs = You bear certain risks working through an agent.
o Apparent authority difers from estoppel in that the principal becomes immediately a contracting party irrespective of
intent and with no reference to any change of position by the third party.
o Prior dealings can give apparent authority, but must be similar to the one at issue and have a degree or
repetitiveness.

C. Estoppel
 Hoddeson v. Koos Bros., 47 N.J. Super. 224 (Superior Court of New Jersey, 1957)
o Shopping for furniture and Fake salesman steals cash from Plaintiff.
o A principal may be liable for failing to take reasonable precautions against an imposter claiming to be the principal’s
agent, failing to do so estopps a principal from claiming the agent is not his agent.
o The court rejects a notion of agency law that Estoppel requires some form of affirmative action on the part of the
defendant. This is what makes it different from the negligence theory when there is no agency relationship.
D. Inherent Agency Power Concept
 Inherent agency = indicated power of an agent which is derived not from authority, apparent authority, or estoppel, but solely
from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent.
Restatement (Second) §8A
 Autoxchange.com, Inc. v. Dreyer and Reinbold, Inc., 816 N.E.2d 40 (Court of Appeals of Indiana, 2004)
o Actual authority = main claim. He was part owner of the company.
o Apparent authority = alternative claim. A corporate officer is an employee of the company and a salesperson.
Salespeople have the authority to tell people how to make payments.
o Inherent Authority = alternative claim
 How does the inherent agency authority differ from apparent agency authority?
o Class Notes: They rely on the fact that he was a corporate officer.
o Inherent agency authority = principal bound by the actions that would normally be within the authority of the agent
based on his position in the company.
o i.e. Watteau v. Fenwick - also consider estoppel. In estoppel, if the principal held the agent out to have a position
with the company such as owner then they should be estopped from denying that they did not have the authority to
do whatever.
o Inherent authority allows the third party to reach the personal assets of the agent

Chapter 6. The Undisclosed Principal

 Absent special circumstances, the law allows people to do business through agents w/out disclosing their identity. The law is
encouraging deceptive conduct.

A. Rights of the Undisclosed Principal

1. Assertion of Rights by the Undisclosed Principal

 When a contract is made by an agent for an undisclosed principal, the principal can enforce the contract.
Restatement Third §6.03
 If the principal notifies the third party who entered into the contract with the agent to make payment under the
contract directly to the principal, the third party is bound to do so, and payment to the agent after such notice will
not relieve the third party of liability to the principal.
2. Parol Evidence Rule
 Ordinarily, the parol evidence rule would not allow variations from or additions to an integrated contract.
 However, it is well settled that the principal may show that the agent who made the contract in his own name was
acting for him. This proof does not contradict the writing it merely explains the transaction.
 Parol evidence is forbidden if the contract by its terms excludes the principal as a party.
3. Exceptions

o Kelly Asphalt Block Co. v. Barber Asphalt Paving Co., 211 N.Y. 68 (Court of Appeals of New York, 1914)
 A competitor buys asphalt from its competitor case.
 Cardozo’s rationalization for undisclosed principal = He says there is a contract in which the agent is
bound. There was no misrepresentation made. Contracts are presumptively enforceable. Agent could have
bought this and assigned it to anyone (including undisclosed principal)
 This isn’t all that different from an economic point of view from a transaction in which an agent purchases
and resells to his principal, which, of course, is legal.
 Cardozo leaves the door open if there was an act of misrepresentation on which the third party relied
then maybe that contract b/w the agent and the third party is voidable.
o Finley v. Dalton
 Agent assembling parcels of property for the principal. The principal can’t do it directly b/c he knows that
if he was the one doing it the third parties would be able to drive a harder bargain and he would have to pay
more. So he sends an agent out there to solicit the sales for them. Agent outright lied to the third party
when asked why he was buying the land. So the landowner sells it to him. Subsequently finds out that it’s
Duke Power that actually bought it. The landowner wants to rescind the contract because he was lied to.
 He is seeking an equitable remedy for rescission. In order to get rescission, you have to demonstrate that
the equities are in your favor by showing that there was some sort of fraud/deceit and there should be
rescission. Elements of fraud = misrepresentation, made by the defendant, which the plaintiff relied upon,
and which caused damage to the plaintiff.
 Holding: The court does not grant rescission to the plaintiff.
 Plaintiff’s claim of misrepresentation doesn’t work because it was not material.
 It was not material because it wasn’t for that reason that he sold the property.
  What would have been material? It is possible that the seller owned an adjoining piece of property and the
use of this piece of property would have been material.
 Court says “it played no role in his decision to sell the property to this agent.”
 Plaintiff’s claim of deception also fails. Deception = buyer did not disclose that the undisclosed principal is
Duke Power.
 It fails because he did not have any duty to disclose. General Rule = Parties dealing at arms length with
each other do not have a duty to disclose unless required by statute.
 Public policy of principals to act in an undisclosed fashion? This sanctions deceptions.
 How do we resolve this policy dilemma?
 If the seller straight out asked if the agent was working for someone else and the agent lied about
that, there might be a different outcome.

B. Liabilities of the Undisclosed Principal

1. Authorized Transactions

 General Rule: The principal is bound by the contract and can be sued by the party contracting with the agent. Restatement
(Third) §6.03

a. remedies of the third-party

o The third party has the customary contractual remedies against the agent since the agent signed the agreement as a
contracting party.

b. the election rule

o Election Rule = Traditional American Rule = if the third person with knowledge of the facts obtains judgment
against either one, he cannot have judgment against the other. If he obtains judgment against the agent with no
knowledge of the identy of the principal, he can later get judgment against the principal. Restatement Second
o The election rule has been the subject of criticism and the Restatement (Third) has abandonded the rule.
o Class Notes:
 Restatement Third abandons the rule completely and says that the relevant question to ask is whether the
third party has gotten relief. End of story. He can get it from agent or principal it doesn’t matter.

2. Unauthorized Transactions
 Watteau v. Fenwick, 1 Q.B. 346, (Queens Bench Division, 1893)
o Facts: Defendant owned a hotel-pub that employed Humble to manage the establishment. Humble was the
exclusive face of the business; Humble’s name was on the bar and the license of the pub. Defendant explicitly
instructed Humble not to make any purchases outside of bottled ales and mineral waters, but Humble still
entered into an agreement with Plaintiff for the purchase of cigars. Plaintiff discovered that Defendant was the
actual owner and brought an action to collect from Defendant.
o Issue: Defendant is liable for damages resulting from an agreement between Plaintiff and Humble, who is
knowingly acting outside his actual authority as an agent for Defendant. Holding: Defendant is liable for
damages.
o Reasoning: Humble was acting with an authority that was inherently reasonable for an agent in that position.
The situation is analogous to a partnership wherein one partner is silent but is still liable for actions of the
partnership as a whole.
o Reasoning: The decision could not be based on apparent authority because the principal is disclosed under that
doctrine.
o The principal is held liable for actions by an agent that are expressly forbidden, but the case limits a principal to
actions of an agent that are reasonable under the circumstances.
o Rule: An undisclosed principal can be held liable for the actions of an agent who is acting with an authority that
is reasonable for a person in the agent’s position regardless of whether the agent has the actual authority to do
so.
o Class Notes: This is an important case illustrating the general rule that an agent for an undisclosed principal,
can bind the principal even to unauthorized contracts provided that the contract is one that one would
otherwise think to be w/in the authority of the agent.

 Senor v. Bangor Mills, 211 F.2d 685 (United States Court of Appeals, Third Circuit, 1954)
o Facts: Principal gave agent strict instructions about buying nylon yarn which was in limited supply. The
intermediary began to buy the yarn for more than was allowed by the Mills on their account for him. Bangor
was an undisclosed principal.
 o General Rule: An undisclosed principal who entrusts an agent with the management of his business is subject
to liability to third persons with whom the agent enters into transactions usual in such business, and on the
principal’s account, although contrary to the directions of the principal.
o Court will not bind the undisclosed principal for acts of an agent beyond his actual authority.
o Class Notes: We start out with a general principal = an undisclosed principal is bound by a contract made by
its agent. Watteau says that this is true even if the principal didn’t authorize the agent to make that particular
contract. So what is Bangor’s defense here?
 1) He wasn’t an agent at all b/c he was acting on his own behalf.
o Does a settlement by an agent also bind a principal?
o Even if Shetzline acted as an agent, the principal has settled with the agent, and therefore, the third pary has to
go after the the agent. This is because the third party ALWAYS believed that it was dealing with the agent, it
didn’t even know aobut the principal. And because of this it is ovbiouv that the third party was looking only at
the credit of the agent. So it is more or less of a windfall when the third party finds out that there is another
pocket out there.
o When the principal in good faith has ssettled with the agent, the third party is set out (this is the last para. on pg.
382).
o Restatement Third is more protective of third parties = takes tehe position tbat a contract is a contract.

C. Payment and Setoff

1. Payment by the Third Party

 When an agent has made a contract on behalf of an undisclosed principal, until the third party has notice of the
principal’s existence, the third party’s payment to or settlement of accounts with the agent discharges the third party’s
liability to the principal.
 What happens if the third party settles with an agent? And the agent doesn’t give the money to his principal. The
principal sues the third party.
o The third party acted in good faith and shouldn’t be required to pay twice.
o Additionally, the whole situation came about because of the fact that the principal was operating as an
undisclosed principal.

2. Payment to the Third Party

 Majority Rule = that discussed in Senor. A principal who settles in good faith with his agent while still undisclosed,
expecting that the agent will pay T, is protected fro liability to T if A neglects to discharge her duty to pay T.
 Minority Rule = that preferred by the third restatement. An undisclosed principal is not discharged by payment to the
agent unless he does so in reasonable reliance upon the conduct of T that indicates that A has settled the account.
Restatement (Second) §208 and Restatement Third §6.07

3. Setoff
 Situations where an agent enters into contract for undisclosed principal, perhaps motivated in part because the agent
owed the third party money.
 Rights of a third party to setoff amounts owed to it by the agent when dealing with an undisclosed principal.
 Restatement Third provides that “When an agent makes a contract on behalf of an undisclosed principal,
o (a) the third party may setoff:
 (i) any amount that the agent independently owed the third party at the time the agent made the
contract and
 (ii) any amount that the agent thereafter independently comes to owe the third party until the third
party has notice that the agent acts on behalf of a principal against an amount the third party owes the
principal under the contract
o (b) after the third party has notice that the agent acts on behalf of a principal, the third party may not set off any
amount that the agent thereafter independently comes to owe the third party against an amount the third party
owes the principal under the contract unless the principal consents. . .
 Oil Supply Company, Inc. v. Hires Parts Service, Inc., 726 N.E. 2d 246 (Supreme Court of Indiana, 2000)
o Facts: William Dolin (a commodities broker) was indebted to Oil Supply (P) entered into an agreement with
Dolin under which Dolin would arrange sales through Oil Supply. The profits would be split b/w Oil Supply
and Dolin. Dolin was also indebted to Hires Parts Service, Inc. (Hire)(D). To remedy this debt, Dolin
represented to Hires that he had a load of 720 cases of anti-freeze that he would ship to Hires in exchange for
his debt to Hires. The cases were sent and received. Prior to this transaction, Oil Supply and Hires were
unaware of each other’s existence. Hires has neither paid for nor returned the antifreeze.
 o Issue: If an agent is authorized only to contact in the principal’s name, does the other party have a set-off for a
claim against the agent only if the agent has been entrusted with possession of chattels which he disposes of as
directed or the principal has otherwise misled the third person into extending credit to the agent?
o Holding: Yes. If an agent is authorized only to contract in the principal’s name, the other party does not have a
set-off for a claim due him from that agent unless the agent has been entrusted with possession of chattels which
he disposes of as directed or unless the principal has otherwise misled the third person into extending credit to
the agent.
o Reasoning: Principals are generally in a better position to prevent potential fraud by their agents than are
buyers.
o Reasoning: Here, Oil Supply could have prevented this situation by making a confirmation of the sale, or by
closer supervision of its agent Dolin. These failings by Oil Supply were neglectful. On the other hand, Hires
might just as easily have prevented the defalcation by taking the time to ponder why some company it had never
heard of had just deposited a truckload of antifreeze on its doorstep. The principle that between two innocent
parties, the loss should be placed on the party who has put the agent out to deal does not apply if the party
seeking refuge in the principal haw wittingly or otherwise aided an unscrupulous agent to defraud the principal.
here, because Hired was chargeable with notice of the existence of Oil Supply as Dolin’s principal before it
accepted the goods, and because hires had the last opportunity to prevent the loss before the transaction was
complete, Hires should bear the loss. Hence, Hires was not entitled to set off its Dolin debt in the lawsuit
brought by Oil Supply. Accordingly, the court affirmed.
 Class Notes:
o All of the shipping documents said that the shipment of anti-freeze came from Oil Supply so to say that Hires
should have known that the anti-freeze didn’t come from Dolin but from Oil-Freeze.
o The third party settles with Dolin after it receives its shipment. What if Hires PAID Dolin after it received
notice that it was working on behalf of an undisclosed principal? The rule is once the third party knows of the
existence of the agent then that person must settle with the principal and can not longer settle with the agent.
o Hires was on notice merely by looking at shipping document (however, Hires might have thought that Dires
paid oil supply).

Chapter 7: Liability of the Agent to Third Persons

A. Liability on the Contract

1. Liability When the Principal is Unintentionally Undisclosed
Jensen v. Alaska Valuation Service, 688 P.2d 161 (Supreme Court of Alaska, 1984)

2. Liability When the Principal is Disclosed: Special Circumstances

Copp v. Breskin, 782 P.2d 1104 (Court of Appeals of Washington, 1989)

3. Liability When the Principal is Partially Disclosed or Inidentified

Van D. Costas, Inc. v. Rosenberg, 432 So.2d 656 (District Court of Appeal of Florida, 1983)

B. The Agent’s Warranty of Authority – an agent is personally liable to third party is he contracts without, or in excess of, P’s
authority, unless he states that he lacks such authority
 Agent will be liable even if he has a good faith belief that he possesses the authority.
 Will not be liable if third party has actual knowledge that agent lacked authority/reason to know does not bar liability.
 P may still be liable under apparent authority/estoppel theorys.
 Husky Industries v. Craig Industries, 618 S.W.2d 458 (Court of Appeals of Missouri, 1981)
o When dealing with a corporate officer, how can a third party verify the officer has the authority to make the
transaction?
o Need something from board of directors.
o Is it enough that the corporate sends you a photocopy of the board of directors meeting? No, you probably need
something signed by the secretary of the board.
o Copy of resolution, certification from secretary, review the bylaws of the corporation to make sure the corporation’s
secretary was in fact authorized to do that, some indication that the persons who purport to be officers of the
corporation are in fact officers of the corporation. Still at some point you have to have faith that not everyone is
lying to you. You have to trust but verify as much as you can.
o If an agent breaches a warranty of authority is to place the plaintiff in the same position he would have been in had
the tort not occurred. This is a restitution case and not expectation damages
 Coker v. Dollar, 846 F.2d 1302 (U.S. Court of Appeals, 11th Cir. 1988)
o Bottom line: If agent breaches an obligation to the principal, third parties cannot get judgment against the agent.
o Facts: Agent failed to set up an escrow account which caused the third party not to receive funds he otherwise
would have been paid. So the third party sues the agent.
 o Here, the agent is absolved from damages, on the contract, but if an agent, in the course of executing an agency
relationship, personally injures a third party, the third party can bring an action for damages against the agent.
Economic damages resulting from breach of duty to principal? Personal injury damages also arising from breach of
duty to principal BUT ALSO arising from breach of duty to the third party (i.e. agent negligently driving craches
work truck, he breaches duty to both principal and third party._
 AN agent is not liable to a person other than the principal for harm resulting from failiure to adequately perform his duties as
an agent – only Principal is responsible for NONFEASANCE – Coker; but 3rd party beneficiary might make agent liable for
nonfeasance.
 Agent remains liable for MALFEASANCE – stil lliable in tort, acting as agent does not confer immunity for personal torts.

Chapter 9: Notice and Notification; Imputed Knowledge

A. Introduction
 General Rule: If notice is given to an agent in the course of an agency relationship, and the agent is authorized (expressly or
apparently) to receive such notice, then the principal is bound by that notice.
 Rationale for this rule: We don’t want principals to be able to isolate themselves from the imputation of knowledge by
using an agent by saying “I didn’t know that. He never told me.” So if you choose to do business through an agent you’ll be
bound by notice given to the agent in the course of the relationship.
B. Notification
 Notification = deliberate effort to bring some fact to the attention of a person or group of persons, or all present or future
persons who may have or claim an interest in the subject matter.
 St. Louis & St. Charles Bridge Co. v. Union Electric Light & Power Co., 216 Mo. App. 385 (1925)
o Should an organization be held to the composite knowledge of several of its employees?
o A power company entered into a contract with a bridge company to string high tension wires aboce the bridge.
Power company promised to provide safety personnel whenever the Bridge companypainted the bridge upon
receiving notice that they were going to paint.
o One employee of Power company sees painters working on the bridge. Another employee knoew that Power
company is supposed to supploy safety personnel under that circumstance.
o Issue: Is power company subject to the composite knowledge of its two employees?
o Holding: no, unless this affair was entrusted to the agent tho observed the painters.
o It’s not only that the Bridge Company intended to give notice, but also that the power company has to know that
they’re being given notice. (must be received in an official capacity; can’t just be any agent).
 Montana Reservoir & Irrigation Co. v. Utah Junk Co., 64 Utah 60 (Supreme Court of Utah, 1924)
o The agents of Montana Power were also Agents of Montana Reservoir (P), so their knowledge (that Rosenblatt
was an agent) is imputed to them.
o In this case, knowledge does not arise out of their relationship with the defendant, it arises out of their relationship
with another party.
o Disputed fact in the case = whether or not the Defendant had given notice to the plaintiff that they had terminated
their agency relationship with Rosenblatt. The court says though that we do not impute knowledge from a
principal to an agent.

C. Imputed Knowledge
 The doctrine of imputed knowledge involves holding a principal to the knowledge of, and sometimes the wrongs (broadly
defined) committed by, his agent by imputing the knowledge of the agent to the principal.
 Rationale for this doctrine =
o 1) creates an incentive on the part of the principl to select and monitor their agents with care.
o 2) discourages the use of agents to “insulate” principals from information of which principals consciously wish to
remain ignorant.
o 3) it is more efficient for third parties to communicate with agents rather than directly with principals and if there
was no doctrine of imputed knowledge, third parties would be discouraged from communicating with agents.
 Constant v. University of Rochester, 111 N.Y. 604 (Court of Appeals of New York, 1889)
o Issue = if an agent learns of information in a prior unrelated agency relationship, is that agent deemed to still
have that knowledge in a subsequent unrelated agency relationship?
o Rule: If the complaining party can demonstrate by clear proof (more than a preponderance) that the agent
remembered the knowledge at the time of the subsequent transaction, then it would be imputed.
o Presumption = A person’s knowledge, obtained outside the scope of the agency relationship, is not imputed to the
principal. This presumption can be overcome though.
o Dealing with indirect proof. How do you prove whether or not someone remembers? Ask them? Has to be
something more than the agent’s own testimony. What more?
  1) Time period between the two transactions. Question of fact. Longer the time period more likely the
agent forgot about it.
 2) Prominence of the transaction. It’s one thing to forget what you had for breakfast 11 months ago,
another thing to forget that you won the lottery 11 months ago.
 Bird v. Penn Central Co., 341 F. Supp. 291 (United States District Court, Eastern District of Pennsylvania, 1972)
o D&O said that A has known problems. Was A the A for everyone covered? Basically claimed that A made a
misremresentation and thereby voided the policy. Odd circumstances a bunch of innocent policy-holders have
coverage voided because A made a misrepresentation.
o Even if Bevan called in sick that day and said to Kirk, take care of insurance policy, it seems coverage might still be
denied. This is unfair because the policy covers not just the person signing the application. “No named insured is
aware.”
o ratification theory = you can’t argue that you get the benefit of the agent filling out the insurance application and at
the same time argue that he wasn’t your agent.
 Shapiro v. American Home Assurance Co., 584 (United States District Court, District of Massachusetts, 1984)
o Shapiro court rejects the ratification argument that Bird accepted. They said because there was no control there
couldn’t be an agency relationship. Control turns not only on controlling what the agent does but the right to
control. The right to control arises from the consent of the parties.
o Applying this control criteria seems kind of artificial in this context. Some of the directors and officers may have
been unaware that the application was even being filled out and who was filling it out.
 First American Title Insurance Co. v. Lawson, 177 N.J. 125 (Supreme Court of New Jersey, 2003)
o The insurance company is saying that they were defrauded b/c they made a material misrepresentation on the
insurance applications.
o The relief they seek is rescission.
o Defense = nonimputation of the agent’s knowledge on the insured. There are really two sets of insureds here 1)
officers and directors, and 2) the company.
o Adverse interest exception? It doesn’t work here. It’s not a breach of contract b/c we contemplated that it would
only void coverage as to the person who filled out the application not the other applicants.

D. The Adverse Interest Qualification

o Rule: If an agent is acting adversely to the principal and entirely for his own or another’s purposes, his knowledge is not
imputed.
o However, conflicting goals (desire to make a commission and thus keep silent about outstanding equity) does not rise to the
level of an adverse interest.
o Kirschner v. KPMG LLP, 2010 WL 4116609 (N.Y. 2010) (in supplement)
o Company’s claims against the auditors = 1) breach of contract; 2) tort claim – professional malpractice/negligence.
o Auditor’s defense = 1) we have fulfilled our contractual obligation; 2) we were not negligent.
o auditors are saying that the company had knowledge of the agent’s fraudulent acts b/c of imputation. then, under in
pari delicto, while we may be negligent, you are more culpable b/c you were committing a fraud and the law won’t
involve itself in a conflict b/w two wrongdoers.
o Company’s response = management is acting adverse to the company thus, imputation is cut off because if they are
acting adverse to the company they are no longer agents of the company.
o Court says = must be acting completely adverse to the company. In this case they are not because they were still
doing things for the company.
o Practically, according to Lowenstein, the adverse interest exception almost never applies. The only time it would apply is
when the manager is looting the company itself, but these are really rare cases.
o Exceptions to the adverse interest qualification:
o 1) sole actor doctrine
o 2) policy basis/accountability by the auditors – this is exactly what they were hired to do.
Restatement Third §5.03 and 5.04 are very important and listed in the statutory supplement:

E. The Sole Actor Doctrine

 The sole actor rule is an exception to the adverse interest exception.
 Applies when agent, even though clearly acting as an adverse party to the principal, by for example, selling some of his own
property to the principal, also receives that property in the capacity of agent for the principal and iss the only agent acting in
that capacity.
 Agent wearing two hats – one as adverse party, one as sole recipient of the property for the principal.
 It is in the latter capacity that the sole actor rule applies, imputing the agent’s knowledge to the principal.
 Munroe v. Harriman, 85 F.2d 493 (United States Court of Appeals, Second Circuit, 1936)
o Harriman borrowed securities from Munroe on a personal basis, committing fraud in the process. He then pledged
the securities as collateral for a loan from a bank of which he was the president and used the loan proceeds for his
 own purposes. Harriman dominated the bank’s other officers and employees, including the loan committee that
approved the loan.
o Holding: Harriman’s knowledge of the fraud was imputed to the bank, allowing Munroe to rescind the transaction
and obtain the securities from the bank.
o Reasoning: Harriman’s knowledge was imputed even though he obviously was an adverse party borrowing money
for his own benefit and even though the bank gave value for the securities and thus was not unjustly enriched. Also,
estoppel did not play any role in these facts. The bank was held to Harriman’s knowledge b/c he dominated the loan
committee.
o ”Harriman’s domination was exerted to affect the action of the bank with respect to the particular transaction. His
will alone caused the making of the loan and the acceptance of the collateral. Therefore he should be treated as the
sole actor on behalf of the bank as fully as though he had physically placed the note and securities in the bank’s
vault.

Chapter 11: The Creation of a Partnership

A. Introduction
 If two or more persons associate as co-owners of a business and take no steps to formalize their relationship, they have
created a partnership.
 Partnership = default way of doing business b/c of its lack of formality. If you don’t file any papers or formalize the
relationship it’s a partnership.
 UPA (1914) = at one time it was adopted in all states except LA. It is still governing law in about 1/3 of states. The other
states have adopted the RUPA.
o Defines partnership as “an association of two or more persons to carry on as co-owners a business for profit.”
o Mandatory rules = §§11-15
o Default rules = i.e. §18
 RUPA (1997)
o Has replaced UPA in 32 states.
o Defines partnership identically to UPA.
o All rules in RUPA are declared default in nature except for a list of ten set forth in §103(b).
 fiduciary duties are mandatory in §103(b)(3)-(5)
 Elements of a partnership relationship:
o 1) Association = organized body of persons who have some purpose in common. A partnership is created by
agreement, express or implied, including delectur personae (choice of the person).
o 2) Persons – includes not only individuals but also corporations and other partnerships. Capacity to contract is only
requirement b/c partnership agreement is a contract.
o 3) To carry on as co-owners a business
 UPA §6 & RUPA §202 = ownership includes “the power of ultimate control.”
 Refers to ownership of the business, not of the capital contributed to the partnership.
 UPA §2 & RUPA §202, cmt. 1 = business is defines as “every trade, occupation, or profession” and
consists of “a series of acts directed toward an end.”
o 4) For profit = self explanatory.

B. The Partnership Relationship Defined and Distinguished From Other Relationships

1. The Uniform Partnership Act (1914) and the Revised Uniform Partnership Act (1997)
 JOINT VENTURES
o Joint ventures – arrangements in which two or more parties combine forces to engage in a specific economic
activity.
o Court apply partnership law to joint venture situations.
 This minimizes the practical significance of distinguishing b/w joint ventures and partnerships, with the
exception that the contractual and tort liability of members of a joint venture may be more limited than that
of partners due to the narrower scope of activities of a joint venture.
 Martin v. Peyton, 246 N.Y. 213 (Court of Appeals of New York, 1927)
o An investment banking partnership had gotten itself into serious economic trouble through a series of bad
investments. Hall, one of the partners of the firm, had three wealthy friends who were persuaded to make
substantial sums of money available to the partnership but who wanted more than a mere loan with interest.
o An elaborate agreement was entered into b/w the partnership and the three individuals. The agreement provided that
the three individuals would make a substantial loan to the firm, receiving 40% of the profits of the firm as interest on
the loan, and that the management of the firm would be placed in Hall’s hands. Also, the three individuals were
entitled to inspect the firm books, to be kept advised on the conduct of the business, and consulted on important
 matters. They had veto power over any business they considered injurious or highly speculative. In addition, they
were given an option to join the firm as partners. Finally each partner of the firm placed his resignation in the hands
of Hall. If at any time Hall and the three agrees, the resignation would be accepted and the partner forced to retire.
o Creditors of the firm sued the three individuals, claiming that this combination of profits and extensive control
created a partnership, not a creditor relationshipo. A unanimous court decided tht there was not enough evidence to
support a fair inference that a partnership was created at the time the agreement was entered into and there was
nothing in the subsequent conduct of the parties that added to the agreement.
o The three were merely creditors with a very strong presence I nthe business. Although they had the right to veto
business, they did not have the right to “initiate transactions as a partner may do.” Their receipt of profits was as
interest on their loan and thus did not constitute presumptive evidence of partnership status under UPA §7(4).
o This case is significant b/c of its express distinction b/w affirmative and negatice control by creditors. It appears to
sanction creditor control by veto power and to characterize a right to initiate transactions as inherently inconsistent
with creditor status, at least in ordinary situations.

D. The Underlying Theory of Partnership – Aggregate of Entity?

 Aggregate (UPA) = a partnership is not a distinct entity; it is a collection of partners. Therefore, a partnership exists only so
long as the exact aggregate of partners remain the same. Admission of a new partner, retirement/death of old partner
dissolves partnership.
o UPA §15 = each partner immediately is suable for obligations of the partnership (adopts aggregate). So an
employee may not sue a partner if he has recovered under Workers Comp. – Mazzuchelli.
o When a partner assigns his entire undivided interest a new partnership is formed and the new partnership cannot sue
to enforce Ks enteres into by previous partnership – Fairway (title insurance – inequitable decision!)
 However creditors of first partnership are also creditors of the second if the business continued without
liquidation. – UPA §41(1)
o Mazzuchelli v. Silberberg, 29 N.J. 15 (Supreme Court of New Jersey, 1959)
 This case provides a practical example of the aggregate theory playing a determinative role in a lawsuit.
 Facts: An employee (Mazzuchelli) of a partnershio was injured by the negligent driving of a paetner iof the
firm while on firm business. Mazzuchelli reovered in workers compendation for his injuries, then sure the
negligent partner for personal tort liability. Mazz invpked the rule in workers compensation that allows an
injured employee to sue a third party tortfeasor for damages even though the employee has recovered
workers compensation from his employer.
 The partner invoked the aggregate theory, arguing that he was plaintiff’s employer and thus in effect had
already paid plaintiff for his injuries.
 Court upholds this defense, noting that §15 of UPA, which mandates personal liability of each partner for
the debts of the partnership, adopts the aggregate theory.
 Entity Theory (RUPA §201) – partnership is an entity distinct from the partners. Partnership can agree that change of
partners wil not cause dissolution and will continue to have standing to enforce Ks entered into by first partnership. But they
must agree that dissolution will not occur when a partner leaves. – RUPA §801
o Fairway Development Co. v. Title Insurance Co. of Minnesota, 62
 Title insurance company writes title insurance. The insured is a partnership. The personnel of the
partnership changes. Then partnership has a claim on the title insurance policy and the title insurance
company says, “Who are you? We don’t have a contract with you! We have a contract with these people
(partnership consisting of A,B, and C.) We have a contract with is A, B, and C. You are A, D, and E!”
 The court accepts the title insurance company’s argument.

E. Income Tax Considerations – A Brief Summary

 In this respect the Code adopts the aggregate theory:
o Partnerships do not pay federal income tax on the income generated by partnership business.
o Each individual partner is taxed directly on his share of the partnership’s taxable income.
o He also takes losses directly into his personal return. Internal Revenue Code (IRC) §701.
 In this respect the Code adopts the entity theory:
o Partnership is required to file tax return

F. Contributions of Property to the Partnership

1. Ambiguities Concerning Ownership of Particular Property
 Under UPA §8(1) & (2) there is a presumption that property purchased with partnership funds is partnership
property.
o This is confusing because it’s impossible to
o “When the intention of the partners to convert individually owned property into firm property is inferred
from circumstances, the circumstances must be such as do not admit of any other equally reasonable and
satisfactory explanation.” Robinson Bank v. Miller, 153 Ill. 244 (1894)
  Under RUPA §§203 and 204 = more detail is provided but same approach as UPA. Two presumptions:
o 1) property purchased with partnership funds is partnership property
o 2) Property acquired in the name of one or more of the partners without an indication of their status as
partners and without use of partnership funds is presumed to be the partners’ separate property, even if used
for partnership purposes.

2. The Special Matter of Title to Real Property

 Doctrine of equitable conversion = realty will be deemed in equity converted into personalty to facilitate satisfaction of
legitimate claims.

3. The Property Rights of a Partner

 Groff v. Citizens Bank of Clovis, 898 F.2d 1475 (United States Court of Appeals Tenth Circuit, 1990)
o Defendant borrows money from bakn and secures with cattle including all after acquired and he goes into joint
venture.
o Issue: Can partnership assets also apply to joint ventures?
o Defendants say that the property is partnership property, and not individual property. “It’s not my cattle.”
o Bank is trying to make an argument that a joint venture ought not to be treated as a partnership. They obviously
think that this would only increase their chances of reaching the cattle. So this case is fundamentally important
to reaching the conclusion of whether or not a joint venture will be treated different from a partnership. They
are arguing that in a joint venture, each joint venturer continues to own all the property they brought into a
partnership. The joint ventures co-opperate but their cooperation is in the context of them owning their own
property. This argument only succeeds if a creditor can convince a fact finder that this is not a partnership (two
or more persons associating together to co-own a business for a profit.
o The court concludes that this is partnership.
o Just be cause there are only two and they are cooperating for a single purpose DOES NOT mean that they are
not a partnership. It can be extremely limited in goals and purposes and still be a partnership.
 Putnam v. Shoaf, 620 S.W.2d 510 (Court of Appeals of Tennessee, 1981)
o A lady wants to get out of partnership. She makes a deal with someone who wants to buy her interest in
partnership. Subsequent to deal they find out that bookkeeper has been stealing from company. They ake a
claim against bank and recover. The plaintiff (the lady who sold her partnership interest) says “I should get part
of that.”
o P’s argument = the money I didn’t know was there is actually my personal asset and so I didn’t sell it. She says
“I made a list and told you what I sold you. This was not on the list so it is mine.”
o Issue: What does a partner in a UPA partnership really own? What is owned by the partnership? Holding:
Ms. Putnam has no interest in the money b/c she conveyed her interest in the partnership and had no specific
interest in the admittedly unknown choses in action to separately convey or retain.
o Rule: §24 – the property rights of a partner are:
 1) rights in sspecific property
 2) right to participate in management
o §8 UPA
o §§203 and 204 RUPA

CHAPTER 12: The Operation of a Partnership.

A. Contractual Powers of Partners

 Rule: Partners are regarded as agents of their partnership when dealing on behalf of the firm; unless otherwise agreed all
partners have an equal right to participate in the management of the partnership.
 RUPA § 303: a partnership has the option of filing a statement of authority with the Secretary of State of the state where the
partnership is located.
o This statement can either grant, or limit the authority of a partner
o w/r/t notice: filing a limitation of authority does not operate as constructive notice to third persons, however, except
with regard to real property and then only if a certified copy of the filed statement is recorded in the office for
recording transfers of that property.
o Constructive notice also: 90 days after statement of disassociation or dissolution is filed.

1. Actual Authority
 Actual authority = a partner is actually authorized to act with express or implied consent of fellow partners.
o Implied authority = was the acting partner reasonable in assuming he was authorizd to act based on
manifestation of fellow partner?
  based on interpretation of partnership agreement; customary way business is run; prior authorizations
or ratification of similar condut; acquiescencein assumption of authority, etc. Babbitt (partners could
tacitly agree to partner assumption of power by not objecting).
 Elle v. Babbitt, 259 Or. 590 (Supreme Court of Oregon, 1971) – implied authority
o Facts: The partnership is leasing tooling to the corporation. The motivation is not tax driven but
economically driven – the corporation doesn’t have the funds to do it. In this particular controversy
the partnership agreed to lower its lease fee to allow the corporation to put in a competitive bid on a
job. One of the partners complained that he has a larger stake in the partnership than he has in the
corporation so he got screwed. He complains about Mr. Beale himself b/c he was on both sides of the
transaction.
o Rule: UPA §22 provides “any partner shall have the right to a formal account as to partnership affairs
(a) if he is wrongfully excluded from the partnership business or possession of its property by his
copartners, (b) if the right exists under the terms of any agreement . . . (d) whenever other
circumstances render it just and reasonable. “
o Issue: Did Beale act without authority?
 the source of Beale’s authority would be either the partnership agreement or statute.
 did Beale exclude them from the management of the partnership? Their basis for this claim is
§18 which says that each partner has the equal right in the management and conduct of the
management of the business.
o Holding: the court holds that Beale had this authority by implication. Partners can agree otherwise
(forfeit, agree not to have management rights, etc.) and this can come about by implication.
o This is a powerful holding b/c the statute does not say that. But the court says that there was an
implied agreement among the parties that Beale would have full management authority and
therefore was not acting in contravention of the agreement and the partners have no claim because they
at least implicitly agreed to it.
o Rule: No act in contravention of any agreement b/w the partners may be done rightfully w/out the
consent of all the partners. UPA §18(h)
o Rule: The members of a partnership may if they wish agree to leave the management of the business
in the hands of a single managing partner. Such an agreement may be implied from the parties’ course
of conduct.
o Class Notes: This is a common fact pattern. Corporation engaged in some ongoing business activity
and it has some connection to partnership with common principles to both common partnership and
corporation. i.e. often partnership will buy real estate and lease it to the corporation the shareholders of
which are also partners in the partnership. There used to be tax advantages to this.
 Summers v. Dooley, 94 Idaho 87 (Supreme Court of Idaho, 1971)
o Facts: Two trash partners. One of them wants to hire someone else. The other partner refuses. He
does it anyway.
o Rule: Any difference arising as to ordinary matters connected with the partnership business may be
decided by a majority of the partners. UPA §18(h)
o Rule: UPA §18(e) bestows equal rights in the management and conduct of the partnership business
upon all the partners.
o Rule: Thus the only reasonable interpretation of UPA §18(h) is that business differences must be
decided by a majority of the partners provided no other agreement between the partners speaks to the
issues.
o Rule: If the partners are equally divided, those who forbid a change must have their way.
o Holding: The guy who hired despite objection from his partner screwed up.
o Reasoning: The partner who dissented did not sit idly by and acquiesce in the actions of his partner.
He was vocal about his opposition.
o Class Notes: Explores the idea of forfeiture of management duties through implication principle even
further. Court says the co-partner could not recover what he shelled out personally to pay the new
employee. The court said that partnerships have to have majority consent, which he did not have.
What should he have done? Dissolved the partnership was basically his only option. The threat of
dissolution may encourage the parties to work it out.
 National Biscuit Co. v. Stroud, 106 S.E.2d 692 (Supreme Court of North Carolina, 1959)
o One partner notifies a vendor “we don’t want anymore of your bread. My partner has no authority to
order it.”
o The partner orders anyway.
o National biscuit ignored the instructions of the partner told them that the other partner had no authority
to order. They delivered it anyway and seek to recover the costs. He says “I told you I was not going
to pay because he didn’t have authority to order it.”
 o Court says, “sorry, you can’t limit the authority of your partner.”

2. Apparent Authority
 Act of any partner for “apparently carrying on the business in the usual way” binds partnership. But, if (1) T knows that
partner lacks authority or (2) not act carrying on in usual way (unless authorized) doesn’t bind.
o Power of position = two factors determine whether in ordinary course: (1) usual in the course of the
particular business; (2) usual for similar businesses in same locale (Burns), RUPA §301 explicitly endorses
(2).
o Statement of Authority (RUPA §303): = filed with Secretary of state. Grant = conclusive in favor of BFP;
Limitation = only notive to T with real property, and then only if recorded in property transfer office.
o Other Constructive Notice to T under RUPA: 90 days after statement of dissocation or dissolution filed; cuts
off lingering apparent authority.
o An act that makes it impossible to carry on business of partnership cannot bind without consent – UPA §9(3)
 Burns v. Gonzalez, 439 S.W.2d 128 (Court of Civil Appeals of Texas, 1969)
o Rule: Every partner is an agent of the partnership for the purpose of its business, and the act of every partner,
including the execution in the partnership name of any instrument, for apparently carrying on in the usual way
the business of the partnership of which he is a member binds the partnership, unless the partner so acting has
in fact no authority to act for the partnership in the particular matter, and the person with whom he is dealing
has knowledge of the fact that he has no such authority. UPA §9(1)
o Rule: The act of a partner binds the firm if such act is for the purpose of “apparently carrying on” the business
of t he partnership in the way in which other firms engaged in the same business in the locality usually transact
business, or in the way in which the particular partnership usually transacts its business.
o Rule: Under a reasonable interpretation of the language of §9(1), the burden of proving the “usual way” in
which advertising agencies transact business is on the third party. One who asserts that the particular act of an
agent is within the scopr of the agent’s authority has the burden of proving the extent of such authority.
o This case is a narrowing of authority. Third party acting in good faith with an agent of the partnership
(partners) and settles a dispute with the partnership (promissory note).
o This is a very close case. It illustrates the problem of “what is in the ordinary course of business”?
 RNR Investments Limited Partnership v. Peoples First Community Bank, 812 So.2d 561 (Court of Appeals of Florida
2002)
o Partnership agreement required the general partner to prepare a budget covering the cost of acquisition of
property in Destin and construction of the project and further provided that in no event w/out limited partner
consent shall the approved budget exceet more than 5%, not shall any lime item thereof be exceeded by more
than 10%. Also restricted the general partner’s ability to borrow, spend partnership funds and encumber
partnership asets. Finally it also said that the general partner shall not incur debts, liabilityes, or obligations of
the Partnership which will cause any line item to be exceeded by 10%.
o General partner exceeded his budget. The partnership eventually defaulted. Bank sought to foreclose.
Partnership answered with defense of “you failed to look at the general partner’s limited authority before giving
him the money.” Negligently failed to investigate.
o Rule: even if the partnership agreement denies the partner authority, if the third party doesn’t know that, the
third party can hold the partnership liable.
o Rule: Knowledge and notice under RUPA §102 = a person knows a fact if the person has actual knowledge of
the fact. Further, a third party has notice of a fact if that party knows of the fact, has received notification of the
fact, or has reason to know the fact exists from all other facts known to the person at the time in question.
o Rule: Under RUPA §303 a partnership may file a statement or partnership authority setting forth any
restrictions in a general partner’s authority.
o Rule: Third parties have no duty to inspect the partnership agreement or inquire otherwise to ascertain the
extent of a partner’s actual authority in the ordinary course of business . . . even if they have some reason to
question it.”
o Class Notes: The drafters of RUPA were cognizant of the fact that it was very difficult to limit the authority of
a partner AND treat third parties fairly. No one wanted a situation in which a third party had to inspect a
partnership agreement before dealing with a partnership. This would be inefficient and add transaction costs.
Can we give third parties the assurance that the partner does have the authority w/out making the third party go
back and inspect the partnership agreement? Should there be some inexpensive way to put the third party on
notice? None of this was addressed in UPA.
o RUPA said = if you file a limitation or grant of authority w/r/t real estate transactions, this is binding on third
parties. Important innovation.

B. Tort Liability for the Wrongs of Partners

 1. In General
 UPA §13 = partnership bound by “any wrongful act of omission of any partner acting in the ordinary course of business
of the partnership”
 UPA §14 = partnership bound by partner’s breach of trust
 UPA §15 = partners are jointly and severally liable for everything charged to the partnership under §13 and 14.
 These three sections of UPA make it clear that the partnership and individual partners are vicariously liable for the
wrongs committed by partners acting within the scope of business.
 RUPA §305 and 306 = same as UPA sections above.
 “The ordinary course of business” = similar to “scope of employment.”
2. Tort Liability of Partnership to an Injured Partner: The Co-Principal Doctrine
 UPA §13 = a partnership is liable for the wrongful acts of partners to any person “not being a partner in the partnership.”
 Co-principal doctrine = no vicarious liability under UPA when the injured party is a partner.
 RUPA §305 = deletes the language in UPA §13 b/c entity theory – under RUPA there can be liability.
 Injured partner’s remedies under UPA:
o (1) = could dissolve partnership and sue other partners for tortious conduct;
o (2) = Separate Transaction = if partner was harmed while acting in the capacity of a customer of the
partnership (Farney) or an Independent Contractor hired by partnership (Hensley) the partner can recover
damages minus his share of the liability.
 Smith v. Hensley, 354 S.W.2d 744 (Supreme Court of Kentucky, 1962)
o Rule: The law is well settled that a partner who has paid an obligation of the firm out of his own funds may
obtain contribution from his copartners. Also, a partner is entitled to reimbursement from the firm for losses
suffered by him in the ordinary and proper course of the firm affairs.
o This case involves an interpretation of UPA §13.
o The court here resists this underlying notion and treats the partnership as an ENTITY (embracing the RUPA
approach BEFORE RUPA is even drafted.) The court can’t find reason for disputed clause in §13.

3. The Fraudulent Partner

 §14 UPA = a partnership is bound to make good the loss where “one partner acting w/in the scope of his apparent
authority receives money or property of a third person and misapplies it.”
 RUPA §305(a) = says same thing though less clearly. A partnership is liable for a partner’s wrongful act done “with
authority of the partnership.” Comment states that this “is intended to include a partner’s apparent, as well as actual,
authority.”
a. The Traditional View = partnership will not be liable for a partner’s fraudlent misappropriation of another’s property
where his acts are unrelated to his partnership duties, unless they authorize, participate, ratify.
 Rouse v. Pollard, 21 A.2d 801 (Court of Errors & Appeals of New Jersey, 1941)
o Facts: Client deals with a lawyer. The lawyer says “I can help you out in some investments.” The client
agrees and gives the lawyer money. The money disappears, the lawyer disappears and the client sues. The
client says to the law firm “He was your lawyer. You should make good on this loss.” The law firm’s
response is “He wasn’t authorized to take your money.”
o Issue: Since he had no actual authority, was there apparent authority? Hold: No.
o Reasoning: The law firm/principal/partner never did anything to purport that the defrauding lawyer had
actual authority.
b. A Conflicting View = minority view. Law partnership may still be liable for fraudlent acts of partners that are unrelated
to legal duties if (1) occurred during attorney/client relationship AND (2) within scopr of apparent authority.
 Cook v. Brundidge, Fountain, Elliott & Churchill, 533 S.W.2d 751 (Supreme Court of Texas, 1976)
o Facts: Lawyer sent money by a law firm in Champagne Illinois. With client’s consent invested money.
Money was lost. Client sues firm. Law firm prevails on Summery Judgment motion. Reversed at this
court.
o Rule: Good example of the principle that if a court is sympathetic to the plaintiff, it will deny summary
judgment.
o What justifies this more liberal view? Restatement 219(2)(d) = would fit nicely in the context of the law
partnership. Couldn’t have defrauded the client w/out this type of relationship.

C. The Nature of a Partner’s Liability – Joint As Opposed to Joint and Several Liability
 UPA §15 = Joint v. Joint and several. Partners are jointly and severally liable for torts; jointly liable for contracts. The
difference is that in joint liability partners have the right to have all partners over whom jurisdiction can be obtained
joined in the suit (if not joined can dismiss); in joint and several partners have no such right and can be indemnification
from other partners under §18(b).
o RUPA §306 = partners are jointly and severally liable for all firm obligations. Can seek indemnity from
partnership under §401(c).
  Liability does not extend to obligations incurred prior to jointing the firm, absent contrary agreement.

D. Suits Against the Partnership

 RUPA §307 = a partnership is an entity and can sue and be sued. Many states have adopted laws that allow a firm to sue
and be sued in its name (instead of having to name all partners in a contract action), even though they follow UPA. If no
leg. then have to name all partners in a K action or all partners you want to sue in tort action; where firm is suing, all
partners must be named as Ps.

E. Suit By the Partnership

 Same as suits against the partnership.
 Not allowed under UPA (aggregate theory). Fine under RUPA (entity theory).
 Adams v. Land Services, 194 P.3d 429 (2008)
o There was a cause of action available – accounting. Seek dissolution of partnership, and in connection of teht
dissolution a full accounting to the partnerships assets.
F. Notice and Notification to the Partnership
 FDIC v. Braemor Assocs., 686 F.2d 550 (United States Court of Appeals, Seventh Circuit, 1982)
o Notice case
o §12 of UPA = imputation of knowledge that tracks the imputation of knowledge in agency law.
o Facts: One partner was a bank officer who committed a breach of fiduciary duty regarding the bank by not
disclosing to the bank that the ultimate beneficiary of the loans that he was making was him and his partnership.
After the bank went bust, the FDIC brought a cause of action against the partnership (aiding and abetting a
breach of fiduciary duty) and the partner (breach of fiduciary duty).
o Aiding and abetting breach of fiduciary duty? How could they aid and abet the president of the bank’s breach
of fiduciary duty if they didn’t know about it? This is where UPA comes in and says “you did actually have
that knowledge because it was imputed to you.” Even though, as the trial court found, they did not know or
have reason to know this.
o The rule here sounds a lot like the adverse interest exception. You have to be acting completely adverse to your
principal and then knowledge is not imputed. §12 captures pretty well the adverse interest exception and the
imputation theory.

G. Keeping Track of Things – A Brief Look at Partnership Accounting

 Income statement = covers defined period of time. aka profit and loss statement.
o sets forth revenues and the expenses of a business during an accounting period.
 Balance sheet = shows financial condition of a partnership at one particular point in time.
o statement of assets, liabilities and the owners’ equities at a given point in time.
 Capital Account = shows the equity of each partner in the business.
o UPA says nothing about accounts of the partners.
o RUPA §401 (counterpart to UPA §18) = “each partner is deemed to have an account” that is credited with the
net amount of the contribution and share of profits of the partner and charged with distributions to and the share
of losses of the partner.

H. Rights and Duties Among Partners

 Partners are agents of the partnership and this imposes fiduciary duties UPA §9(1); RUPA 301(10). RUPA §404(e)
recognizes that partner does not breach fiduciary duties because his conduct furthers own interest.
 Duties under UPA §21 = does not include the duty of care and duty of loyalty. These come from common law.
o The drafters of UPA were drafting against a rich body of common law case law that reflected the fact that
partners are fiduciaries of one another.
o Courts have §21 paired with common law in recognizing broad fiduciary duties of partners.
 Duties under RUPA §103 = nonewaiveable provisions.
o (a) You can do whatever you want (b) but 10 things you can’t alter or contract around.
o Basically all fiduciary duties. Mostly deal with duty of loyalty.
o RUPA also specifies what the fiduciary duties consist of.
o Much more confining than UPA since UPA says nothing about contracting around and little about what the
fiduciary duties really are.
 Duties under RUPA §404 = This is the most controversial section of RUPA.
o (a) the only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and
the duty of care set forth in subsections (b) and (c).
o (b) the duty of loyalty is described:
 duty to account
 to refrain from competing
  (c) duty of care = refrain from engaging in grossly negligent or reckless conduct, intentional
misconduct, or a knowing violation of the law.
o (d) duty of good faith. protects parties reasonable expectation under the agreement and serves as a gap-filler.
Can’t expect parties to think of everything that could happen so we have this duty of good faith. This is a
contractual duty of good faith, not a fiduciary duty.
 Fiduciary duties in Colorado – CRS 7-64-404
o Uses the word “include” meaning there are additional fiduciary duties that may not be mentioned in the statute.
a. The Duty of Loyalty = Under UPA §21: largely governed by CLAW, mandatory accounting pfor profits; Under RUPA
§404(b): duty of loyalty limited to (1) duty to account for profits (generally self dealing); (2) duty not to deal on behalf
of adverse party; (3) duty to refrain from competing before leaving
(i) Duty during formation of partnership = RUPA specifically excludes during formation. UPA specifically
requires it for any transaction connected with formation (Corley). This is default. Partnership may exist by
implication, so even under RUPA liability is possible if partnership has already been formed, even if no agreement
has been signed.
 Corley v. Ott, 485 S.E.2d 97 (Supreme Court of South Carolina, 1997)
o Facts:

(ii) Pre-empting business opportunities = information that is useful to the firm for any purpose within the scope of
its business which is learned while a partner belongs to the partnership, using that infor for personal advantage is a
breach of loyalty, even if used to compete only when partnership expires. (Meinhard). Partner must also disclose
intention if useful and within scope.
 Meinhard v. Salmon, 249 N.Y. 458 (Court of Appeals of New York, 1928)
o Facts: 2 guys in a partnerhip/joint venture possess some real property under a lease. The lease comes
up for extension. The landlord asks Salmon, the managing partner, if he is interested in going in on a
re-development lease on his own. Salmon says okay. Meinhard finds out about it and goes nuts! Says,
“I thought we were partners.” He thinks he had a right to participate in the new lease/venture.
o Why does he think that he has this right? Where does this right come from?
o 1) good faith. The interpretation of the partnership agreement using the obligation of good faith in
order to fill in any gaps.
o 2) fiduciary duty. Salmon has an obligation to act in the best interest of Meinhard and the
partnership. He can’t hide anything from him and has to disclose to him everything that is going on.
o Cardozo’s language has been often quoted b/c it justifies every result you want if you want to impose a
duty on somebody. “not honesty alone but the punctilio of an honor most high, is the standard of
behavior”

(iii) Leaving the business = partners may plan to compete with the firm before leaving, but must not violate
fiduciary duties – Meehan. Remedy is disgorgement of ill-gotten profits, plus fees due for taking business as
provided by agreement.
 Before leaving: fiduciary duty applies. (1) cannot unfairly solicit clients (joint-letter); (2) cannot conspire with
other employees or partners to leave in a way that would materially damage partnership – but may invite
personnel to join after serving notive of intent to withdraw; (3) duty to disclose material info to partnership –
tell them you’re leaving.
 Meehan v. Shaughnessy, 535 N.E.2d 1255 (Supreme Judicial Court of Massachusetts, 1989)
o Holding: the way in which they soliciteated their former clients violated their fiduciary duties. When
co-partners asked if they were leaving they lied. When they were asked about former clients they
delayed. Court said this is just not right.

(iv) dealing with conflicts of interest

 RUPA §404(b) = a partner’s duty of loyalty is limited to three specified duties: duty to account for partnership
property, duty to refrain from self dealing, and duty to refrain from competing with partnership.
 Some states have altered §404 to provide that a partner’s duty of loyalty included these three duties, implying
that the duty of loyelay may include other duties.
J&J Celcom v. AT&T Wireless Services, Inc., 169 P.3d 823 (Supreme Court of Washington 2007)
Classic self dealing situation. ATT was on both buyer and seller side! The exact type RUPA prohibits.
So why was AT&T able to get away with this if RUPA explicitly forbids it? The judge in this case though cites a law review article
for the principle that “If there’s full disclosure, if partnership agrees with transaction, and if it is fair, then it should go forward.”
Loewenstein says that this is a decent rubric for dealing with this, the only problem though is THAT IS NOT WHAT THE LAW IS.

What is the reasonable expectation of the parties in these circumstances? This is the position that Andrews (dissenter) takes in
Meinhard v. Salmon.
w/r/t fiduciary duties RUPA is more contractual, UPA is more fiduciary.

(v) Fiduciary duties and freedom of contract.

 Singer v. Singer, 634 P.2d 766 (1981)
o Stands for the propositioan that partners can contract around the duty of loyalty under UPA (but not
RUPA).
o Partner bought land behind other partner’s backs. He allegedly breached his duty of loyalt in this case
by self-dealing. He took valuable information. And competing
o Partnership agreement here includes a pretty broad waiver of fiduciary duty.
o Paragraph 8 of the waiver promotes “spirited if not out and outright competition among the partners”
according to the court,
o What is the argument here that the court was wrong/that this was not covered by the waiver of
Paragraph 8? Why should they not have been able to get away with this?
 Because they were basically stealing partnership confidential information.
o This is more a lenient case than normal. Normally courts will NARROWLY construe waivers and if
there is an interpretation that will not cover the conduct in question then will normally use that
interpretation.
o This is a UPA case. Would this case come out differently under RUPA?
 Yes. It this waiver is EXPLICITLY prohibited by §404(b)(3).
 RUPA §103 says that you may not limit the duty of loyalty but a partnership may prescribe
the standards by which the performance of the obligation is to be measured, if the standards
are not manifestly unreasonable.” §103(5)
 If not manifestly unreasonable? This is the toughest part of §103. How do you determine
this?

b. The Duty of Care.

 Under UPA = partners not liable to partnership for mere negligence.
 RUPA §404(c) = same rule but explicitly makes partners liable to partnership for grodd negligence, intentional
misconduct or violation of law. (Jax)
o Business Judgment Rule = presumption of care; once gross negligence is shown though presumption
goes away; burden shifted back to D.
o Mismanagement = gross negligence in handling partnership business; unless involves self-dealing or
conflict of interest, then breach of loyalty.
 According to RUPA, the duty of care = “refraining from engaging in grossly negligent or reckless conduct,
intentional misconduct, or a knowing violation of law.”
 this means partners can be negligent
 Bane v. Ferguson, 890 F.2d 11 (United States Court of Appeals, Seventh Circuit, 1989)
o Posner says
o this is a statement of what the standard of care of a partner is vis-à-vis co-partners. Gross Negligence.
o In corporate world – what is the stndard of care that the directors of a corporation have?
o If you want to challenge a decision that the directors made, you have to demonstrate that they were
grossly negligent with the way they came to that decision. This is because we want directors to be
willing to take risks on behalf of the corporation.
 Moren v. Jax Restaurant, 679 N.W.2d 165 (2004)
o The court notes that the partnership has the obligation to indemnify a PARTNER who suffers a loss,
under thestatute. Loewenstein thinks that if they have the obligation to indemnify her, she couldn’t
possibly have an obligation to indemnify them.
 Walter v. Holiday Inns, Inc., 985 F.2d 1232 (United States Court of Appeals Third Circuit, 1993)
o When partners deal at arms length, does one partner owe to the other fiduciary duties? Do they have to
look out fir the best interests for the guy across the table, or, given that the parties are dealing at arms
length, do they look out for their own interest?
o There is a duty for partners to be somewhat paternalistic.
o The Court notes that there are some contrary authorities but is not ready to eliminate the duties owed
by partners when dealing at arms length.
o There is no duty to disclose material information. What is material? If it would affect the parties
judgment.
o RULE: The more adverst the parties are, the heavier burden it is on the complaining party to
demonstrate materiality. Because the information that they wanted were the internal projections that
the defendant (buyer/partner) had. Court sets the bar low w/r/t fiduciary duties.
c. The Duty of Good Faith and Fair Dealing
 UPA §31(1)(d) = only UPA section that mandates good faith. Deals with the expulsion of a partner pursuant to
a provision in the agreement.
 Rule: Generally courts will not look into the process of expulsion nor will they require reasons given so long as
the expelled partner’s interest was fairly evaluated and paid.
 RUPA §404(d) = increases the duty of good faith. RUPA also makes it a mandatory duty under §103.
 Good faithhinges on the reasonable expectations of the parties.
 Expulsion Power must be exercised in good faith. If agreement is silent on cause, good faith expulsion means
that interest was fairly evaluated and paid. (Holman)
 Also, if (1) expulsion is solely to deprive partner of profits (Holman) or prevent from asserting rights under
agreement (Nosal) OR (2) motivated by spite or malice, there is a breach of good faith.
o But as long as not either and interest is fairly evaluated and paid – no breach.
 Exception to spite or malice rule = where expulsion is to resolve a fundamental schism then no breach.
(Bohatch) Look for p’ner to do something uncool, like whistle-blowing.
 Holman v. Coie, 522 P.2d 515 (Wash. App. 1974)
o Rationale for above rule.
o Facts: Expelled partner says he should have been given a notice and opportunity. Court recognizes
that this is what the parties agreed to. Plaintiffs arguing that Ds have a duty of good faith and expelling
him violated that duty.
o Rule: Partner can in fact be expelled if the partnership agreement so provides.
o UPA §31 = if a partner ship agreement doesn’t provide for expulsion then under §24 the partners
cannot decide to expel a partner. Even though they wouldn’t be in violation of §31, they would violate
§24 b/c they would have deprived the expelled partner of his right to participate in the management of
the partnership.
o UPA §32 = grounds for judicial dissolution
o Holding: “We conclude that these parties contractually agreed to the very method of expulsion
exercised by the defendants, i.e. a clean, quick, and expeditious severance, with a clear method of
accounting.”
o Reasoning: “It is not difficult to understand why parties to such a professional relationship would find
this method desirable. The foundation of a professional relationship is personal confidence and trust.
Once a schism develops, its magnitude may be exaggerated rightfully or wrongfully to the point of
destroying a harmonious accord. When such occurs, an expeditious severance is desirable. To imply
terms of notice, hearing, and good cause, not expressed in this partnership agreement frustrates the
unambiguous language of the agreement and the result contemplated.”
 Winston & Strawn v. Nosal
o Limitation on the interpretation of the good faith principle = good faith requires only that the
expulsion not cause a wrongful withholding of money or property legally due the expelled partner at
the time he is expelled.
o Fact: partner in a large law firm was denied the right to inspect the firm’s books and records, which he
contended would have revealed self-dealing on the part of the executive committee of the partnership.
The executive committee determined the share of income for each partner. Nosal claimed that it gave
unjustified increases to its own members. He was expelled soon thereafter. He sued, claiming
expulsion was in bad faith.
o Holding: Nosal raised a triable issue of bad faith.
o Reasoning: Court relied heavily on the denial of the right to information Nosal was entitled to under
both UPA and the p’nship agreement, raising an inference that Nosal was expelled solely b/c he
persisted in invoking these rights.
d. Freedom to Contract around fiduciary duties
 Under UPA = absent fraud or illegality partners can contract away fiduciary duties (Singer – language disclaiming
fiduciary duties upheld – could preempt opportunities.)
o Some courts say basic fiduciary duties can’t be contracted around (Appletree)
 Under RUPA §103 = 10 things can’t be eliminated by agreement including fid dut and GF
 A partner owes no fiduciary duties to former partners – (Bane)


e. The Right to an Accounting

 Accounting = stands as an obstacle to bringing a lawsuit against your co-partners.
 UPA §22 RUPA §405(b) = entitled to accounting (1) on dissolution; (2) if wrongfully excluded; (3) appropriation
of business opportunity; (4) as provided by agreement; (5) when circumstances make it “just and reasonable”;
  Accounting required where partners sue each other over partnership business = usually strictly enforced
(Manchester Management)
o Two exceptions: (1) simple, isolated transaction (Schuler); (2) personal bligations between partners
(Manchester). Under UPA, should provide in agreement that suits for indemnification don’t require
accounting. Under RUPA accounting is not prerequisite for availability of suit; but certain claims may
require. i.e mismanagement.
f. Indemnity Rights
 UPA §18(b) = right to indemnity for payments or liabilities incurred in “ordinary and proper” course or to preserve
property of partnership. Partner can seek indemnification for his himple negligence, which is different than from
agency. RUPA §401(c).
 RUPA §401(c) = indemnity even where solely partner negligence. (ordinary and proper deleted). But it is not
explicitly clear under either whether a partner can seek indmenification for ordinary negligence.

I. Claims by Creditors of the Partnership

a. Rights Against Partnership Assets

 Under UPA = primary liability of partners. Could not sue partnership (agg. theory). However, many states statutes
have allowed partnerships to be named as defendants.
 RUPA converts partners from being primariliy liable to being secondarily liable (entity theory). Creditors can’t go
after partners personal asssets until the assets of the partnership are firs dissolved.
b. Rights Against the Personal Assets of Individual Partners
 UPA §15 = where obligation is joint and several, can hit any partner’s personal assets underl underlying claim is
satisfiet; partner will have indemnity. Where joing can sue all and hit personal assets. However, many states insist
that creditors first exhaust partnership assets, especially where joint liability.
 RUPA §307(d) = creditors may not hit personal assets until assets have been exhausted.


J. Claims by Personal Creditors of a Partner Against the Partnership Interest of the Partner = personal creditory may go after
the partnership interest, but not partnership property (UPA §25 – all partners must be joined in transfer of property rights). Apply for
charging order from court under UPA §28 – distributions (payments of profits and surplus) are made to creditor. Courts have broad
discretion to modify order to meet circumstances. i.e. appoint receiver, modify notce provision, etc. (Kroc)
 if a creditor will not satisfy debt w/in a reasonable amount of time through distribution, courts will allow foreclosure on and
sale of interest. UPA §28(2). Only the partner’s economic interest is lost, he still has managerial rights and is still a partner.
o the partner may redeem the interest before judicial sale and may use partnership property if they agree
 The purchaser is an assignee of the partner’s interest and has no management rights or right to inspect books – §27, but may
apply for judicial dissolution under 32(2) if term p’ship must wait until end of term, can apply at any time in at-will.
Assignee is not owed any fiduciary duties or other duties arising from p’ship agreement – Bauer. Under RUPA §601(4)(ii)
other p’ners may, by unanimous vote, expel a p’ner who has transferred substantially all of his interest.
 Tupper v. Kroc = charging orders
o Tupper, a general partner, and Kroc, a limited partner, each with fifty percent interest purchased land together.
Tupper had financial problems and asked Kroc for a loan. Kroc did loan him the money, but filed an action to
recover on the notes. He recovered $54,609. Then to collect, he forced the partnership into receivership, eventually
purchasing Tupper's share for $2500.
o Issue: Does the court have the power to charge one's partnership interest and have it sold to satisfy a money
judgment?
o Holding: Yes. No partnership agreement can divest the court of the power it has to charge and sell an interest of a
partner in a partnership agreement to satisfy a judgment against a partner. Failure to follow through with dissolution
caused the bankrupt partner to remain in control.
o Judgment: Affirm
o Analysis:
o This was pretty harsh, as it closed off the ability of Tupper to collect his surplus or his share of the profits.
o Because he did not dissolve, he lost the ability to terminate the partner. Kroc owned the entire corporation, yet had
to keep the partner.
o Take away:
 partnership is not dissolved upon retention of charging order.
 RUPA §504(e) = charging order and foreclosure this is the exclusive remedy. can’t ask the court to place
you in there as a partner (i.e. Blomfield).
o Bauer v. Blomfield Co./Holden Joint Venture
  Facts: creditor had a charging order. partners decided that they didn’t like the creditor. decide they’re
going to give him a hosing. partners give the creditor a hosing by distributing all the money among
themselves (through commissions or some other form). Creditor sues.
 What is creditor’s argument? The partners owe the creditor a duty of good faith. What are the sources of a
duty of good faith?
 1) Contract = if you have a right under the contract, you have to exercise it consistent with what the
partners expected.
 either default provision in UPA
 or agreement between parties
 Here, the creditor can’t find a contractual source for the duty of good faith because he wasn’t a
party to the agreement
 2) Fiduciary relationship = a fiduciary owes a duty of good faith to the beneficiary
 here, nobody owes the creditor a fiduciary duty.
 most courts find this as flowing from the contract, not a free flowing obligation.
 Bottom line:
 1) there’s still a judgment out there. the judgment debtor does have some incentives here to
protecte the interets of the creditor b/c if the debtor has any other property, the creditor may be
able to reach that too. so the creditor should still have an advocate in the partnership.
 2) He could threaten foreclosure preventing that partner from ever realizing anything from that
partnership.
 3) Coases theorom
 4) Parties can contract around this, this is just another default rule

K. The LLP Shield

 Ederer v. Gursky
o LLP deals with liability of partners to third parties, NOT liability of partners to other partners. Partners can still be
personally liablt to other co partners.
o partner withdrew and got a judgment against other partners. Partnership had no partnership agreement.
o As a result of this case, an LLP is not treated the same as other limited liability entities (i.e. corporations and LLCs).
o Lowenstein thinks the court is wrong. The court should have at least given policy reasons for it – should give
reasons why partners should remain personally liable for obligations to other partners.

Chapter 13: Dissociation of a Partner and Dissolution of a Partnership

Under UPA
 Dissolution is the change in relation between p’ners by any p’ner ceasing to be associated – UPA §29; Liquidation rights –
allows a p’ner to have p’ship property applied to discharge liabilities; surplus reduced to cash and paid out to p’ners. The
reduction to cash is effected though sale of the p’ship and its assets.
o Unless otherwise agreed, dissolution automatically triggers liquidation rights in each p’ner - §38(1): (1) P’ship
agreement may provide for continuation of business and buyout of departing p’ner’s interest, (2) if all p’ners,
including departing p’ner, agree to continue business after dissolution.
o Dissolution does not trigger liquidation for (1) a p’ner expelled in good faith; (2) where a p’ner wrongfully
dissolves, remaining p’ners may unanimously elect to continue the business under §38(2)
 Some courts allow a p’ner that wants to continue business to buy out other p’ner, even though agreement is
silent, if it is possible to establish value of interest by determining how much would be generated in a sale
o Estate of deceased p’ner possesses liquidation rights, but many courts say no rights if hardship to p’ship. Under
RUPA, doesn’t come up often bec. default rule is that death doesn’t trigger dissolution.
o The default rule is that cash must be paid outside extraordinary circumstances – Dreifurst: only where (1) no
creditors to be paid from proceeds; (2) no market for assets; (3) fair to all p’ners may distribution in kind be ordered.
 RUPA §402 provides that no p’ner has a right to receive nor can be forced to accept distribution in kind.
Surplus after payment of obligations must be paid in cash to p’ners §605.
 Causes of Dissolution: UPA §31: A p’ner always has the power to dissolve, even if no right.
o Dissolution w/o violating agreement – (1) at the end of the term (date or undertaking); (2) by express will of any
p’ner if no term specified (giving notice – Haley); (3) expulsion of any p’ner under terms of agreement; (4) if all
p’ners in a term p’ship elect to dissolve
 An at-will p’ship may be dissolved by express notice to any p’ner but must be exercised in good faith –
good faith is satisfied when adequate compensation is paid to fellow p’ner when purchasing interest; in
evaluating interest the p’ner must pay for newfound prosperity of p’ship; if he attempts to appropriate the
newly successful p’ship to himself without adequate compensation to p’ner then breach of good faith (and
 loyalty) – Page. Just because dissolution causes harm to other p’ners however (e.g., bec. under
disadvantageous circumstances) is not breach of GF.
 P’ship Term may be express or implied – but will be implied only where there is clear evidence. Where a
p’ner loans substantial sums to p’ship with the understanding that loan is to be repaid from profits, then
p’ship is for term necessary to recoup loan – Owen. Also where there is a discrete and terminable objective
(build and operate until can be sold).
 While there may have been an understanding in former p’ships that profits would pay obligations,
if there is no understanding as to present p’ship then no term – Page.
o Dissolution in contravention of agreement – express will of any p’ner; often applies in a term p’ship, but will also
apply when breach of good faith involved, or other breach of agreement.
 Wrongful dissolution – 38(2): remaining p’ners may continue business by unanimous agreement. No
liquidation: buyout rights = value of interest minus damages for breach of K; no goodwill in valuation. In a
term p’ship damages include profits that would have been received by non-breaching party if term would
have continued – Southern Oaks. Must indemnify p’ner against present and future p’ship liability.
o Provisions of agreement irrelevant, these situations cause dissolution – (1) death; (2) bankruptcy of p’ner; (3)
dissolution by decree of court under §32; (4) becomes unlawful to carry on p’ship business
 Dissolution by Decree of Court - §32: a p’ner should apply for dissolution IF (1) it’s a term p’ship and
wants to preserve liquidation rights; (2) want to expel a p’ner, but have not provided for it in p’ship
agreement. Court will dissolve if (1) incapacity; (2) misconduct; (3) not reasonably practicable to carry on
business w/p’ner; (4) on application of assignee.
 Dissolution for misconduct results in wrongful dissolution for guilty p’ner – but courts generally
require serious misconduct; this means that misconduct has affected the p’ship business – Potter. Many
trifling interferences may be sufficient if they destroy cooperation and affect business.
Under RUPA: Dissociation (Art 6) and buyout (Art 7); Dissolution (Art 8)
 Under RUPA dissolution DOES = termination of business; happens under §801 when: Not waivable: (1) upon judicial
decree under 801(5); (2) application by assignee; (3) unlawful to continue business. Waivable: (1) p’ner gives notice to
withdraw in a p’ship at will; (2) term expires; (3) in term, if at least ½ p’ners agree to wind up w/in 90 days of a p’ner’s
dissociation by death/bankruptcy/wrongful dissociation (under UPA all p’ners must agree)
o In all other situations, and in waivable situations if waived by agreement, there is a buyout of p’ners interest
under §701 (they are deemed to be dissociating), and the business continues unaffected. Death or bankruptcy,
p’ship continues automatically.
 A p’ner does not have the power to dissolve a term p’ship during term – p’ner dissociates wrongfully and gets buyout under
§602. Wrongfully dissociating p’ners do not forfeit goodwill under RUPA. Not entitled to payment until end of term –
unless court finds it will not harm p’ship. Is not wrongful if withdrawal from term is w/in 90 days of another’s dissociation
by death/bankruptcy/wrongful dissociation.
 Wrongful Dissociation: §602 - only if: (1) breach of express provision of agreement; (2) for term: (a) left before term, (b)
expelled under §601(5), (c) dissociated by becoming a debtor in bankruptcy. Liable for damages to p’ship.
o Expulsion under §601(5): expulsion by judicial determination, including willful breach of p’ship agreement, or other
conduct that adversely and materially affects p’ship business. Cannot be waived
o RUPA does not refer to dissolutions as rightful or wrongful – there is no wrongful dissolution under RUPA, and
a judicial decree of dissolution does not entitle other p’ners to damages. Either the dissolution was provided for by
agreement or by §801(5) – which cannot be altered by agreement – or the decree was wrongful and should be
reversed – Southern Oaks.

NOTICE OF DISSOLUTION AND TERMINATION OF AUTHORITY

Termination of Actual Authority
 Effect of Dissolution on P’ners Authority – UPA §§33, 34: terminates all authority, except for wind-up and complete
ongoing transactions. But, if you give impression of on-going entity – estoppel – Royal Bank.
o Right to contribution from p’ners for liabilities incurred on behalf of p’ship outside wind-up: If dissolution by
act: right exists unless p’ner had actual knowledge of dissolution; If by death or bankruptcy: if any p’ner had notice.
o Under RUPA §806 – a p’ner is entitled to contributions for any liabilities incurred after dissolution, unless she had
actual knowledge, in which case p’ship is bound, but she pays damages to p’ship.

Ability to bind P’ship to Ts: effective when no notice of dissolution (Apparent Authority)
 Under UPA §35 – Ts who extended credit to p’ship prior to dissolution require individualized notice to cut off lingering
apparent authority; Ts who merely knew of firm get constructive notice through publication.
 Under RUPA Dissociated P’ner binds P’ship to Ts with no notice of dissociation - §§702, 703. Under §704, p’ship may
file a statement of dissociation, which operates as constructive notice 90 days after filing. Lingering authority terminates
after 2 years w/o filing. Similar provisions for dissolution under RUPA §804-5
 Look for problems when p’ship incorporates or otherwise becomes a limited liability entity – is there sufficient notice? Some
say continuous use of corporate checks is good, but cf. Jensen.
CONTINUING THE BUSINESS
All P’ners Can Agree to Continue Business and waive Liquidation Rights – except wrongfully dissociating p’ner, even if there is no
prior agreement to do so. Business continues as if dissolution had never occurred.
 Buy-Sell Agreement – calls for remaining p’ner to purchase withdrawing or deceased p’ner’s interest and avoid liquidation.
This is the most common way for liquidation to be avoided under both UPA and RUPA.
o Two standards for evaluating interest: (1) fair value – total value of p’ship as going concern X % interest; (2) fair
market value – includes discounts like minority interest and market demand. Unless p’ship agreement specifically
includes costs incurred on purchase in evaluation of buyout then FV – Seattle First.
o P’ners may also agree to set buyout price every year, but court will fashion new price if unfair
 Continuation Clause – this prevents not only liquidation, but also dissolution; still must include buyout terms for
withdrawing p’ner. There is no question as to the validity of this type of provision under RUPA §801 (except with
nonwaivable causes).
o Under UPA this is not permitted under §§29, 31, 32. The departing p’ner argues that UPA controls and not
agreement to avoid unfavorable buyout terms – Straube. But, this argument would fail because regardless of
whether continuation clause succeeds, there is no doubt that buy-sell provision succeeds under UPA, so liquidation
rights are waived by that provision. This is why it best under UPA to draft these provisions in the alternative.
o When all p’ners agree to continue under UPA – (1) creditors of first p’ship are creditors of second; (2) liability of
new p’ner for debts of old p’ship is satisfied out of p’ship assets only; (3) withdrawing p’ner is still liable to
creditors but is entitled to indemnity from p’ship, unless creditors agree to change.

Winding Up – the process of settling p’ship affairs after dissolution. Dissolution – point in time when p’ners cease to carry on
business together. Termination – when all p’ship affairs are wound-up.
 Under UPA §37: subject to agreement, any p’ner has the right to wind-up so long as he is not wrongfully dissolving, and
would otherwise be able to obtain winding up by the court. RUPA §803 same.
 No Compensation Rule – a p’ner owes a duty to wind-up old business and is not entitled to extra compensation for doing so.
Income collected by p’ner for winding up affairs is distributed by % interest. – Resnick. However, under 18(f) if dissolution
is caused by death, then surviving p’ners entitled to compensation. Under RUPA §401(h) – a p’ner is entitled to
compensation for winding up.
 P’ners owe each other fiduciary duties in the course of winding up. However, p’ners may eliminate winding up and
proceed directly to termination; there are no fiduciary duties owed after termination. Langhoff – p’ners accomplish this by,
e.g., agreeing that departing p’ner will take certain business upon payment of a fee and that surviving firm gets the rest
(Meehan). No fiduciary exist with respect to the “new business” – Langhoff

Termination – Order of Distribution of Assets upon Liquidation – UPA 40(b): (1) creditors outside p’ship; (2) claims of p’ners
other than capital distribution (e.g., indemnity); (3) capital contributions returned; (4) balance distributed equally as profit, subject to
contrary agreement (default rule is that profits are shared equally in Gen p’ship).
 If assets are insufficient to discharge obligations to creditors: losses are shared by solvent p’ner equally or in the proportion
that they share profits if they agree to share profits differently; If insufficient to return capital, again losses share shared as
they have agreed to share profits, if no agreement then equally. – 18(a); 40(d)
 Distribution order may be varied, except that outside creditors may not be prejudiced w/o agreement.
 Under RUPA §807 – abolishes priority of outside debt over inside debt (p’ners as creditors), but this doesn’t really make a
difference bec. p’ners still liable for unsatisfied outside debt.
 Judicial Sale – when a sale is ordered, any p’ner may bid at that sale even when that p’ner wrongfully excluded another,
unless that p’ner acted in bad faith by attempting to avoid paying adequate compensation for the other p’ner’s interest or
otherwise acted fraudulently – Prentiss; wrongfully dissolving p’ner (breach of GF) is only entitled to buyout so could have
avoided sale to begin with.

CHAPTER 14: THE LIMITED PARTNERSHIP

Definition – form of doing business made available by statute and created by filing a certificate for a p’ship consisting of at least one
general and one limited p’ner. Has tax advantages of p’ship form and shields L p’ners from personal liability so long as (1) it is
properly formed and (2) the L p’ners are careful not to exercise control over the business.
 Differences from Gen P’ship – (1) filing required to create; (2) liability protection for LPs; (3) LPs do not have an equal
right to management under default rule; (4) profits are shared according to capital contributions, rather than equally in Gen,
under default rules; (5) LPs do not have agency power; (6) Limited P’ships are harder to dissolve.

The Limited P’ner

The Control Question

  Generally – ULPA §7: a L P’ner shall not become liable as a G P’ner unless, in addition to exercising his rights and power
as a L P’ner, he take part in the control of the business.
o De Escamilla (two p’ners had power to withdraw p’ship funds from banks w/o knowledge or consent of GP, they
voted on which crops would planted and got their way sometimes against the wishes of the GP, the required GP to
resign and selected his successor)
o However in times of severe financial crisis LPs may take control w/o incurring liability under §7.
o Definition of control: ultimate decision making responsibility; but may otherwise be actively involved in day-to-
day affairs of p’ship. The question is whether LP has exercised at least an equal voice in making p’ship
decisions, not whether he provides advice and counsel.
o RULPA §303 is pretty much the same.
o If a LP’s control is not substantially the same as the exercise power of the GP, he is liable only to creditors with
actual knowledge of control. Actual knowledge need not come from direct contact with the LP  the
reasonableness of the creditor’s belief in control is not based on the LPs conduct it needs only to arise from some
actual knowledge. Therefore, an LP may be held liable to T if the GP revealed the control and the T never had any
contact with the LP. – Gateway Potato
 RULPA is reluctant to hold LP liable if he had no direct contact with the creditor.
o A LP who secures credit in the p’ship’s name exerts sufficient control to be held personally liable – Pitman (the
creditor is deemed to have reasonably relied on this participation)
o Outside of exercising substantially the same control as a GP, a LP is liable only to those who relied on the LP’s
control and thus regarded him as a GP
o Control of the Corporate General P’ner – a LP does not incur liability as a GP solely by serving as officer or
director of a corporate GP, so long as makes clear that he is acting in the capacity of director of the corporation,
thereby cutting off any reliance on his personal status as a GP in virtue of the control exercised - §303(b)(1) –
Safe Harbor provisions – Wilf.
o For reliance – look to the other party’s understanding – sophistication? Knowledge of the entities involved?
Personal guarantees by LP? Did LP make clear that he was not dealing on a personal basis or acting in his capacity
as a LP?
o Re-RULPA §303 – states that a LP will not incur personal liability, even if he participates in the management and
control of the p’ship

The General P’ner – has the rights and powers and is subject to the liabilities and restrictions of a p’ner in a Gen p’ship – RULPA
§403. Thus the provisions of UPA and RUPA apply to GPs, specifically with regard to fiduciary duties, personal liability (unless
LLLP), agency powers, and managerial rights
 Generally, GP has intensified fiduciary duties – but Courts are split on the extent to which a GP would be able to tailor
their duties to allow them to take personal benefits or otherwise breach default duties:
o Appletree – while p’ners are free to vary many aspects of their relationship, they are not free to destroy its fiduciary
character. Thus, agreement could not substitute narrow disclosure obligation (only upon demand) for broad CLAW
one (omission is fraudulent and breach if knew material to affairs of p’ship and should have known that p’ners did
not know) because it would encourage fraud.
o Gotham – the trend, especially in DE, is to increase flexibility to eliminate or reduce fiduciary duties (although
elimination is controversial with regards to LP, it has been recognized with GPs). DRULPA §1101(d) – allows for
expansion or restriction of duties and creates a Safe Harbor for a p’ner who relies in good faith on the provisions of
the agreement, where the terms of the agreement supplant CLAW duties  e.g., by providing that specific powers
may be exercised at the “sole discretion” of the GP, though they may have misinterpreted the agreement. Gotham
interpreted the provision to mean that such p’ner is not liable though they may have breached the agreement (and
breached CLAW fid duties) as a result of the misinterpretation, but only where the terms of the provision were
ambiguous. It also recognized another approach where the GP is not liable IFF it has accurately applied a provision
supplanting CLAW fid duty.
 Duty of Disclosure – RULPA §305 – LPs have a right upon reasonable demand to obtain info from GPs. This does not
supplant broad CLAW duty to disclose all material facts that GP should know LP does not know – Appletree
(sophistication of buyer revealed nothing because they still would not have known that building contained asbestos). Whether
this can be varied by agreement will depend on jurisdiction – above – Appletree said no.

CHAPTER 15: THE LIMITED LIABILITY COMPANY – LLC

Generally – (1) Have freedom from personal liability for business debts (K or tort), p’ship taxation, and option to manage the
business. Owners are liable for personal wrongdoing.
 Management: can be member managed (informal like a p’ship) or manager managed (like a LP – non-managers are
passive)
o This is relevant to the question of whether investment in an LLC is a “security” (something is a security when a
person invests his money in a common enterprise with the expectation of profits solely from the efforts of
 others) and thus whether registration and disclosure are required. Manager managed LLCs (like LPs which are
normally securities) may require compliance with securities law,
o Taxation – Check the Box Regulations allow LLCs to have corporate characteristics (continuity of life, free
transferability of interest, limited liability, centralized management) and be taxed as p’ship by default.

Creation of an LLC - Must file articles of organization, which contain, at a minimum: name, designation as LLC, address of
principal place of business, and name/address of agent for service. Must file annual reports with state, or else face administrative
dissolution.
 After AOO are filed, organizers enter into Operating Agreement, but lack of one is not fatal - ULLCA §103 (will be
governed by default provisions). LLC will be funded by contributions of property or Ks for services – ULLCA §401.
 Conversion into an LLC – an entity, whether Gen or Lim. P’ship or sole proprietorship, that converts to an LLC retains
by operation of law all of the rights and obligations of the previous entity. The LLC may sue on and enforce Ks to which
the previous entity was a party and is a successor in all other interests. A T maintains all suits against the p’ship or p’ners
of the p’ship in their individual capacities, or sole proprietor that it had before conversion - ULLCA §903 (as applied to
p’ships; C & J Builders as applied to sole proprietorships).

The Agreement – the policy of the ULLCA is to give maximum effect to freedom of K and enforce the agreements - Elf
 The LLC itself does not need to sign the agreement – requires signature of “member or members” – Elf
 An operating agreement can probably contract around derivative actions; essentially stripping the power of a claimant of
his power to enforce his rights. Elf
o In Delaware there are certain non-waivable provisions, but derivative actions are not non-waivable. This is
quite concerning.
 A forum selection clause is conclusive, even if it waives jurisdiction granted by statute and even if it classifies those
claims as derivative (individual suit by shareholder to enforce a corporate cause of action against directors, officers, or
Ts; these are allowed against management of LLC provided that managers will probably not bring it) or direct– Elf.

Creditors of Members – similar rights to creditors of LPs – ULLCA §504

Piercing the Veil – when a creditor asks the court to disregard the corporate or LLC entity so as to make the personal assets of its
owners available to satisfy the liabilities of the entity; Reverse piercing is when the creditor asks that the corporate assets be made
available to satisfy the personal debts of the owner (even though ownership of entity property is vested in the entity itself ).
 Will happen when a corporate entity has been so controlled and dominated that justice requires liability to be imposed:
two disjunctive test:
 The Instrumentality: 3 elements -
o (1) Control: complete domination of finances, and policy and practice such that with respect to the transaction
attacked, the corporate entity had no separate mind. Factors:
o Don’t Need to Know
 Absence of corporate formalities – regular distributions not made, no meetings held
 Inadequate capitalization
 Funds withdrawn for personal use/corp’s property used as if it were owned by user – in Howell:
funds used to pay personal expenses, purchase gifts and give interest free loans to family members
 Overlapping officers/personnel – in Howell Δ owned 97% and 100% of each LLC (the overlap was
between her personally and the entity). She was GM of both entities
 Common office space (address/phones) – both entities operated out of same space in Δ’s house
 The amount of business discretion by the allegedly dominated corp
 Whether corporations dealt with each other at arms length – retention of revenue generated by other
corp w/o reimbursement.
 Whether the corporations are treated as independent profit centers - ditto
 Payment or guarantee of dominated corp’s debt
 Majority or even complete stock ownership by itself is not enough
o (2) Such control was used to commit a wrong – fraud, violation of statutory duty, dishonest or unjust act.
 Howell – Δ started LLCs after Π had obtained DJ against her in a foreign jurisdiction, but before
enforcement in home jurisdiction. She used the LLCs to pay her expenses directly instead of getting
salary or distribution, thereby depriving Π of any means of collecting judgment against her (by
getting a charging order).
o (3) The aforesaid control and breach of duty was the proximate cause of injury – because she transferred her
personal assets (liquidated life insurance policy) to the LLC, Π was prevented from getting satisfaction of
judgment.
 Identity Rule –  must show that there was such a unity of ownership and interest that the independence of the corp
ceased or had never begun, and observance of fiction of separate existence would sanction a fraud or promote injustice.
Factors: stock or interest ownership, using control of company to manage assets as if it were the dominator’s own.
  Note that Instrumentality required a fraudulent conveyance, but Identity might not

Entity Theory and the LLC – an LLC is a “person” for purposes of sale, transfer, or assignment.
 Members of an LLC have no interest in specific LLC property; once members contribute assets to an LLC those
members lose any interest they had in the assets and therefore any individual control over them that they formerly had –
ULLCA §501(a); Equilon (holding that contribution of gas stations to LLC was a “transfer” bec. title, possession, and
control were relinquished)
o But if the owner of property transfers title and retains some ownership/risk characteristics, it is not a “sale”
under a brokerage agreement. Premier Van Schaack (Owner transferred property into development LLC and
retained some interest and remained liable on the debt. Court held that it was not a sale and the broker did not
receive a commission.)
o It is difficult to square Premier and Equilon.

Operation of an LLC
 Management – ULLCA §404: Unless otherwise provided, In a member managed LLC each member has equal rights in the
management of business and majority vote is required for any matter relating to business except some crucial matter in (c)
(admission of a new member, ratification of acts that would violate duty of loyalty, dissolution, etc.).
o In a manager managed LLC – each manager has an equal right to management, and all matters may be decided
exclusively by the manager, or by a majority of the managers if there is more than one.
o Members may base voting rights on capital contributions rather than the default per capita rule (e.g., 1 person with
60% outvotes 2 with 20% apiece)
 Authority and Apparent Authority of Members – depends on whether the LLC is member or manager managed –
ULLCA §301:
o Member Managed: (a) each member is an agent for the LLC and act of a member for apparently carrying on in the
ordinary course binds the company. Unless, had no authority and T knew it. IF not in the ordinary course of
particular company’s business or businesses of that kind, then binds only if authorized.
o Manager Managed – a member is NOT an agent in this case. A manger is an agent as above. If act was not in
ordinary course, it must be authorized under §404, which provides that manager has sole discretion, unless it would
violate fid duty and then ratification by all members required.
o Instrument Transferring or Affecting LLC’s Interest in RP: signed and delivered by any member of a member
managed LLC or any manager of a manager managed LLC is conclusive in favor of a BFP for value who gave w/o
knowledge of lack of authority.
 Raghipour – a manger has apparent authority to execute a mortgage on the property even though the OA
expressly forbids it.
o Restrictions on the authority in the OA do not affect apparent authority, but as in the other entities, the wrongful
member or manager will be liable for breach of K/duty to obey, and maybe loyalty or care.
o But, a limitation on authority of anyone to affect the LLC’s interest in RP is effective if reflected in the
Articles of Organization when filed. It is effective even against BFP’s giving value without knowledge of lack of
authority.
o Also, apparent authority terminates for a dissociated member 90 days after statement of dissociation is filed; or 2
years after dissociation if no filing  both are effective even against persons w/o knowledge of dissociation.
 Fiduciary Duties - §409 distinguishes between member and manager managed:
o Member Managed: The only fiduciary duties owed by members are (1) loyalty – limited to (a) account for benefit
received in the course of business, winding up, including appropriation of an opportunity; (b) acting as or on behalf
of a party having an adverse interest; (c) refrain from competition with business before dissolution AND (2) care –
gross negligence, intentional misconduct or violation of law
 Duty of good faith – duties under statute or agreement must be performed in good faith; not fiduciary duty.
 VGS – although technically members vote was proper, they knew that disclosure of plans to majority
manager would have foiled them, so they kept their plans from him, in contravention of maj’s right
to notice inferred from structure and purpose of agreement. In so doing they violated their duty of
loyalty to him and also failed to exercise their rights in good faith (equity looks to intent rather than
form)
 A member may lend money/transact business with LLC – is treated as nonmember for purposes of said
transaction.
o Manager Managed: NO duties owed by member to company or other members in this case. Manager has all duties.
 A member in a manager managed LLC may have duties imposed if he exercises some or all the rights of a
manager pursuant to the agreement; i.e., if agreement allows a member to exercise managerial powers, all
duties are imposed with respect to said exercise of authority.
o Terminates on Dissociation – but member may not use confidential info obtained adversely to LLC. Also must
exercise care in completing on going transaction and account for profits from old.
 o Agreement may not waive or eliminate any of the duties – but may identify activities and determine standards for
measuring performance of them if not manifestly unreasonable – ULLCA §103(b).
 An agreement that allows members to compete with the LLC will be upheld and a member will not be
liable if he competes, even in a member managed LLC because the duties imposed are those created by
agreement among members – McConnell (provision allowing competition applied to case where member
took advantage of opportunity declined by LLC, might be manifestly unreasonable if provision was
interpreted to allow direct/secret competition, as in Salmon)
Many agreements say that reliance on advice of counsel is conclusive evidence of good faith: this will save manager/member only if
advice was sought for purpose of benefiting LLC – Flippo