Business Law 5 parts

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Key Terms

Click on each key term to see the de�inition.

af�irmative defense (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A defense raised by the defendant that, if proven, will result in dismissal of the lawsuit.

hostile work environment (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A workplace that is discriminatory and laden with sexual intimidation, ridicule, and insult.

quid pro quo sexual harassment (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The exchange of sex for employment bene�its or advancement.

reasonable care (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The degree of caution that would be exercised by an ordinary, prudent person under the given circumstances. A question for a jury to decide in tort cases about the defendant’s actions.

reasonable efforts (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

In the context of workplace harassment, measures the employer can take to prevent such incidents, e.g., by formulating and distributing company policies that prohibit harassment and swiftly punishing those who violate the policies.

remand (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When an appeals court sends a case back to a lower court from which it was appealed so that the lower court can correct an error.

sexual harassment (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Unwelcome sexual advances, requests for sexual favors, and other verbal or physical conduct of a sexual nature by someone of the same or opposite sex that is tied to job status or that permeates the workplace environment with sexual innuendo.

tangible employment action (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

An of�icial act of an enterprise or company that causes a signi�icant change in employment status, e.g., hiring, �iring, failing to promote, reassigning with signi�icantly different responsibilities, or signi�icantly changing bene�its.

vicarious liability (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

In tort law, the placing of responsibility on one party (e.g., an employer) for the actions of another (e.g., an employee in the scope of employment).

Chapter 25 Flashcards

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Critical Thinking and Discussion Questions

1. When is an employer liable for harassment in the workplace?

2. How does the Equal Employment Opportunity Commission de�ine sexual harassment in its guidelines?

3. What is the difference between quid pro quo sexual harassment and harassment that stems from a hostile work environment?

4. Samantha, the general manager of ABC Corporation, asks Sam, her secretary, out for drinks after work. Sam believes this to be a sexual advance on Samantha’s part and is deeply offended by it. He immediately calls the EEOC to �ile a sexual harassment complaint. What do you think would result?

5. Read the article "Female kicker says she was raped at CU (http://usatoday30.usatoday.com/sports/college/football/big12/2004-02-17-colorado-rape- allegation_x.htm) ". Then outline what speci�ic steps you would take to investigate the claim discussed in the article.

6. Read Simpson v. University of Colorado (http://www.aclu.org/racial-justice-womens-rights/simpson-v-university-colorado) , and the amicus briefs (legal briefs �iled on behalf of a plaintiff to add favorable or expert evidence to their case) referred to at the end of the article. Then answer the questions below: a. Do you agree with the 10th Circuit’s decision that the football program was guilty of sexual harassment? Why or why not? b. What steps should the university have taken once it learned of the alleged harassment? c. What steps did the university actually take? d. How can an entity such as a university keep sexual harassment like this from taking place?

A defense raised by the defendant that, if proven, will result in dismissal of the lawsuit.

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Chapter 26

Other Types of Discrimination Chapters 22–25 in this unit have explored the application of Title VII of the 1964 Civil Rights Act to race, color, sex, and sexual harassment. However, federal protection under the act also extends to religion and national origin. This chapter begins with an examination of the protection of religious beliefs in the workplace and how employers can best comply with the law. It then explores discrimination based on national origin (under Title VII) and the numerous types of discrimination that are not covered by Title VII but instead mandated by federal statute, including the Age Discrimination in Employment Act (ADEA) of 1967, the Americans With Disabilities Act (ADA) of 1990, and the Americans With Disabilities Act Amendments Act (ADAAA) of 2008. Those who run businesses should be aware that disability discrimination lawsuits under Title VII are the fastest-growing segment of discrimination claims in the workplace. In addition, many types of discrimination are still legal, or at least legal in some states, for certain types of employees. We �inish our exploration of this topic with an investigation into classes of people who are not protected by antidiscrimination laws.

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26.1 Religious Discrimination Title VII protects employees in the workplace from being treated unfairly because of their religious beliefs and practices as follows:

It shall be an unlawful employment practice for an employer—(1) to fail or refuse to hire or to discharge any individual, or otherwise to discriminate against any individual with respect to his compensation, terms, conditions, or privileges of employment, because of such individual's race, color, religion, sex, or national origin. . . .

"Religion" is de�ined to include only those "aspects of religious observance and practice" that an employer is able to "reasonably accommodate . . . without undue hardship on the conduct of the employer's business" (42 U.S.C. §2000e(j)). Title VII imposes an obligation on the employer "to reasonably accommodate the religious practices of an employee or prospective employee, unless the employer demonstrates that accommodation would result in undue hardship on the conduct of its business" (29 C.F.R. § 1605.2(b)(1),(2)).

There are no absolutes with regard to the exact de�inition of a religion or what constitutes a religious practice. However, 43 U.S.C. § 2000 3(j) sheds some light on the subject, as described here in Fowler v. Rhode Island, 345 U.S. 67, 70, 73 S. Ct. 526, 97 L.Ed. 828 (1953):

The term "religion" includes all aspects of religious observance and practice, as well as beliefs. . . . Nevertheless, this does not help an employer who has an employee claiming his or her activities are "religions" and therefore protected. The Supreme Court did little to help when it stated, "[I]t is no business of courts to say . . . what is a religious practice or activity."

Various court decisions have determined that certain types of activities are neither religions nor religious activities. These have included a professor's beliefs in "scrupulous honesty in the pursuit of scienti�ic knowledge" (Seshadri v. Kasraian, 130 F.3d. 798), the racist views of the Ku Klux Klan (Bellany v. Mason Stores, Inc., 368 F. Supp. 1025), and a religion founded on the belief in the ritual eating of cat food (Brown v. Pena, 441 F. Supp. 1382 (S.D. Fla. 1977)).

One court (more helpfully) de�ined a bona �ide religious belief as follows, stating that a belief is religious if it

(1) is religious within the plaintiff 's own scheme of things, and (2) is sincerely held. As long as a party's beliefs are religiously based, it is not for the courts to inquire whether those beliefs "derived from revelation, study, upbringing, gradual evolution, or some source that appears entirely incomprehensible." Thus, the individual's assertion "that [his or her] belief is an essential part of a religious faith must be given great weight." Courts may not engage in an extensive inquiry into the religious beliefs of the plaintiff in order to determine whether religion mandates the employee's adherence. (EEOC v. Abercrombie & Fitch Stores, Inc., 798 F. Supp.2d 1272 N.D. Okla. (2011))

When Title VII was originally enacted, its language prohibited discrimination on the basis of religion, meaning religious beliefs, but did not address issues with regard to religious practices. To clarify the coverage of the legislation, in 2008, Congress amended the law to speci�ically include practices, as follows:

Section 703(a) of Title VII states in part that "[i]t shall be an unlawful employment practice for an employer . . . to discriminate against any individual with respect to his compensation, terms, conditions, or privileges of employment, because of such individual's . . . religion."

Reasonable Accommodation

The employer, apart from the motivation to do the right thing by its employees, may �ind it more cost effective to err on the side of caution by �inding that the employee's requested activity or practice has a religious basis and then to reasonably accommodate that activity. Often the accommodation costs much less than �ighting the request and can often be something as simple as a schedule change.

Employers who reasonably accommodate their employees' religious beliefs, or make good-faith attempts to do so, greatly decrease their liability. In Sánchez- Rodriguez v. AT&T Mobility Puerto Rico, Inc., a cellular phone sales clerk alleged religious discrimination on the basis that he was a Seventh Day Adventist and needed to take off Saturdays to attend religious services. His job involved retail sales, and the company needed him to work a shift that sometimes rotated onto Saturday. In court, AT&T introduced evidence that it had tried to accommodate the plaintiff by offering him another job in the organization; allowing him to change shifts; and refraining from disciplinary action for his absenteeism. Nonetheless, Sánchez sued AT&T for religious discrimination, and the court then had to consider whether or not he had been "reasonably accommodated at work." Excerpts from this case follow.

Cases to Consider: Sánchez-Rodriguez v. AT&T Mobility Puerto Rico, Inc.

Sánchez-Rodriguez v. AT&T Mobility Puerto Rico, Inc., 673 F.3d 1 (1st Cir. 2012)

. . . [W]e need not decide whether either of these accommodations was reasonable in isolation, because they were not offered in isolation— rather, they were offered as part of a series of attempts by AT&T to accommodate Sánchez. Many courts have found similar accommodations or combinations of accommodations to be reasonable under Title VII. See, e.g., Trans World Airlines, Inc. v. Hardison, 432 U.S. 63, 77–78, 97 S. Ct. 2264, 53 L.Ed.2d 113 (1977) (holding that employer reasonably accommodated Seventh Day Adventist employee by, inter alia, agreeing to permit any shift exchanges that employee could arrange on his own); Thomas v. Nat'l Ass'n of Letter Carriers, 225 F.3d 1149, 1156–57 (10th Cir. 2000) (�inding that where employer "remained sympathetic to [the plaintiff]'s religious requirements, approved all voluntary schedule swaps that [the plaintiff] was able to arrange, and imposed no restrictions or impediments on [the plaintiff]'s ability to attempt to arrange further voluntary schedule swaps with other employees," employer did "all that Title VII reasonably requires the [employer] to do") (citing

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29 C.F.R. § 1605.2(d)(1)(I)); Eversley v. MBank Dallas, 843 F.2d 172, 176 (5th Cir. 1988) (�inding reasonable accommodation where employer delayed planned schedule changes in order to accommodate employee and offered lower-paying position that did not con�lict with Sabbath); Hudson [v. Western Airlines, Inc.], 851 F.2d at 266 (provisions set forth in a collective bargaining agreement which "provided a means by which [an employee] could bid upon work schedules, work domiciles, vacation time, and personal leave . . . [and] allowed [an employee] to modify her schedule by trading her entire schedule or speci�ic days off with other employees," taken together, provided the employee with a reasonable accommodation); Smith v. Pyro Mining Co., 827 F.2d 1081, 1088 (6th Cir. 1987) (holding that as long as employee has no religious constraints against arranging his own schedule swap with other employees, employer reasonably accommodates employee by simply allowing swaps).

Taken together, we believe that the efforts made by AT&T constituted a reasonable accommodation of Sánchez's religious beliefs. Therefore, we af�irm the judgment of the district court on the discrimination claim. We need not reach the question of whether accommodating Sánchez would have been an undue hardship for AT&T.

Read the full text of the case here (http://law.justia.com/cases/federal/appellate-courts/ca1/10-2177/10-2177-2012-03-08.html) .

Questions to Consider

1. Do employers have to make any accommodation for an employee on the grounds of religious discrimination? Where do the courts draw the line in terms of what is required?

2. Often it is dif�icult to determine what a reasonable accommodation is. As a manager, what factors would you consider if an employee asked for a special dispensation?

In recent years, a number of interesting and provocative cases have come down in the area of religious accommodation. For example, a counselor at a hospital refused, on religious grounds, to counsel same-sex couples in the recent case of Walden v. Centers for Disease Control and Prevention, 669 F.3d 1277 (11th Cir. 2012). (The full opinion of the case can be found here (http://www.leagle.com/xmlResult.aspx? xmldoc=In%20FCO%2020120207083.xml&docbase=CSLWAR3-2007-CURR) .) However, the hospital was held to have made a reasonable accommodation because it gave the counselor 30 days to seek employment elsewhere and provided her with the use of its in-house placement (job) counselor.

In EEOC v. Abercrombie & Fitch Stores, Inc., 798 F. Supp.2d 1272 (N.D. Okla. 2011), mentioned above, the court considered the situation where a business had a certain "look" in mind for its employees but certain religious beliefs went against that look. The Equal Employment Opportunity Commission (EEOC) brought an action on behalf of Samantha Elauf, a Muslim teenager who applied for a job at an Abercrombie store and was not hired because, as a Muslim, she wore a head scarf. Can an employer mandate a certain look if that goes against religious beliefs? The court said no: This was in fact religious discrimination under Title VII.

In short, many litigated cases have indicated that as long as the employer makes a reasonable effort to accommodate the employee, the employer will not be found in violation of Title VII.

At the EEOC website, there are helpful lists of what employers can ask during the preemployment phase and how to best accommodate employees. See "Best Practices for Eradicating Religious Discrimination in the Workplace (http://www.eeoc.gov/policy/docs/best_practices_religion.html) ".

Burden Shifting

As with the other types of discrimination previously discussed, the same burden-shifting approach applies in these cases when they reach litigation. Speci�ically, the plaintiff must show that he or she:

1. Had a bona �ide religious belief that con�licts with an employment requirement;

2. Informed the employer of this belief; and

3. Was not hired (or was �ired) for failing to comply with the employment requirement.

The burden then shifts to the defendant, who must counter the claim in three ways:

1. Conclusively rebut one or more elements of the plaintiff 's prima facie case;

2. Show that it offered a reasonable accommodation; or

3. Show that it was unable to accommodate the employee's religious needs reasonably without undue hardship.

See Chapter 23 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec23.2#sec23.2) for more details on this three-phase process.

Exempt Organizations

Certain types of entities are exempt from Title VII religious coverage and may discriminate on the basis of religion without violating Title VII. These include religious institutions or organizations that are involved in religious activities. For example, a synagogue can advertise for a Jewish rabbi; likewise, Catholic schools can require that an employee be a practicing Catholic. These rules are applied as long as the organization is "a religious corporation, association, educational institution, or society with respect to the employment of individuals of a particular religion to perform work connected with the carrying on by

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such corporation, association, educational institution, or society of its activities" (42 U.S.C. § 2000e-1). However, claiming that a business is religious merely because the owners declare it so or require employees to attend daily religious services that include praying, singing hymns, and discussing work-related topics does not exempt the organization (EEOC v. Townley Engineering & Mfg. Co (http://law.justia.com/cases/federal/appellate-courts/F2/946/898/421109/) ., 946 F.2d 898 [1991]).

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26.2 National Origin Discrimination "Discrimination on the basis of national origin" refers to discrimination at work because of a person's birthplace, ancestry, culture, or religion. Refusing to hire someone because of his or her accent or country of origin would be an example. On its website, the EEOC provides the following example:

Muhammad, an Arab-American, works for XYZ Motors, a large automobile dealership. His coworkers regularly call him names like "camel jockey," "the local terrorist," and "the ayatollah," and intentionally embarrass him in front of customers by claiming that he is incompetent. Muhammad reports this conduct to higher management, but XYZ does not respond. The constant ridicule has made it dif�icult for Muhammad to do his job. The frequent, severe, and offensive conduct linked to Muhammad's national origin has created a hostile work environment in violation of Title VII. (http://www.eeoc.gov/policy/docs/national-origin.html (http://www.eeoc.gov/policy/docs/national-origin.html) )

National origin is protected under Title VII for hiring, terms of employment, and harassment, as for the other protected classes, and applies whether an employee is a U.S. citizen or not. One common question that frequently arises in employment is whether or not an employer can require its employees to speak only English at work. The courts have consistently held that the answer is "yes," but only if the employer can show a business necessity for such a rule, such as safety on the job.

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26.3 Disability Discrimination We next turn our attention from discrimination on the basis of religion to that of disability. For the �irst time in our discussion of discrimination, Title VII does not apply. Instead, disability is covered by federal legislation: the Americans With Disabilities Act of 1990, or ADA. Title I of the ADA forbids discrimination against quali�ied individuals with physical or mental disabilities in hiring, �iring, or promotion and requires employers to make reasonable accommodations for disabled employees. Title III of the ADA mandates accessibility for the disabled to new and existing public and private facilities that are open to the general public.

This landmark legislation expanded the Rehabilitation Act of 1973, which had prohibited discrimination in hiring on the basis of a person's handicap in federal employment and by federal contractors and companies receiving federal assistance. The ADA is enforced by the EEOC, which has the authority to bring actions. And, as of July 25, 1994, the ADA applies to all employers engaged in interstate commerce who employ at least 15 employees per day for at least 20 weeks per year. The following entities are exempt from the ADA: the United States, corporations wholly owned by the government of the United States, Indian tribes, and social clubs that are not open to the general public.

The salient provisions of Title I of the ADA include the following:

Prohibits discrimination against quali�ied disabled individuals based on their disability in hiring, retention, or promotion;

Mandates that reasonable accommodation be made for quali�ied disabled individuals by employers unless such accommodations would impose an undue hardship on the business operation;

Allows private individuals to bring lawsuits to enforce the act through injunction (but not for monetary damages); and

Allows the U.S. attorney general to bring legal action that includes injunctions, �ines, or damages against employers who violate the act (including reasonable attorney's fees, court costs, reinstatement, and treble damages, where appropriate).

In its regulations relating to the ADA, the EEOC de�ines an individual as quali�ied for a speci�ic job if he or she "satis�ies the requisite skill, experience, and education requirements of the employment position" (29 C.F.R. 1630.2(m)). The ADA does not require lesser quali�ied disabled individuals to be hired; it only forbids discrimination against otherwise quali�ied individuals merely because of their disability.

In 2008, Congress revisited the ADA by enacting the Americans With Disabilities Act Amendments Act (ADAAA). This legislation greatly expanded the de�inition of a disability as an impairment that substantially limits a major life activity. In order to qualify for a reasonable accommodation at work, an employee must have either an actual disability or a record of disability. Under the ADAAA, ailments such as epilepsy, diabetes, cancer, HIV infection, and bipolar disorder are considered disabilities.

Reasonable Accommodation

The ADA gives some examples of what the term reasonable accommodation may include. See 42 U.S.C. § 12111(9) and 29 C.F.R. § 1630.2(o)(2). See also 29 C.F.R. §§ 1630.2(o)(1), which de�ines "reasonable accommodation" to include "modi�ications or adjustments" to application processes, work environment, and access to bene�its and privileges of employment.

Accommodations can consist of the following:

(A) Making existing facilities used by employees readily accessible to and usable by individuals with disabilities; and

(B) Job restructuring, part-time or modi�ied work schedules, reassignment to a vacant position, acquisition or modi�ication of equipment or devices, appropriate adjustment or modi�ications of examinations, training materials or policies, the provision of quali�ied readers or interpreters, and other similar accommodations for individuals with disabilities. (42 U.S.C. § 12111(9))

Undue Hardship

If an employee does suffer from a disability, the employer has a duty to make a reasonable accommodation as long as the employee is "otherwise quali�ied," unless to do so would cause an "undue hardship" to the employer. According to the EEOC, undue hardship means signi�icant dif�iculty or expense for the employer.

Undue hardship refers not only to �inancial dif�iculty, but to reasonable accommodations that are unduly extensive, substantial, or disruptive, or those that would fundamentally alter the nature or operation of the business. An employer must assess on a case-by-case basis whether a particular reasonable accommodation would cause undue hardship.

The Direct Threat Defense

In some cases, employers may determine that an employee poses a signi�icant threat to others as the result of a disability and thus are able to dismiss the employee without incurring ADA liability. For example, in LaChance v. Duffy's Draft House Inc (http://law.justia.com/cases/federal/appellate- courts/F3/146/832/514153/) ., 146 F.3d 832, 8 AD Cas. (BNA) 652 (11th Cir. 1998), a worker with a history of epilepsy was hired by a restaurant as a line cook. During his �irst night of work he had two seizures, one occurring in the dining hall where customers were present. He was told that he was a liability

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because of his epilepsy and was then discharged. The court held that this condition was a direct threat to customers. In upholding the dismissal, it found that the employer did not have a duty to make an accommodation. The court opined:

LaChance failed to produce probative evidence that he was not a direct threat. His argument that he has performed the job safely at other places is unavailing. The evidence indicates that his employment before Duffy's consisted mainly of prep work and there is no evidence that any of those jobs involved using the kind of appliances he was required to work with at Duffy's. The af�idavit from his supervisor at a job after Duffy's, indicating that he had worked around the same appliances without incident for 13 months, does not overcome his own admission and his doctor's statement that he posed a risk of harm.

With regard to drug addiction and alcoholism, the courts distinguish between the disease and the actions of the impaired person. While the disease may be protected, acting impaired is not. Therefore, an employee under the in�luence cannot use his or her addiction as an excuse. To wit, a hospital nurse who was a recovering drug addict was found to pose an unacceptable risk to patient safety where she failed to follow protocols for administration of narcotics to patients (Griel v. Franklin Medical Ctr., 234 F.3d 731 (1st Cir. 2000)), as was an alcoholic doctor with a history of treatment and relapse (Altman v. NYC Health & Hosp. Corp., 100 F.3d 1054, 6 AD Cas. (BNA) 73 (2d Cir. 1996)). A plaintiff who twice attempted suicide because of bulimia and depression was also deemed a direct threat (EEOC v. Amego, Inc., 110 F.3d 135, 6 AD Cas. (BNA) 997 (1st Cir. 1997)), as was a depressed civil rights investigator who said to a coworker, "If I had come in Friday, I could have shot somebody" (Palesch v. Missouri Comm. on Human Rights, 233 F.3d 560 (8th Cir. 2000)).

Title III of the ADA

Title III of the ADA requires greater accessibility by all to places open to the public. The act mandates in great detail changes to existing and new construction to make it accessible to the physically challenged. The regulations require greater accessibility through a number of means, including detailed building code changes controlling the height of water fountains, the number of restrooms in buildings, and the installation of elevators in all new construction taller than two stories or with more than 3,000 square feet per �loor. The regulations go as far as to specify the number of parking spaces that must be set aside for handicapped drivers, the number of theater seats that must be made handicapped-accessible, and the height of dining tables in restaurants. In addition, the act mandates telephone companies to provide telecommunications devices for the deaf and covers accessibility to public transportation by the disabled.

Many people think that older buildings are "grandfathered in" and therefore do not have to comply with the law, but that is not true. All places of public accommodation, as well as of�ices, must comply with Title III. That includes removing architectural barriers to existing facilities when it is "readily achievable to do so." According to the ADA National Network (http://www.adata.org) :

The ADA requires that small businesses remove architectural barriers in existing facilities when it is "readily achievable" to do so. Readily achievable means "easily accomplishable without much dif�iculty or expense." This requirement is based on the size and resources of a business. So, businesses with more resources are expected to remove more barriers than businesses with fewer resources. When a business undertakes an alteration to any of its facilities, it must, to the maximum extent feasible, make the alteration accessible.

All new construction must comply with the ADA guidelines, and existing structures must be made handicapped-accessible unless doing so would prove an undue hardship. Note, however, that social clubs, religious institutions, residential facilities covered by fair housing laws, and owner-occupied inns with fewer than six rooms to rent are all exempt from the act.

Permissible Interview Questions

The ADA speci�ically limits the use of interview questions and medical examinations for vetting new hires. Any recognition of a disability by inquiry or examination at the interview stage is strictly prohibited. A manager may not even ask how a person became disabled or the prognosis of the individual's disability.

According to the EEOC's Technical Assistance Manual: Title I of the ADA, examples of questions that may not be asked include the following:

Is there any health-related reason you may not be able to perform the job for which you are applying?

Do you have any disabilities or impairments that may affect your performance in the position for which you are applying? and

Do you have any physical defects which preclude you from performing certain kinds of work?

It is permissible for a job description to be attached to the application form with information regarding speci�ic job functions. A manager may then ask the applicant if he or she can perform these functions. An example of a permissible question would be:

Are you able to perform these tasks with or without an accommodation?

If the applicant responds that the task can be performed with an accommodation, a permissible follow-up question would be:

How would you perform the tasks, and with what accommodation(s)?

Therefore, managers may ask questions regarding a prospective employee's ability to perform job-related functions but may not ask the questions in terms of a disability. Managers should also note that after a job offer has been made, the company may require a medical examination and may condition the offer on the results of the examination, that is, as long as the results are not used to discriminate against the person. (All of the above information was taken

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from the EEOC's Technical Assistance Manual: Title I of the ADA, available at the Job Accommodation Network website (http://askjan.org/links/ADAtam1.html) .)

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26.4 Age Discrimination The Age Discrimination in Employment Act (ADEA) forbids age discrimination against people who are aged 40 years or over but does not protect workers under the age of 40. The law covers all aspects of employment—from hiring and �iring to terms and conditions of employment and retirement. For example, in a recent case involving AT&T, the EEOC said that persons who participated in the company's early retirement plan were discriminated against when they were not allowed to reapply for a position there. The company settled the suit by agreeing to do away with a policy that excluded from reemployment employees who had left AT&T under one of the early retirement plans. The decree also prohibited AT&T from requiring a different process for selecting retirees than for other former employees (http://www.eeoc.gov/eeoc/newsroom/release/10-26-11.cfm (http://www.eeoc.gov/eeoc/newsroom/release/10- 26-11.cfm) ).

Age discrimination is unlike other types of discrimination lawsuits in two ways. First, it is generally more expensive in terms of damages for employers who lose because employees are entitled to their salary for the remaining years that they would have been employed. Considering that a prevailing plaintiff may garner 20 or 30 years of lost wages, including bene�its, the sums awarded may be in the millions of dollars. If it is a class action, the amounts can be staggering. Second, if the employer can establish that its behavior was reasonable, it may prevail using a defense called an RFOA (reasonable factor other than age). Unlike the business necessity defense in other forms of discrimination, the RFOA line of inquiry does not require the trier of fact to ask whether there might have been other ways for the defendant to achieve its goals without resulting in a disparate impact on older workers.

The age discrimination lawsuit requires that the plaintiff prove discrimination based on age using the same three-stage process described for race and sex discrimination (see Figure 23.1 in Chapter 23 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec23.2#sec23.2) ). That is, "but for" the employer's discriminatory behavior, the employee would not have been discriminated against (29 U.S.C.A. § 623(a)(1)) (Gross v. FBL Financial Services, Inc., 557 U.S. 167, 129 S. Ct. 2343 (U.S. 2009)).

The following case excerpts illustrate a lawsuit under the ADEA.

Cases to Consider: Christie v. Foremost Ins. Co.

Christie v. Foremost Ins. Co., 785 F.2d 584 (7th Cir. 1986)

Foremost Insurance Company specializes in selling insurance for mobile homes and recreational vehicles. In late 1975 or early 1976, Foremost hired Richard Christie, who was then forty-�ive years old, to be Foremost's district manager in the southeastern district of Michigan. Christie regularly received "excellent" ratings from his supervisors at Foremost[,] and Foremost never questioned his competence.

On November 4, 1980, Christie's division manager Paul Forsthoefel telephoned Christie to set up a meeting for November 5. At that meeting, Forsthoefel informed Christie he was "terminated," and handed Christie a letter explaining that Foremost found it "necessary to implement a reduction in our �ield sales staff in Michigan." The letter, dated November 4, informed Christie he was terminated as of November 7, 1980. In Foremost's �inal status report on Christie, dated November 7, 1980, Christie was again rated "excellent." Christie, who was forty-nine when �ired, was replaced by Danny Starnes, who was thirty-two years old and had begun working for Foremost in January, 1979.

***

Foremost concedes that Christie made out a prima facie case, which created a rebuttable presumption of age discrimination. Foremost contends, however, that it met its burden of production by articulating a lawful reason for Christie's discharge, and Christie failed to meet his burden of proving that Foremost's proffered reasons were merely a pretext. Foremost claims, therefore, that the trial court erred by refusing to grant Foremost's motion for a judgment notwithstanding the verdict.

Foremost offered a nondiscriminatory reason to legitimize its decision to �ire Christie. Foremost said that Christie's termination occurred as part of a legitimate reduction in force. Foremost further claims it terminated Christie and replaced him with Starnes because Foremost's supervisors concluded that Starnes would perform better in an economic recession. Foremost contends that Christie failed to prove that the reduction in force was a pretext for �iring Christie. Foremost claims that "Christie's age discrimination case rested on nothing more than his beliefs and feelings and other evidence which, as a matter of law, does not create an inference of age discrimination."

Foremost claims that, in order to prove pretext, a plaintiff like Christie must present evidence of either (1) age-related comments, (2) statistics of disparate effect on employees aged 40–70, (3) more favorable treatment of similarly situated employees under 40, or (4) the falseness of the employer's reasons for termination. Foremost contends that Christie presented no evidence of the �irst three, and failed to establish the fourth. Christie contends that he proved Foremost's proffered reasons were "unworthy of credence."

. . . [W]e �ind that Christie presented substantial evidence that Foremost's proffered explanations were merely a pretext for age discrimination.

First of all, Christie presented evidence of his consistent excellent ratings from his supervisors. He also presented evidence that the evaluations which allegedly showed Starnes was a superior employee were suspect. Unlike Christie's evaluations which were based primarily upon achieving objective goals, Starnes' evaluation was wholly subjective. Furthermore, Christie presented evidence suggesting that Foremost ignored much relevant data. Finally, Christie showed that many of the items on which Starnes was evaluated were "soft"—such as

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completing most of the company's twenty-three instruction manuals and obtaining a necessary insurance license. Starnes' evaluation rested entirely upon Forsthoefel's personal opinion, and Forsthoefel's credibility was very much at issue in this case because he was the Foremost manager who initiated the decision to �ire Christie.

Christie also presented evidence from which the jury could have found that Foremost did not comply with its own reduction in force policy and thus was probably not making a legitimate reduction in force. One of the Foremost managers who decided to terminate Christie, Ronald Crippin, did not even know that Foremost had a policy governing reductions in force. A jury could infer from this fact that Foremost was not actually making a reduction in force, because if it was[,] its managers would have known of or located the company policy and followed it. Christie also presented evidence from which the jury could have inferred that had Foremost actually followed its own reduction in force policy, Christie would not have been discharged.

Christie presented other evidence which, with the evidence discussed above, was substantial enough to persuade the jury that Foremost's proffered reasons either had "no basis in fact, or, if they [had] a basis in fact, . . . were not really factors motivating the discharge."

One �inal argument by Foremost deserves special mention, however. Foremost alleges that rather than producing evidence of pretext, Christie merely invited the jury to second-guess Foremost's business judgment. Foremost is correct that a plaintiff cannot argue that the defendant made a bad business decision in choosing between two employees to discharge. For example, in this case Christie could not prevail by arguing that Foremost used poor judgment in replacing him with Starnes.

Christie's argument was different, however. He argued not that Foremost used the wrong criteria and bad judgment in terminating him as part of a reduction in force, but rather that Foremost never made a decision about who to terminate as part of a reduction in force. Christie argued that Foremost merely used the reduction-in-force rationale as a pretext to cover age discrimination. A plaintiff cannot argue that the defendant showed bad judgment in deciding another employee had greater potential, but he can argue that the method used by the defendant showed that the defendant was not really trying to decide which employee had greater potential. Granted this is a �ine line, but the law often places such a burden on the jury. Foremost does not contend that at any time during trial the court allowed Christie to invite the jury to second-guess Foremost's business judgment. Neither does Foremost allege that the jury instructions impermissibly invited the jury to second-guess Foremost's business judgment. Therefore, we conclude that Foremost's statement of the law is accurate, but inapplicable to this case.

Read the full text of the case here (http://openjurist.org/785/f2d/584/christie-v-foremost-insurance-company) .

Questions to Consider

1. How did Christie make out a prima facie case of discrimination?

2. How did the employer rebut Christie's contentions?

3. Why did the court reject the employer's explanation?

4. What evidence most hurt the employer?

5. In hindsight, what could this employer have done to have a more successful outcome?

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26.5 Discrimination Against Nonprotected Classes Discrimination on the basis of sexual orientation and gender identity provides a unique opportunity to look at a discrimination claim when there is no constitutional protection, no Title VII protection, nor any federal statutory protection. In cases where the persons being discriminated against are not part of a protected class, and in which federal legislation has not stepped in to prevent discrimination, two fallback positions are possible. First, the claimant can determine whether there is state or local law, and second, the claimant can determine whether the employee handbook provides any contractual protection.

For an illustration of how inconsistent the states are with regard to employment discrimination on the basis of sexual orientation and gender identity, go to the American Civil Liberties Union website (http://www.aclu.org/maps/non-discrimination-laws-state-state-information-map) and view the map showing the hodge-podge of laws. The 21 states banning sexual orientation discrimination in employment are California, Colorado, Connecticut, Delaware, Hawaii, Illinois, Iowa, Maine, Maryland, Massachusetts, Minnesota, Nevada, New Hampshire, New Jersey, New Mexico, New York, Oregon, Rhode Island, Vermont, Washington, and Wisconsin (the �irst state to do so, in 1982). Ten states have laws prohibiting sexual orientation discrimination in public employment only: Arizona, Indiana, Kansas, Kentucky, Michigan, Missouri, Montana, Ohio, Pennsylvania, and Virginia. Nineteen states have no laws prohibiting discrimination on the basis of sexual orientation.

A federal Executive Order 13087, issued on May 28, 1998, is also in place to protect executive branch civilian employment. More information on that law can be found at the U.S. Of�ice of Personnel Management website (http://www.opm.gov/er/address2/guide01.asp) .

In all the above discussions, employees were protected by either a federal law, such as Title VII or the Americans With Disabilities Act, or, at least, a patchwork of state laws. But if someone has not been discriminated against on the basis of race, color, national origin, sex, disability, age, or, in some states, sexual orientation, then could an employer discriminate legally? In other words, if one is not in a protected group, is discrimination then legal?

Take, for instance, the case of smokers. Suppose that an employer announced it would no longer hire persons who smoked cigarettes. In a lawsuit brought by the smokers against the company, what would happen? There would be no cause of action, most likely. There is nothing the smokers could sue for because it is perfectly legal to discriminate against this class of people.

Suppose that an employer required all women employees to wear a skirt and all men to don a tie. Are dressing and grooming standards discriminatory? Not under the law. The same is true of sexual orientation (in some states), felons, and persons who are unattractive or overweight. In fact, in many instances of employment discrimination, the employee does not have any legal recourse for being dismissed or not hired in the �irst place, because the employee is not in a legally protected class.

Keep in mind that discrimination law does not excuse misconduct, as the case law illustrates. If an employer can prove that the employee failed to perform the job required or could not get along with others in the workplace, that person can be dismissed.

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Key Terms

Click on each key term to see the de�inition.

accessibility (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

In public and private facilities that are open to the public, a level of availability that is required for disabled people under the terms of the ADA.

Age Discrimination in Employment Act (ADEA) of 1967 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Federal law that describes the rules for hiring and �iring employees above the age of 40 and protects these older workers from being unfairly treated in employment decisions.

Americans With Disabilities Act (ADA) of 1990 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Spells out how employers must accommodate disabled workers. This is a federal law that applies to all businesses, as opposed to a state law that applies only to businesses within that particular state.

Americans With Disabilities Act Amendments Act (ADAAA) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

In 2008, Congress amended the ADA and expanded the de�inition of disability to mean an impairment that substantially limits a major life activity.

bona �ide religious belief (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Under Title VII, a sincerely held religious tenet within the plaintiff 's own scheme of things.

burden shifting (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

After the plaintiff has established its prima facie case, the burden shifts to the defendant, who must counter the plaintiff 's claims by rebutting the plaintiff 's presumption and showing its good-faith actions to reasonably accommodate the plaintiff (if doing so would not have caused undue hardship).

business necessity defense (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

An argument the defendant employer can advance to justify discriminatory employment actions against an employee. Bona �ide occupational quali�ications (BFOQs) fall into this category.

disability (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

An impairment (e.g., deafness, epilepsy, diabetes, cancer, HIV infection, bipolar disorder) that substantially limits a major life activity.

injunction (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A judicial remedy that requires a party to refrain from (or not initiate) certain actions in order to prevent future injuries or harm. Can be temporary (as in prior to litigation during a trial) or permanent (issued upon completion of a trial).

judgment notwithstanding the verdict (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

At the conclusion of a trial, a judgment whereby a judge overturns the decision of the jury in the interest of justice, thereby reversing the jury decision.

reasonable accommodation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Under the ADA, when an employer changes the structure of the job, application process, or bene�its so that the employee with a disability can perform the tasks. Under Title VII, employers must make reasonable accommodations for employees to eliminate employees' con�licts between work and practicing their religion, unless doing so would cause "undue hardship on the conduct of the employer's business."

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reasonable factor other than age (RFOA) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A defense in an age discrimination inquiry where the employer can establish that its behavior was reasonable; does not require the trier of fact to ask whether there were other ways for the defendant to achieve the goals that would not have resulted in a disparate impact.

Rehabilitation Act of 1973 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Prohibited discrimination in hiring on the basis of handicap in federal employment and by federal contractors and companies receiving federal assistance.

Title I of the ADA (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Forbids discrimination against quali�ied individuals with physical or mental disabilities in hiring, �iring, or promotion and requires employers to make reasonable accommodations for disabled employees.

Title III of the ADA (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Mandates accessibility for the disabled to new and existing public and private facilities that are open to the general public.

undue hardship (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

According to the EEOC, signi�icant dif�iculty or expense that would be necessary for an employer to accommodate an employee's disability, religious practice, etc.

Chapter 26 Flashcards

Critical Thinking and Discussion Questions

1. What are the two main areas covered by the 1990 Americans With Disabilities Act?

2. Title VII imposes an obligation on the employer "to reasonably accommodate the religious practices of an employee or prospective employee, unless the employer demonstrates that accommodation would result in undue hardship." What is a religious practice? What constitutes a reasonable accommodation?

3. What types of organizations are exempt from Title VII religious coverage?

4. What is a "hostile work environment" on the basis of national origin? What forms of discrimination are covered by national origin discrimination?

5. How is an age discrimination lawsuit different from other types of discrimination lawsuits?

6. Your supervisor has placed you in charge of hiring the new administrative assistant for your department: a full-time job starting immediately. a. Write an advertisement for an open position at your place of employment. This advertisement must be detailed and include all information about the position and the bene�its that will be offered. The minimum length of your job description is 300 words. You can make up the job details.

In public and private facilities that are open to the public, a level of availability that is required Click card to see term 👆

Choose a Study ModeView this study set

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b. Write �ive illegal federal questions and �ive illegal state questions; then write �ive legal federal questions and �ive legal state questions. Clearly indicate which one is legal or illegal, and which is state or federal.

c. Write a memorandum to your supervisor with an explanation of why you did not hire this person for the position.

7. Frank, a legally blind attorney who has just been admitted to practice in his state, applies for a position as an associate at a law �irm, answering an advertisement that lists as one of the requirements of the job a minimum of �ive years of relevant experience. In his letter of application, he notes that he is legally blind but claims to be capable of performing the necessary duties, with only minor accommodations by the employer. He is not granted an interview and decides to sue, claiming that he was discriminated against in violation of the Americans With Disabilities Act. a. What do you think the result of the lawsuit would be?

b. If, instead of having just been admitted to practice, Frank had been employed as an attorney by another �irm for 10 years, would your answer to the last question change? Explain.

c. Assume that Frank is one of the �inest attorneys in his state and that he has recently begun to lose his vision owing to irreversible glaucoma. Further assume that his current employer dismisses him, claiming he can no longer perform his regular job duties. The total cost of the new equipment to accommodate Frank's condition would be $5,000 for the employer, and the employer is a large law �irm. If Frank can show that he would be able to continue performing his job if the employer purchased a larger computer monitor for him to use, as well as furnished him with better lighting in his of�ice, would he likely succeed in his case? What if he worked for a small �irm with just two partners?

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Unit VII

Business Organizations

Brand New Images/Getty Images

Chapter 27: Principal–Agency Law

In this chapter you will:

Describe a principal–agency relationship, how it is formed and dissolved, and the rights and liabilities thereunder.

Chapter 28: Sole Proprietorships and Partnerships

In this chapter you will:

Describe a sole proprietorship, how it is formed and dissolved, and the rights and liabilities thereunder.

Describe a partnership, how it is formed and dissolved, and the rights and liabilities thereunder.

Chapter 29: Limited Partnerships

In this chapter you will:

Describe the limited partnership form of business organization, its advantages and disadvantages, how it is formed and dissolved, and the rights and liabilities thereunder.

Chapter 30: Corporations

In this chapter you will:

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Describe a corporation, its unique characteristics, its classi�ications, how it is formed, and how it is managed.

Chapter 31: Federal Securities and Antitrust Laws

In this chapter you will:

Identify the major types of federal securities and antitrust laws and describe their importance to business.

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Principals and Agents

Chapter 27

Principal–Agency Law In business as well as in our personal lives, it is often necessary to have others act on our behalf in order to carry out routine tasks that we may not have the time or expertise to perform ourselves. An entrepreneur might go into business for herself and initially perform all of the required tasks personally while the enterprise is in its early stages. But if the business is successful and the owner wants to expand its operations, it will be impossible to do so without hiring additional help to take on some of the responsibilities of the expanding venture. As new employees are hired, they may become agents of the owner, and thereby empowered to carry out certain tasks in her place. Put another way, the owner of a business can delegate some responsibilities to agents whom we normally call employees and empower these agents to act on the owner's behalf in accordance with the terms of employment. Thus, a used car salesman hired by the owner of a used car lot is empowered to sell cars on the owner's behalf and can bind the owner to sales contracts he enters into with third parties (used car buyers).

Similarly, an individual can authorize another to act as his or her agent for the purpose of carrying out any legal task by executing a valid power of attorney. In both of these instances, if the agent acts on behalf of the principal (the employer on whose behalf the employee–agent acts) with the principal's authority, the acts of the agent bind the principal exactly as if the principal had acted. This simple principle forms the basis of agency law and is of critical importance to the formation of business organizations we will discuss in this unit (e.g., sole proprietorships, partnerships, limited partnerships, corporations, and limited liability companies). In this chapter, we will explore the basic principles of the law of agency and discuss their application to employment relationships.

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27.1 Creation of an Agency Agency is a consensual relationship that comes into existence when one person authorizes another to act on his or her behalf to conduct some lawful business. An agent acts as a stand-in for the person he or she represents (called the principal) and, as long as the conduct is within the scope of employment, may enter into contracts on the principal's behalf. When a duly authorized agent acts on behalf of a principal, it is as though the principal had acted.

Because the principal–agency relationship requires "consent," only a person with the mental wherewithal to enter into a contract can be a principal. If an incompetent (one lacking mental capacity) or a minor becomes a principal in a principal–agency relationship, for example, that person can disaf�irm, or choose to get out of the contract, at which time the principal–agency relationship would end. Interestingly, there is no requirement that the agent be competent. In most states, any person may be an agent, including incompetents and children. This is because principals are free to choose whomever they wish to act on their behalf, and this includes persons lacking full mental capacity (see the discussion of competency in Chapter 9 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec9.2#sec9.2) , Contracts, Part I).

Generally speaking, no formalities are necessary for the creation of a valid agency. Oral instructions as well as written ones can lead to its creation; even a conversation can lead to the formation of this relationship. Suppose, for example, that the owner of a large apartment complex said to the employee in charge of operations, "Please hire some staff to clean up the yard." The principal (owner) has asked the employee, an agent, to enter into a contract on the principal's behalf. One way to represent this relationship is shown in Figure 27.1.

Figure 27.1: A principal–agency relationship

Note that this diagram depicts two contracts. The �irst contract is the one forming the principal–agency relationship. This is a special type of employment arrangement in which the principal hires the employee/agent and gives him or her power to enter into contracts on the principal's behalf. By so doing, the employer is allowing the employee/agent to act in his or her stead. When we say the agent "binds the principal," we mean that the principal is legally obligated to pay for work done by the third party, just as though the principal had personally hired the third party. As you can see, few formalities are needed, only "orders," to accomplish the creation of the principal–agency relationship. No speci�ic form is required, or any legal �ilings or attorneys.

The second contract in the diagram is the one between the agent and the third party: the yard workers. As long as this particular agent had the authority from the principal to hire the workers, then the principal is obligated to pay the workers for the job done because the agent acted in place of the employer.

The formation becomes more complicated, however, when it has to be in writing to be enforceable. Recall from chapter 9 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec9.4#sec9.4) on contracts that the Statute of Frauds is the law covering which contracts must be in writing to be enforceable:

1. The sale of real property;

2. The sale of goods worth greater than $500; and

3. A contract that cannot be performed in a year.

In the example given above, in which the apartment complex owner says, "Hire workmen," the contract could be oral and still enforceable because it does not fall under any of the three criteria. But suppose that the principal had said to the agent, "I want you to go out and buy another apartment complex." In that case, the contract between the agent and the third party would have to be in writing because it is for the sale of real property. Since the contract

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between the agent and the third party must be in writing, then the contract establishing the principal–agency relationship must also be in writing. This is referred to as the equal dignities rule, meaning that the principal–agency agreement is given the "same dignity" as the agent–third party contract: Each must be in writing and signed by the party to be charged (the defendant) if it goes to court. (See chapters 9 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec9.4#sec9.4) and 10 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec10.3#sec10.3) for further discussion of contract writing requirements.)

Agent's Authority

The following is a general theory of principal–agency:

The principal is bound by the act of his or her agent when he has placed the agent in such a position that persons of ordinary prudence, reasonably conversant with business usages and customs, are thereby led to believe and assume that the agent is possessed of certain authority and to deal with him in reliance upon such assumption. (Feely Lumber Co. v. Bookstaver–Burns Lumber Co., 181 Wash. 503, 510, 43 P.2d 953 (1935))

So how much authority does this particular agent really have? The answer is that it depends on the type of authority granted to the agent by the principal. The most common type of authority is called actual express authority. In law, the phrase express authority means oral or written, so in these cases, the principal communicates orally or in writing to the agent that the agent has the authority to enter into the contract, as did the apartment owner. Any type of order from a principal to an agent, then, could be considered actual express authority.

When the principal orders his or her agent to "buy a building," that order has two types of authority. First, because it was spoken, it has actual express authority; also, �lowing out of that express authority is another type of authority called implied authority. This is the authority that comes from express authority and gives the agent the power to take any reasonable steps necessary to carry out the express authority granted by the principal. For example, it may be implied from the order to buy the building that the agent has to enter into additional contracts, such as hiring an attorney to review title and hiring a contractor to do an inspection. Although the principal did not order these two other contracts, the agent cannot unilaterally buy a building without entering into the additional obligations; thus, they too are authorized under the umbrella of implied authority.

Agent's Apparent Authority

An agent may have another type of authority called apparent authority. This is not created by any type of oral or written communication between the principal and the agent. Instead, apparent authority is the authority that an agent seems (or appears) to have to a reasonable person under the circumstances based upon the nature of the agency. Note that apparent authority is created by the principal, not the agent.

An example will suf�ice. If an employee is behind a desk in the lobby of a hotel, then it will appear to third parties that the employee can take money and assign rooms. The principal has allowed this employee to appear to the general public as an agent. Therefore, if a reasonable third party approaching the desk at the hotel gave the impostor money, the hotel would be liable for creating the appearance of an agent having authority. Such authority generally �lows from the customs and practices of an industry or the general assumptions about a person's position that a reasonably prudent person might make.

An agent with the appearance of authority is different from an employee who exceeds his or her authority. In the above example, the impostor had no authority, but the employer allowed the situation to exist. In the following situations, the agent has authority but exceeds it. Unfortunately for employers, they will be liable for these actions by an employee, since ultimately, the responsibility for hiring an errant employee lies with the employer. For example, it is generally true that the director of Human Resources has the power to hire new employees; thus, an interviewee who is offered a job by a company's director of Human Resources can accept such an offer and bind the principal to honor it even if the speci�ic HR director was not expressly authorized by management to make employment offers. The HR director's apparent authority will bind the organization to the agreement.

Consider the following excerpts from Northern Assurance Company v. Lark et al., dealing with an agent who exceeded the scope of her authority.

Cases to Consider: Northern Assurance Company v. Lark et al.

Northern Assurance Company v. Lark et al., 845 F. Supp. 1301 (1993)

Barbara Nash is an employee of Sycamore Agency, Inc., an insurance sales enterprise. Sycamore offers its clients a selection of several insurance companies from which to choose auto insurance. Defendants Connie and William D. Lark were clients of Ms. Nash. . . .

Nash was aware that both William and Connie Lark were currently uninsured and that William had several driving violations of record. Connie Lark knew that she could not obtain coverage from Northern Assurance for herself and William, because of his or her driving record and the prohibitive cost he would add to the premium. Notwithstanding that neither Connie nor William met Northern Assurance's mandatory Personal Auto Acceptance Standards, on July 5, 1991, Nash offered to bind Northern Assurance to coverage for Connie Lark (only) and to submit an application to Northern Assurance.

On July 8, 1991, Nash completed a majority of a Northern Assurance application/binder for insurance and mailed it to Connie Lark. Lark did not sign, return, or pay any consideration regarding the application until July 22, 1991. On the evening of July 19, 1991, William Lark drove Connie Lark's car; William's car's registration had expired. In the early morning hours of Saturday, July 20, 1991, William was intoxicated and at fault in an auto accident with William J. Summers.

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Connie contacted Nash on July 22, 1991, and told Nash about the accident. Nash told Connie to bring in the application as soon as possible; Connie brought in the signed application and the initial premium payment that same day. The Agency Agreement between Sycamore (Nash's employer) and Northern Assurance required Sycamore to notify Northern Assurance within �ive working days after issuing a binder. After Nash received the application, Sycamore added a "1" to the "effective date" on the Binder/application and thereby changed the date from July 5, 1991 to July 15, 1991. . . .

Under the criteria provided by Northern Assurance's Personal Auto Acceptance Standards, Northern Assurance would not have issued the Policy to Connie. Under the criteria provided by Northern Assurance's Personal Auto Acceptance Standards, Sycamore/Nash was without authority to issue the Binder to Connie. The facts known to Nash regarding Connie and William prior to the time Nash issued the binder plainly indicated that Connie was an unacceptable risk for the Northern Assurance coverage bound by Nash. The criteria that Connie failed to meet include the following: (1) The Policy application did not name all automobile exposures in Connie's household (William lived in her house but was not listed as a named insured); (2) Connie's insurance had been cancelled/non-renewed during the past three years (the Amerisure policy); (3) Connie had been divorced within the past year; and, (4) Connie was not then currently insured for automobile liability by a standard carrier.

Had Nash disclosed the true nature of the Connie Lark and William Lark risk to Northern Assurance within the required time period under the Agency Agreement, then Northern Assurance would not have issued the Policy. Had Nash disclosed that William Lark had been at fault in a collision on July 20, 1991, then Northern Assurance would not have issued the Policy. . . .

Connie does not have the legal authority unilaterally to bind an insurance company to a contract of insurance. Northern Assurance did not issue the Binder to Connie Lark: Sycamore issued the binder to Connie Lark. It is axiomatic that Sycamore must have contractual or common law authority to act on behalf of Northern Assurance to bind Northern Assurance to the Binder with Connie Lark.

Summers and the Larks argue merely that Sycamore, through Nash, "believed" that it was an agent of Northern Assurance and therefore Sycamore had the authority to bind Northern Assurance to the contract called a Binder. The question of agency is not resolved by referring to deposition answers regarding what the purported-agent "believed"; instead, this issue requires an analysis of the circumstances to determine whether Nash was a contractual or common law agent. Sycamore was in fact not acting in the capacity as Northern Assurance's contractual or common law agent when Sycamore issued the Binder. . . .

Agency is a consensual agreement between the principal and agent [citations omitted]; the keystone of the agency relationship is the principal's ability to de�ine and control the agent's activities. The Agency Agreement is a contract in which Sycamore and Northern Assurance agreed that Sycamore Agency shall be Northern Assurance's Agent in Terre Haute, Indiana. The Agency Agreement is the de�initive document controlling the relationship between Sycamore and Northern Assurance. The Agency Agreement provides Sycamore the following authority:

Agent shall have the authority to receive and accept proposals for contracts of personal lines and commercial lines insurance (as de�ined by Company) as Company and Agent have authority lawfully to make; subject, however, to the restrictions placed upon Agent by the laws of the state . . . to the terms and conditions set forth herein, and to such general and speci�ic instructions, authorizations, restrictions and criteria as may from time to time be given to Agent by Company in writing.

. . . Connie plainly did not meet mandatory requirements of Northern Assurance's Personal Auto Acceptance Standards. She did not currently have auto insurance and she was not able to allow Northern Assurance to cover William—he was indisputably an unacceptable risk. The Personal Auto Acceptance Standards, which are implied into the Agency Agreement, expressly forbade Sycamore from binding coverage to an applicant with Connie's characteristics. The Agency Agreement, therefore, expressly directed the agent not to bind coverage for precisely the kind of risk presented by Connie Lark. The Agency Agreement is the de�initive expression of the scope of Sycamore's authority to act on behalf of Northern Assurance.

Even assuming that the Binder took effect immediately when mailed (or when discussed, as Connie argues), the Binder was not an enforceable contract between Northern Assurance and Connie Lark. Sycamore issued the Binder outside the scope of the contractual Agency Agreement. A principal is not bound to a contract executed by an agent if the agent does not act on behalf of the principal when executing the contract. Although Sycamore purported to act on behalf of Northern Assurance when Sycamore purportedly bound Northern Assurance to the contract (Binder), Northern Assurance was not so bound. Accordingly, Northern Assurance has no obligation to provide coverage to Connie (or William) under the Binder issued to Connie by Sycamore.

In addition to agency arising by written or parol (oral) agreement, an agency relationship may be implied by conduct also. This is the common law concept of apparent agency. Even if Northern Assurance and Sycamore had no express agency agreement, Sycamore could have been acting as Northern Assurance's agent vis-à-vis Connie Lark if, and only if, Northern Assurance had acted toward Connie such that she would have been instilled with the reasonable belief that Sycamore was an agent for Northern Assurance. The evidence establishes that Northern Assurance had no contact with Connie regarding the Binder; absent any manifestation by Northern Assurance, there can be no apparent agency.

Moreover, Sycamore had neither the actual or "apparent" authority to issue to Connie Lark a Binder binding against Northern Assurance. Apparent authority is similar to apparent agency and requires a manifestation by the principal to the third party. There was no such manifestation in this case. Merely by providing Sycamore with Northern Assurance application forms, Northern Assurance did not instill

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Connie with the reasonable belief that Sycamore could bind coverage for any type of risk that Sycamore saw �it. Almost every contractual agent will have some indicia of authority from the principal; however, it would pervert the legal principle to say that every agent therefore has "apparent" authority to bind the principal to any type of contract.

Even if there was an apparent agency, it would be irrelevant. The conclusion that Sycamore issued the Binder outside the scope of its agency relationship applies with equal force whether the agency relationship is created by contract or implied by common law. Plain and simply, Sycamore had no authority to act on behalf of Northern Assurance when Sycamore issued the Binder to Connie Lark under the circumstances known to Sycamore at the time. . . .

In the face of Sycamore's misrepresentations and knowing omissions to Northern Assurance regarding Connie's application, Summers and the Larks �irst argue that the Policy was not fraudulently procured because all facts were known to Northern Assurance by imputation through its agent—Sycamore. The position that the policy-dooming information known by Sycamore was imputed to Northern Assurance is unsound for two reasons. First, as discussed above, Sycamore was not Northern Assurance's agent for purposes of the application, because Sycamore submitted that application outside the scope of its agency relationship with Northern Assurance. Therefore, the principle of imputed knowledge does not impute Sycamore's knowledge of Connie's situation to Northern Assurance. Second, Sycamore's own material misrepresentations and knowing omissions played a substantial role in Northern Assurance's decision to issue the Policy. Even if one could conceive of an "agent" who misrepresents material matters to its principal, the agent's own acts would preclude use of the common law �iction of imputed knowledge. . . .

The conclusion that Northern Assurance has no obligation to provide coverage for Connie Lark, William Lark, or Connie's automobile in turn resolves all other outstanding issues and motions in this matter.

Read the full text of the case here (http://scholar.google.com/scholar_case?case=7125581438498018461&hl=en&as_sdt=2,33) .

Questions to Consider

1. This case is concerned with the concept of "imputed knowledge." What knowledge was known by the agent that was imputed to the insurance company?

2. If the insurance company had really known the driving record, would it have issued the insurance policy?

3. How can a principal guard against imputed knowledge?

Authority and Giving Notice

As for apparent authority, the same principle holds true for contracts entered into by agents who have been terminated and behave as if they still work for the business. For example, if a traveling salesperson does not tell a client that he or she no longer works for the business, accepts money from the client, and absconds with it, the principal will be liable to repay the money, even though the agent no longer works for the client. Why? After an agency terminates, ex-agents have apparent authority to bind their principals. This is true until the principal lets third parties who have dealt with the agent in the normal course of business know that the agency has been terminated.

Actual Noti�ication

With regard to third parties who have dealt with the agent in the past, the principal must provide actual noti�ication of the agency's termination. Such noti�ication is generally effective when it is received by the third party. In actual noti�ication, the principal sends that customer an e-mail, a letter, or some other personal communication that informs him or her that the agent is no longer employed. Failure to make this type of communication to third parties with whom the agent has had contractual relations will result in liability for the principal. It is also important that the principal take away from the agent all appearances of agency, such as business cards, letterhead, company cars, and briefcases with the company logo, when the agent (employee) is terminated.

Constructive Notice

The second type of notice is called constructive notice because it is not given to any one particular person, but is "notice to the world." Persons who may have been aware of the agency but who did not deal with the agent directly can be given constructive notice of the agency termination by publication of a legal notice in a newspaper of general circulation in the geographic area or areas in which the person acted as an agent. Constructive notice will effectively destroy an agent's implied authority to bind his or her principal with respect to third parties. Managers must be very careful when posting such a notice not to publish anything defamatory about the agent, lest they risk a tort lawsuit. Instead, they should make an announcement in a newspaper or trade magazine that says something to the effect of "We are pleased to announce that Brenda East is taking over as the sales agent for Motley Dutcher, who is no longer working for the company." This type of notice is effective for anyone that might know of the agency relationship but who has not actually entered into a contract.

Agency by Estoppel

In special circumstances, a principal who has not actually empowered an agent to act on his or her behalf can be bound by acts of the agent under an estoppel theory: This is known as agency by estoppel. If the principal misleads a third party into believing that a person who is not an agent is in fact the principal's agent, then the principal will later be unable to disavow acts of the purported agent. For instance, say that a sole proprietor leads an innocent

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third party to believe that a speci�ic person is his or her agent when no actual agency exists. If so, any contracts entered into by the third party with the purported agent, in reliance on the principal's misrepresentations, will bind that principal as if the purported agent were in fact a duly authorized agent. Note, though, that a purported agent's misrepresentations will not bind the principal unless they are made in the presence of the principal, who did not disavow them. The following examples will illustrate:

Arnold misrepresents himself or herself to be Paula's new purchasing agent to Tom, an innocent third party, in the presence of Paula, who does not correct Arnold's misstatement. Arnold subsequently sends Tom, a wholesaler, a written order for $100,000 worth of electronics equipment for resale in Paula's business. If Paula rejects the shipment when it arrives, Tom is entitled to sue her for damages, including his or her lost pro�its and shipping and insurance costs, as Arnold had apparent authority to order the goods as Paula's purported agent.

Archibald, an unemployed charlatan, tells Tina that he is a new partner in the accounting �irm of Adam, Bloom, and Chang, P.C., a prestigious small �irm in Tina's city. Tina, believing his or her assertions, pays him a sizable retainer for his or her purported �irm to handle her company's payroll and maintain her books. If Archibald cashes the check and skips town, Tina has no recourse against Adam, Bloom, and Chang, P.C., as the �irm did not mislead her. She did not verify Archibald's statements with the �irm, and the �irm is not responsible for allowing her to be misled by the false statement.

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27.2 Termination of an Agency A principal–agency relationship can be terminated in one of three ways: by the consent of the parties, by the completion of the agency purpose or expiration of the agency period, or by operation of law.

Termination by Consent of the Parties

If the principal and the agent mutually agree to end the relationship, this is called termination by consent of the parties. Generally speaking, an agency can be terminated at any time by the mutual consent of the principal and the agent. In the event that only one of the parties wishes to end the relationship, however, then the party leaving the relationship may be liable. That party has the "power" to leave but not the right. This means that the other party cannot force him to stay in the relationship, but because he does not have the right to leave, he will incur liability in the form of monetary damages. Thus, if an agent agrees to serve a principal for a period of �ive years but quits at the end of the �irst year, the principal may be able to recover compensatory damages. These would include the difference between what he would have paid the agent under their agreement and what he must pay a replacement agent for the remaining period of the breached agreement. In addition, the principal may be entitled to incidental and consequential damages, such as the cost of conducting an employment search to replace the agent. In summary, it is possible to end an agency before its term expires, but ending it may lead to a party incurring damages.

Termination by Completion of Agency Purpose or Expiration of Agency Period

If an agency is entered into for a speci�ic purpose, then the agency automatically terminates upon the completion of that purpose. For example, if an agency was created for the purpose of the agent purchasing a speci�ic piece of real estate for the principal, then once the agent completes his or her assigned task, the agency relationship ends. Likewise, an agency that is set up to expire after a set period of time or upon the happening of a given event automatically terminates when the speci�ied time period expires or the speci�ied event occurs.

Termination by Operation of Law

Termination by operation of law means automatic expiration. A number of circumstances will automatically terminate the principal–agency relationship. These include death, incompetence, or bankruptcy of the principal, or death of the agent. (Note that the incompetence or bankruptcy of the agent does not necessarily terminate an agency.) Subsequent illegality or impossibility of performance also causes an agency to be terminated by operation of law, since the purpose of the agency cannot be ful�illed. If the impossibility of performance or illegality is only temporary, however, then the agency resumes as soon as the impediment to completing its purpose is ful�illed.

For example, if XYZ Corp. hires Adam Agent to purchase electronics goods from a speci�ic country for resale in the United States during the next �ive years at a set salary, and Congress places an embargo on that country a year after the contract was entered into, the agency terminates by operation of law. However, if Congress removes the sanctions a year later, then the agency would resume for the remaining three-year period called for in the original agreement.

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27.3 Principal's Duties in an Agency Agreement In every agency, a principal owes certain duties to the agent (see Table 27.1 for a side-by-side comparison of principals' and agents' duties and rights). These duties are generally described by statute or understood to be basic tenets of principal–agency law. They include the following:

The duty to compensate the agent for services (unless compensation is waived by the agent);

The duty to indemnify the agent for any reasonable costs incurred or losses suffered as a result of the agency; and

The duty to cooperate with the agent in carrying out the purposes of the agency.

In addition to these duties that arise by operation of law in every agency, the principal can have other duties speci�ied in the agency agreement. A principal who breaches any duty owed his or her agent will be liable to the agent for damages.

Table 27.1: Select duties and rights of principals and agents under agency law

Principals Agents

Duties To compensate the agent for services Other duties speci�ied in the agency agreement

To reimburse the agent for any reasonable costs incurred To be loyal to principal

To indemnify the agent for losses suffered To be obedient to principal

To cooperate with the agent in carrying out the purposes of the agency (provide necessary information and resources; not to interfere with agent's duties)

To inform the principal of relevant facts agent learns relating to the agency

To exercise due care in carrying out the responsibilities of the agency

To render an accurate accounting of expenses or income received in conducting the principal's business

To put the principal's interests over the agent's personal interests

Rights To recover damages from agent who disregards directions of the principal

To receive agreed-upon remuneration

To obtain an accounting from the agent To receive compensation

To recover moneys collected by agent on behalf of principal Of indemni�ication against consequences of lawful acts or those done in good faith

To obtain details of any secret pro�it made by agent and recover it

To forfeit remuneration of the agent who misconducts the principal's business

Liabilities Liable for contracts entered into by disclosed and partially disclosed agents

Personally liable for contracts entered into on behalf of partially disclosed and undisclosed principals

Liable for torts committed by agents within the scope of employment

Liable for all torts committed while in the scope of employment

Liable for criminal acts of agents if authorized Liable for all criminal acts while in the scope of employment

Duty to Compensate the Agent

Unless a gratuitous agency was clearly intended, the agent is entitled to be compensated for services rendered to the principal. A gratuitous agent is one who works for free, such as a volunteer at a food bank who enters into contracts with vendors to procure goods. Therefore, unless someone is a gratuitous agent, compensation is implied in law, whether or not it was ever discussed with the principal. The agent is entitled to compensation for the reasonable value of the services rendered.

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Duty of Reimbursement and Indemnification

An agent will often need to spend money on behalf of the principal in order to carry out the duties of the agency. If these expenditures are reasonable and necessary to further the interests of the principal, the agent (upon giving an accounting of them) is entitled to have the principal reimburse him or her: The principal has the duty of reimbursement. An accounting means that the agent reports the expenses to the principal and provides proof of their costs. In addition, agents can sometimes suffer personal losses while engaged in the business of the agency. As long as these losses were reasonably foreseeable by the principal at the time of entering into the agency and were not caused by the willful acts of the agent, the agent is entitled to indemni�ication for such losses. For example, if an agent is injured through the fault of a third party or through his or her own negligence while conducting agency business, the principal must indemnify the agent for all medical expenses and related losses �lowing from the injury. Likewise, an agent whose personal property is damaged or destroyed while carrying out agency business is generally entitled to indemni�ication by the principal for such losses.

Duty of Cooperation

A principal must render any reasonable assistance necessary to allow the agent to carry out the responsibilities of the agency. This duty of cooperation extends to providing the agent with any necessary information or resources needed to perform the assigned agency duties. It also includes a duty of the principal not to interfere with the agent while the agent attempts to carry out the duties of the agency.

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27.4 Agent's Duties in an Agency Agreement Like the principal, the agent has certain obligations that �low from the agency agreement by operation of law and by the express terms of the agency agreement. The agent's duties arising by operation of law include the following:

The duty of loyalty;

The duty of obedience;

The duty to inform the principal of relevant facts relating to the agency learned by the agent;

The duty to exercise due care in carrying out the responsibilities of the agency; and

The duty to render an accounting of expenses or income received by the agent in conducting the principal's business.

These duties are described in more depth in the following sections.

Duty of Loyalty

Agency is a �iduciary relationship (a relationship based on trust in which the agent must exercise absolute good faith in his or her dealings on behalf of the principal). The duty of loyalty requires that the agent place the interests of the principal above his or her own. The agent must deal honestly and in good faith in carrying out his or her duties as assigned by the principal.

An agent can breach the duty of loyalty in a number of ways. These include through the obvious means of stealing or misappropriating funds from the principal, and the much more subtle means of competing with the principal or using information learned by means of the agency relationship to further his or her own interests rather than those of the principal. An agent cannot keep gifts (or illicit bribes, for that matter) received in the normal course of conducting agency business on the principal's behalf; such gains are considered the rightful property of the principal and must be turned over to the principal by the agent who receives them.

Duty of Obedience

The agent's duty of obedience to the principal requires following the reasonable instructions of the principal relating to the agency. Failure to do so will subject the agent to liability for any resulting loss the principal suffers.

Duty to Communicate to the Principal Relevant Information Learned About the Agency

A principal is deemed to have constructive knowledge of any relevant information the agent learns during the course of performing his or her duties under the agency. This is also called imputed knowledge. For example, assume that Jack is an insurance agent working for Huge Insurance Company. A good buddy of Jack's comes into his agency and asks Jack to write an automobile policy for him. The friend is a well-known alcoholic and has a history of convictions for driving while intoxicated (DWI). Nevertheless, because he is a good friend, Jack decides to write the insurance policy despite its going against company policy. Jack's knowledge that his or her friend is an alcoholic with DWI arrests is imputed to Huge Insurance. It is as if Huge were writing the policy with the information. Therefore, when the friend runs over a pedestrian and kills him, Huge Insurance will have to pay out the claim because it is as if the company had issued the policy with full awareness of the friend's drinking problems.

Because relevant information learned by the agent is presumed as a matter of law to be known by the principal, agents must communicate any relevant information they learn relating to the agency to their principals immediately. If they fail to do so, they can be held personally responsible for any losses suffered by the principal as a result of their failure to disclose the relevant information. While this might be all well and good in theory, it is also true that the insurance company is more likely to have the money to pay than is the agent (see Northern Assurance Co. v. Lark (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec27.1#sec27.1) ).

Duty to Exercise Due Care in Conducting Agency Business

Agents must exercise the duties of their agency with reasonable care. Failure to do so can result in tort liability for negligence. Agents who have special skills, such as attorneys, physicians, or architects, must exercise a level of professionalism and expertise that is acceptable in their profession; failure to do so can result in liability to the principal for malpractice.

Duty to Render an Accounting

Agents must keep accurate records of expenses incurred on behalf of their principals for which they are entitled to reimbursement or indemni�ication, as well as of any income or other bene�it derived from the agency to which the principal is entitled. Agents must render a formal accounting to their principals from time to time, whenever an accounting is reasonably requested by the principal or as otherwise provided by the agency agreement.

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27.5 Vicarious Liability It might seem hard to believe that an employer could be liable for the actions of an errant employee, especially when the employee's actions are tortious. The law, however, protects the injured party, and few employees can pay for their actions. The burden therefore falls onto the employer responsible for hiring an employee who commits a tort, as described in the sections that follow. As discussed in chapter 21, Establishing the Employment Relationship, such liability is often referred to as respondeat superior, meaning the employer answers (pays) for the torts of his or her servant (employee).

Liability of the Principal for the Agent's Torts

Principals are liable for the torts committed by their employees if the employees were within the scope of employment. The names of the parties change when an employee commits a tort—from that of employer–employee or principal–agent to that of master–servant. Recall from chapter 21 that holding the master liable for the torts of his or her servants is called respondeat superior and includes the employer paying damages for its employees while on the job. The servant, of course, is also liable for his or her own torts with regard to third parties the servant injures while engaged in agency business. Usually, though, servants do not have the money necessary to make a lawsuit worthwhile, nor insurance for actions taken while at work; as a result, most third parties seek redress from the servant's employer, or the master.

In order for the principal–master to be held liable for the servant's torts, two tests must be met:

1. There must be a master–servant relationship, wherein the servant is under the direct control of the master (e.g., the servant must be an employee of the master); and

2. The tort must have been committed by the servant while engaged in conducting work-related business.

If, for example, an innocent bystander is injured by the driver of a delivery truck while making a delivery, the injured person can hold the driver's employer liable for the injuries suffered. But not so if the driver injures someone while driving his or her own car on the way to work, since he or she would not at that time have been engaged in conducting agency business. That is, he or she would not have been within the scope of employment (see Chapter 21 and Table 21.1 for more on employment relationships). For this reason, employers usually invest in third-party liability insurance to protect them from the consequences of such incidents.

Independent contractors are not deemed agents of their employers but rather self-employed and solely responsible for their own torts (see Chapter 21 for discussion of independent contractors versus employees; see Chapter 28 for a discussion of sole proprietorships). In determining whether a given person is an employee or an independent contractor, the most important factor courts weigh is whether or not the employee is "controlled" by the employer in terms of the details of the work performed. Other factors include the number of hours worked by the person on the principal's behalf every week, whether the person has other clients, and whether the person exerts independent judgment in carrying out his or her duties. Thus, a gardener who works for the Jones family two hours per week and has 20 other clients in the area is not an employee but rather an independent contractor. However, a gardener who works exclusively for the Jones family for 20 hours per week, has no other clients, and follows the daily directions of the Jones family might be considered an employee. The difference can be crucial if the gardener injures himself or herself or someone else during the course of his or her employment, for the Jones family would not be responsible for such injuries in the former case but would be liable for them in the latter (see also Chapter 8, Negligence, Strict Liability, and Product Liability).

Liability of Agents for Contracts Entered Into on the Principal's Behalf

As a general rule, agents are not personally liable for contracts they enter into on behalf of their principals as long as they are within the scope of their authority. When an authorized agent enters into a contract on behalf of a principal, it is as though the principal had entered into the contract himself or herself. The agent is merely a facilitator and not a party to the contract.

There are situations, however, in which an agent does have personal liability for a contract that he or she entered into on behalf of a principal. This can occur in two different types of situations. First, if the agent enters into an unauthorized contract, he or she will be personally liable because of acting outside the scope of employment, and thus, not as an agent. Second, agents may be personally liable in situations where their status is partially disclosed or undisclosed, which we will discuss in more detail below.

Agent's Unauthorized Contracts

If an agent enters into a contract with a third party without having actual, implied, or apparent authority, the principal is not bound under the resulting agreement. However, the agent is personally liable because a principal–agency relationship did not exist. Thus, it is as though the so-called agent is entering into the contract for himself or herself, not another. However, if there is a principal–agency relationship and the agent exceeds the scope of his or her powers or violates the agreement, then the principal is still liable. Suppose, for example, that an agent is authorized by his or her principal to bid up to $100,000 at auction for a piece of unimproved real estate and the agent bids $120,000. Despite the fact that the agent bid over the authorized amount, the principal is nevertheless liable because the agent had authority to bid.

Principals are free to honor unauthorized contracts (ones in which the agent had no authority whatsoever; not ones in which the agent exceeded his or her authority) entered into by their agents if they choose but are under no obligation to do so. If a principal elects to honor an unauthorized contract entered into on his or her behalf by an agent, he or she can do so by a process called rati�ication, which means assenting to the contract terms after the fact.

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Rati�ication involves an af�irmance by the principal of a previously unauthorized act by the agent. Once an unauthorized contract has been rati�ied by the principal, the agent is no longer liable under it, since the liability for performing the contract has been assumed by the principal.

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27.6 Types of Agents You might be surprised to learn that there are three different types of agents: disclosed, partially disclosed, and undisclosed. Depending on which type of agent one is dealing with, the principal has different degrees of liability, as discussed in each of the sections below.

Disclosed Principal

A disclosed principal is one whose existence and identity are known to the third party. For example, the agent may say to the third party, "I am an agent of Northstar Bank, and they have authorized me to enter into this contract on their behalf." In this example, both the existence and the identity of the principal are known to the third party, as is the fact that there is a principal–agency relationship. The third party is on notice that he or she is dealing with an agent and knows who that principal is. As a result, the law is well settled that the principal has all of the liability for the contract and the agent has none.

Partially Disclosed Principal

A partially disclosed principal is one whose existence is known to the third party but whose identity is not. Thus, the agent in this case may say, "I am Bill Butler, an agent for a principal who wishes to remain unidenti�ied." Such contracts are common in instances where the principal fears that the third party might be unwilling to deal with him or where the identity of the principal might drive up the price of the contract if it were known. In such contracts, the principal and the agent have joint liability and both can be sued if the contract is breached.

Undisclosed Principal

Finally, there are instances in which the agent may say, "Yes, I am Bill Butler and I would like to buy that car." The agent has not disclosed he is an agent, nor has he disclosed the existence of a principal. In fact, the third party thinks he or she is entering into a contract with Bill Butler. Because the appearance of this transaction makes it look as if the contract is between Bill Butler and a third party, this situation is known as an undisclosed principal. As far as the third party is concerned, the agent acts solely on his or her own behalf and is thus personally liable for the performance of the contract if the undisclosed principal fails to perform. If the third party later learns of the undisclosed principal's identity, the third party may hold both the agent and the undisclosed principal liable under the contract. If you work for someone who asks you to act in this capacity, consider the fact that you will be held personally liable on the contract. If your principal refuses to pay for the car, then you, as the agent, will be held liable.

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Key Terms

Click on each key term to see the de�inition.

accounting (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The process in which an agent reports the expenses incurred in the course of duty to the principal and provides proof of costs.

actual express authority (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A grant of power to an agent from a principal, either orally or in writing.

actual notice or noti�ication (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Personal notice from a principal to a third party that the agent is no longer employed by the principal and has no authority to bind the principal to contracts.

agency (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A consensual relationship that comes into existence when one person authorizes another to enter into a contract on his or her behalf.

agency by estoppel (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When a principal misleads a third party into believing that an unauthorized person is his or her agent (e.g., by silent assent).

agent (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A special type of employee who has the authority to enter into contracts on behalf of the employer.

apparent authority (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The authority an agent seems to have to a reasonable third party.

constructive notice (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Notice "to the world" via a communication of mass media that the agent is no longer employed by the principal.

disaf�irming (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Choosing to get out of a contract or principal–agency relationship by an incompetent person (one lacking mental capacity) or a minor.

disclosed principal (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A principal whose existence and identity are known to the third party.

duty of cooperation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The legal obligation of the principal to render any reasonable assistance necessary to allow the agent to carry out the responsibilities of the agency.

duty of reimbursement (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The legal obligation of a principal to pay back the agent for monies expended in carrying out the principal's business.

duty to exercise due care (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The obligation of an agent to exercise the duties of agency with reasonable care.

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duty to indemnify (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The legal obligation of the principal to reimburse the agent for losses suffered in carrying out the principal's business.

duty to render an accounting (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The duty of an agent to keep accurate records of expenses incurred on behalf of the principal.

equal dignities rule (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A rule that states if the contract between the agent and third party must be in writing, then the contract between the principal and the agent must also be in writing.

errant employee (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

An employee who does not follow the instructions of his or her employer.

gratuitous agent (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

An agent who works for free and whom the principal has no legal obligation to pay.

implied authority (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The permission necessary to carry out the work ordered under express authority; the authority that �lows from express authority.

imputed knowledge (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The principal's constructive awareness of any relevant information the agent learns during the course of performing his or her duties under the agency.

incompetent (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A person who is lacks mental capacity. An incompetent who has been declared so by the court is non compos mentis, and that person's contracts are void.

indemnify (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

To secure against loss or damage that may occur; to compensate for loss or damage that took place; to insure or hold harmless.

malpractice (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Improper conduct, negligence, or incompetent performance of professional duties.

parol agreement (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Oral, rather than written, agreement.

partially disclosed principal (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A principal whose existence is known to the third party, but whose identity is not.

party to be charged (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The party to be sued or the defendant (who has signed a contract) in a breach of contract lawsuit; the party sought to be bound by a contract.

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principal (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The name given to an employer in a principal–agency relationship.

principal–master (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A principal who is held responsible for a tort committed by the agent–servant while conducting work-related business for the principal.

rati�ication (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When a principal agrees to an agent's contracts after the fact; this assumes that the agent had no authority to enter into the contract in the �irst place. Can apply to contracts by minors or incompetent persons as well.

scope of employment (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The boundaries outlining what a speci�ic person is authorized to do at work.

termination by consent of the parties (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When both the principal and the agent mutually agree to end the agency relationship.

termination by operation of law (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The end of a principal–agency relationship owing to death, incompetence, or bankruptcy of the principal; death of the agent; or illegality or impossibility of performance.

undisclosed principal (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Neither the existence nor the identity of the principal is known to the third party.

Chapter 27 Flashcards

Critical Thinking and Discussion Questions

1. What is a principal–agency relationship, and what formalities are necessary in order to enter into one?

2. What are the three basic means by which an agency can be terminated?

3. Explain what effect each of the following has on an existing principal–agency relationship: a. The death of the agent

b. The death of the principal

The process in which an agent reports the expenses incurred in the course of duty to the Click card to see term 👆

Choose a Study ModeView this study set

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c. The bankruptcy of the agent

d. The bankruptcy of the principal

4. What are the basic duties owed by a principal to an agent in every agency relationship? What are the basic duties that all agents owe their principals?

5. What is the agent's contractual liability in contracts entered into with third parties on behalf of disclosed principals? Partially disclosed principals? Undisclosed principals?

6. Marsha asks Muhammad, a fellow student at State U who is a computer whiz, to purchase a computer for her that in his or her judgment would best meet her needs. She tells him that he can spend up to $1,500 on a complete system, including an inexpensive printer. Muhammad, after many hours of research to put together the most cost-effective system at the lowest possible price for Marsha, places an order with Computer World on Marsha's behalf and asks that the complete system be shipped to Marsha. a. Is Muhammad Marsha's agent under the facts given? If so, does he need written authorization before he can purchase the system on Marsha's behalf?

b. If Muhammad orders a system for $1,500 from Computer World after identifying himself as Marsha's agent, is Muhammad liable on the contract if Marsha refuses the computer system when it is delivered? Explain.

c. If Muhammad �inds a $4,000 computer system on clearance for $2,000 and orders it for Marsha, who is liable on the contract if Marsha refuses to accept it when the system is delivered, assuming that there is no issue with the Statute of Frauds? Explain.

7. Barbara hires Enrique as a consultant to set up and maintain her computer network. Enrique works at Barbara's business site approximately �ive to 10 hours per week and bills Barbara at a rate of $100 per hour for his or her work. He does not have an of�ice in Barbara's place of business and is not on the payroll. He works unsupervised and sets his or her own schedule and hours on an as-needed basis. In addition to working for Barbara, Enrique does consulting work for several other clients on an ongoing basis. a. Is Enrique an employee or an independent contractor?

b. What practical difference does it make whether Enrique is an independent contractor or an employee?

c. Would Enrique be considered an employee under the previous facts if he worked 20 hours per week for the past three years for Barbara and had no other clients?

8. Jasmine hires Jemal to run her business as general manager under a three-year contract. After six months, the parties have a falling-out, and Jemal gives Jasmine notice of his or her intention to resign from his or her position. He expresses the willingness to stay on for up to 60 days to allow Jasmine to recruit a suitable successor. a. If Jasmine is unwilling to release Jemal from his or her contractual obligation, can she force him to stay on as her agent for the contractual three- year term?

b. If Jasmine cannot convince Jemal to stay on as her general manager, what recourse does she have against him? Explain.

c. Assuming that Jasmine can �ind several suitable replacements for Jemal for a lesser salary than she had agreed to pay him, what recourse will she have against Jemal?

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Chapter 28

Sole Proprietorships and Partnerships Beginning with this chapter, we will explore the most common forms of business organization in order to understand their fundamental makeup and examine the bene�its and liabilities of structuring a business under each distinct form of business organization. One of the �irst decisions that must be made by anyone seeking to establish a new business is what organizational form to choose. The most common types of business organizations are:

1. Sole proprietorships;

2. Partnerships;

3. Limited partnerships;

4. Corporations; and

5. Limited liability companies (LLCs).

As we will see, each type of business organization offers certain bene�its as well as drawbacks that should be carefully weighed before deciding which form is best suited to the new venture. Table 28.1 provides a comparison of the different types of business entities. The requirements for starting a business under each of the available forms of business organization vary widely. For example, individuals who start a business under their own name alone or in traditional partnerships will have very few organizational formalities, whereas those who wish to organize a new business as a limited partnership, corporation, or limited liability company (LLC) will need to strictly follow the requirements of their state's limited partnership, corporation, or LLC acts. Consult the of�ice of the secretary of state in your location for registration requirements.

Table 28.1: Business entity comparison

Sole Proprietorship General Partnership Limited Partnership

TYPE OF ENTITY

SOLE PROPRIETORSHIP PARTNERSHIP CORPORATION

DEFINED A business owned and run by one person.

An association of two or more people for a pro�it.

An entity that is created by permission of the state whose ownership is represented by shares of stock.

ADVANTAGES No meetings; run the business by yourself; no disagreements with others about how to run the business; liable only for own mistakes.

Have two or more people to help in running the business and share the liability. Have others to discuss the business plan with and share ideas for the business.

Limited liability of the owners and tax advantages.

DISADVANTAGES Taxed on income like regular income; have all of the liability; have no one else to contribute ideas.

Taxes. The pro�its of the partnership are taxed as personal income on each partner's individual tax return, but the entity must �ile Form 1065 with the IRS.

Expensive and complicated to create; must follow state rules and comply with state and federal �iling laws.

WHO OWNS The sole proprietor. The partners. The shareholders.

HOW FORMED Many states require a business certi�icate to be �iled at the county clerk's of�ice; some also require an EIN (federal) number.

Many states require a business certi�icate to be �iled at the county clerk's of�ice; as between the partners, the agreement can be informal and oral.

Preincorporators must �ile Articles of Incorporation with the secretary of state; state must issue charter. Other forms required. If public, must comply with federal and state law regarding the initial issuance of shares of stock.

WHO OPERATES The sole proprietor. The general partners, but they can turn over day-to-day management to a managing partner.

The corporate of�icers.

LIABILITY OF OWNERS

The sole proprietor's assets, personal and business-related, are all subject to a lawsuit.

All the partner's assets (personal and business) are subject to a lawsuit.

Liability is limited to one's investment (i.e., in shares of stock).

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HOW TAXED As personal income on Form 1040. Income is reported on Form 1040 as personal income and paid at the personal rate, but the partnership also has to �ile Form 1065.

At the state's corporate rate.

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28.1 Sole Proprietorships The oldest and simplest form of business organization is the sole proprietorship. Under this form of business organization, the owner of a business personally operates and is solely responsible for all aspects of the enterprise. A sole proprietor who is hired by another to perform services may also be an independent contractor. An independent contractor usually performs one job and works at his or her own discretion. Thus, if ABC Corporation hired Fisher Painting, a sole proprietorship owned by Martha Fisher, Martha would be both a sole proprietor and an independent contractor. (For other employment issues relating to sole proprietorships, see Chapter 21 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch21#ch21) , Establishing the Employment Relationship, and Chapter 27 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch27#ch27) , Principal–Agency Law.)

Formation of a Sole Proprietorship

The greatest bene�it of the sole proprietorship form of business organization is that few formalities are required for its formation. To a certain extent, people wishing to go into business for themselves in a business that carries their own name can start the enterprise at any time without the need to seek state or local approval.

Creating a Tax Entity

The �irst step in starting a sole proprietorship is to open a bank account so that the business can receive money and pay debts, either with checks or electronically. To open a business account, the bank will require a federal tax identi�ication number (TIN). This nine-digit number could be the proprietor's Social Security number or an employer identi�ication number (EIN) that the IRS assigns the business (in the format 12-3456789) and is used for �iling tax returns. (All the information to obtain the federal tax number can be found at GovServices (http://www.taxid-gov.us) .)

All sole proprietors do not need to set up an EIN. If a sole proprietorship does not have employees, it is not required to have an EIN. In fact, the IRS generally prefers that sole proprietors use their Social Security number. However, employers with one or more part-time or full-time employees, no matter how small their business, must have one. Also, if they plan to use an EIN to differentiate between personal and business �inances, they should have an EIN before applying for business permits. In addition, if they pay subcontractors or others for services valued at more than $600 in a calendar year, they may need to get an EIN. Anyone who registers as a limited liability company, corporation, partnership, or joint venture must have an EIN.

Before a sole proprietor can collect any money from sales, the state tax division will require that the business register for permission to collect sales tax. This process may take months, so planning ahead is essential. Once the federal TIN and state tax collection permission have been acquired, there are no other formalities to go through before business can begin.

Licensing

Some types of businesses require licenses to do business, such as bars (liquor license) or real estate �irms. So a sole proprietorship must comply with all state and federal regulations applicable to business concerns. While there may be few formalities for actually forming the business, it is not as simple as simply setting up a lemonade stand.

Doing Business As

Persons who wish to do business under an assumed name must apply for a permit from the appropriate state of�ice in their state (typically the secretary of state's of�ice) and pay a nominal fee for the privilege of doing business under a trade name. The primary purpose of this requirement is to prevent different persons from doing business under the same name in the same area, which might cause consumers confusion, and to have on record the names and addresses of the owners of these businesses so that they may be readily found and held accountable for any civil or criminal transgressions. Thus, Rick Carpenter generally needs no special permission to start a carpentry business under the name Rick Carpenter or Rick Carpenter's Carpentry Service, but he would need to get what is commonly termed a Doing Business As (DBA) certi�icate from the appropriate of�ice in his state if he wanted to call his business Good Homes Carpentry, Expert Carpentry Works, or any other assumed name.

Benefits of Sole Proprietorships

As already discussed, there are few formalities to launch a sole proprietorship, and as a result, persons starting a business often choose this form to begin with. Other types of businesses, such as limited partnerships, corporations, and LLCs, require the drafting and �iling of speci�ic forms and approval from government of�icials before the business can get off the ground—a process that requires an investment of time and money to complete.

Autonomy

If you ask a sole proprietor what the other greatest advantage is to this form of business, he or she will most likely reply that it is not having to share the management with anyone else. The sole proprietor does not have to ask for anyone's permission, wait for votes or meetings, or seek others' approval. Business decisions can occur quickly. Partnerships and corporations, on the other hand, require the members to reach a consensus and, in the case of corporations, sometimes onerous formalities before major business decisions (e.g., the sale of substantial portions of the assets of the business or the acquisition of business property) can be made. These processes can interfere with the smooth operation of some businesses and make instituting major changes slow and often tedious.

Freedom From Vicarious Liability of Co-Owners

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Just as important as the autonomy that the sole proprietorship permits the business owner is the freedom from liability for the negligent acts or bad business decisions of others. General partners in a partnership are deemed to be agents of the partnership and of one another under the common law of partnership (see Chapter 27 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch27#ch27) for a full treatment of principal–agency law). Thus, if there are partners A, B, and C, and only C is negligent, A and B will also be liable. In a corporation (discussed in Chapter 30 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch30#ch30) ), directors and of�icers of a corporation are deemed to be agents of the corporation they serve.

Under the law of agency, principals can be bound by the authorized acts of their agents and are liable for the negligent acts of their agents committed during the course of the agency. Thus, partners in a partnership can be held liable for contracts entered into on behalf of the partnership by any other partner as well as for the negligent acts of any partner that injures a third party. Likewise, a corporation can be held liable for the authorized acts of its of�icers and directors, as well as their negligence. Sole proprietors, however, need never worry about being responsible for the bad judgment, negligence, or bad faith of a co-owner, since they are the only owners; they are responsible only for their own acts and for the acts of their agents.

Cost Savings

There are signi�icant �inancial advantages for the sole proprietorship in terms of tax savings and lower administrative costs. Unlike most corporations, the sole proprietorship does not pay federal, state, or local income taxes as a business entity; instead, all income earned by the business is taxed as simple income to the owner. This means that if the business makes $250,000, then that �igure is reported on the sole proprietor's tax return as income (on a Schedule C form). Because bookkeeping and legal formalities for the business are simpli�ied, the administrative costs are usually lower than for other forms of business organization. For example, the sole proprietorship often has less need for legal and accounting services compared with other business organizations.

Drawbacks of Sole Proprietorships

While there are many bene�its rooted in the simplicity of the sole proprietorship, a number of tangible drawbacks stem from this form of business organization. Chief among these is the unlimited personal liability of the sole proprietor for all debts incurred by the business. The sole proprietorship is not recognized as a separate entity from its owner; as a consequence, the debts of the business are deemed to be the personal debts of the owner, and the sole proprietor has unlimited personal liability for all the debts, contractual obligations, and legal judgments the business incurs. If the business fails, its owner not only can lose the capital invested in the business but can also face the prospect of having his or her personal assets raided to satisfy business debts if the business assets are insuf�icient to cover business debts. Consequently, the business failure of a sole proprietorship often means personal bankruptcy.

Another downside of the sole proprietorship is that the owner must rely solely on his or her own assets and expertise in running the business, including dealing with pro�its and losses. While the business owner need not share pro�its or consult with others on business decisions, neither can the sole proprietor count on others to lend their expertise, share business losses, or shoulder part of the responsibilities for the business's daily operation. Such assistance can be obtained in the form of hiring employees, but individuals who draw a salary are seldom as committed to the enterprise or as motivated to ensure its success as those whose fortunes are tied directly to the success or failure of the business. Further, the lack of co-owners of a business enterprise can be a particularly important drawback when the business owner needs to raise capital to expand or to cover extraordinary expenses.

Property Status and Transferability of Sole Proprietorships

A sole proprietorship is considered personal property (see also Chapter 19 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch19#ch19) ). As such, it can be transferred in whole or in part at any time by its owner through sale or testamentary gift (through a will). If a business concern that is organized as a sole proprietorship is sold or otherwise transferred by its owner, its nature can change, depending on both the terms of its transfer and the wishes of the new owners. A sole proprietorship transferred to a single person who continues to run the business as a sole proprietor, for example, retains its previous status, whereas one transferred to two or more persons as joint owners becomes a partnership. A sole proprietorship can also be reorganized as a corporation if its new owner so desires. The type of business organization can also be changed by a present owner by reorganizing the business from a sole proprietorship to a partnership, corporation, or any other business organization recognized by the state.

Termination of the Sole Proprietorship

If there are few formalities for starting a sole proprietorship, there are none for ending one. The sole proprietorship can terminate as a business concern at any time at the will of its owner. Alternatively, it can end by operation of law—upon the death, incapacity, or bankruptcy of the owner. Consistent with this business form, when the business ends, its owner will remain personally liable for the completion of any outstanding contracts and for meeting any other outstanding business obligations. If the business ends owing to the death or incapacity of its owner, the owner's estate or guardian will be responsible for paying creditors out of estate funds.

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28.2 Partnerships When two or more people wish to start a business together, the sole proprietorship is not a viable entity, and they must consider another form. One of the more popular (and less expensive) businesses to begin is a partnership. There are two types of partnerships: general partnerships (discussed here) and limited partnerships (discussed in Chapter 29 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch29#ch29) ).

Partnership law differs from state to state, but all states have adopted (in one form or another) the Uniform Partnership Act (UPA). Because there are 50 different states, you need to consult individual state law to ascertain the most current version. If you wish to see samples of the act, the following websites will give you the �lavor of the rules: Click here (http://www.law.fsu.edu/journals/lawreview/issues/232/larson.html) (Florida) and here (http://codes.lp.�indlaw.com/cacode/CORP/1/2/5.5) (California). Other states' laws can be accessed on the Internet. All states de�ine partnership as "an association of two or more persons to carry on as co-owners a business for pro�it. . . ." (§ 101(6) Uniform Partnership Act (1997)). Any time that two or more individuals are engaged in a business as co-owners with the intent to make a pro�it, a partnership arises automatically (de jure, or by law), and the rights and responsibilities of each partner will be dictated by the law of partnership in the state where the partnership was formed.

The contractual provisions contained in the agreement de�ine the relationship as well as the rights and responsibilities the partners owe to one another. In the absence of a partnership agreement, or in cases in which the partnership agreement fails to de�ine key rights and responsibilities, the state's common law of partnership (and, where applicable, the state's partnership act) will de�ine these rights and obligations.

Formation of a Partnership

Like the sole proprietorship, the partnership form of business organization does not require speci�ic formalities for its creation. Oral and written agreements to enter into a partnership are generally equally binding. A partnership can also arise by operation of law even absent a speci�ic agreement: Any voluntary association by two or more persons to conduct a business for pro�it as joint owners automatically results in the creation of a partnership by operation of law, whether or not the joint owners speci�ically intended it. This holds true if two people start to sell a product but decide between themselves that they are not partners or they don't consider themselves a partnership.

One would think that people contemplating going into business together would want to put their understanding in writing. That way, if any disputes or misunderstandings arose, the agreement could serve as a guide. In far too many cases, however, partners do not execute a written partnership agreement. This may be because of the cost of hiring an attorney, or mere laziness or aversion to discussing the minutiae of the agreement. It may also result from the partnership being a close family relation or friend with whom they don't foresee con�lict. Whatever the reason, it is a poor excuse, because forming an agreement is easy and the forms are available online. For an example, click here (http://lergp.cce.cornell.edu/Business_Management/Sample%20Partnership%20Agreement_110410.pdf) . The consequences of not setting forth the terms of the partnership can be dire—the loss of the business, personal debt, and damaged personal relationships. It pays to be ready for the worst (dissolution, divorce, creditors, and personal problems of a partner) in order to protect the interests of all parties involved. See Figure 28.1 for a sample partnership agreement.

Figure 28.1: Sample partnership agreement

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Agency Rights and Duties of Partners

When partners act within the scope of their authority, they are agents of the partnership and of each other. As such, they bind the partnership to any contracts they enter into on the partnership's behalf within the regular course of business. As is true of all agents, partners have �iduciary duties to the partnership and to each other. As co-owners of the business, partners also have the interests of principals in the enterprise; since each partner is both an agent and a principal of the partnership, each partner also owes every other partner the duties of a �iduciary. As such, partners must place partnership interests above their own personal gain and must execute their duties as partners with the utmost good faith. (See Chapter 27 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch27#ch27) for a list of �iduciary duties of agents and principals.) Table 28.2 illustrates these relationships.

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Table 28.2: Partnership relationships

PARTNER 1 PARTNER 2 PARTNER 3

Principal of 2 and 3 Principal of 1 and 3 Principal of 1 and 2

Agent of 2 and 3 Agent of 1 and 3 Agent of 1 and 2

The general duties owed by agents to their principals, discussed in Chapter 27, apply to each partner in the partnership. Thus, partners owe the partnership and one another:

The duty of loyalty;

The duty of obedience (they must carry out the rightful requests of the majority of the partners);

The duty to exercise reasonable care and diligence in the exercise of their partnership duties;

The duty to notify the partnership of any facts learned that are relevant to the partnership; and

The duty to make an accounting to the partnership of any bene�its derived from conducting partnership business as well as any expenses incurred on the partnership's behalf.

By the same token, the partnership owes each individual partner:

The duty of reimbursement and indemni�ication; and

The duty of cooperation.

Contractual Rights and Duties of Partners

Although all partners are duty bound as agent and principal, they are generally free to control the nature of their relationship to one another and the duties they owe one another and the partnership by drafting the partnership agreement. This is true as long as they do not violate the law or the public policy of the states in which they do business. Unless there are provisions to the contrary in the partnership agreement, partners have an equal right to manage the business and to share in its pro�its. The mere fact that one partner makes a greater capital contribution to the partnership will not give that partner a greater voice in the management of the business or a greater share in its pro�its unless it is provided in the partnership agreement. Similarly, partners must share in the losses of the business in accordance with the share of pro�its they receive from it. Thus, if partners share pro�its equally, they will also share losses equally. If, however, the partners adopt a formula for the unequal allocation of pro�its among themselves, the same formula will apply to the (unequal) sharing of losses between the partners unless they agree otherwise.

Limitations on Partners' Ability to Define Their Rights and Obligations

Although partners are generally free to de�ine their obligations to each other and to the partnership in the partnership agreement, some acts are speci�ically forbidden by law. The Uniform Partnership Act (UPA) prohibits several activities by partners:

Engaging in certain activities that include unreasonably restricting the right of partners to access partnership books and records;

Eliminating the duty of loyalty (though partners may de�ine what types of activities are not considered a violation of the duty of loyalty, as long as these are reasonable);

Eliminating the duty of care or the obligation of good faith owed by each partner to the partnership;

Restricting the rights of third parties under the act; and

Unilaterally binding the partnership to a contract that assigns the partnership property for the bene�it of creditors, disposes of the partnership's goodwill, or confesses a judgment.

Each of these is discussed in more detail below.

Limitations of Partners' Ability to Bind the Partnership

Because they are agents, partners can individually bind the partnership to contracts entered into on its behalf during the regular course of business. The same rules of agency apply: there must be express, implied, or apparent authority. Therefore, if the partner is authorized, and he or she orders of�ice equipment from a store in the name of the partnership, the partnership is legally obligated to pay the bill. There are certain acts, however, for which the unanimous consent of all partners is required. The reason for this is that these acts are so dangerous for the partnership that every single partner's consent is needed. These acts include assigning partnership property for the bene�it of creditors, disposing of the partnership's goodwill, and confessing a judgment (Uniform Partnership Act § 9(3)(a–e)).

Assigning Partnership Property for the Bene�it of Creditors

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Generally, assigning partnership property means that to resolve a debt with a creditor, the partnership transfers its interest in speci�ic partnership property. In such a secured transaction, if the partnership does not pay the debt, the creditor may keep the property. The UPA prohibits one partner from assigning partnership property to a third party without the permission of all the other partners. This rule makes sense because, as a partner, you would not want one of the other partners assigning property interests without your permission; otherwise, the property of the partnership could be pledged to another without your knowledge.

Disposing of the Partnership's Goodwill

Goodwill is the intangible "name recognition" of a business that has meaning to customers, and in some cases, may be worth a great deal of money. In this case, the partnership would be selling its name or goodwill to a third party. The UPA prohibits one partner from selling the goodwill of the business without the permission of the other partners. Again, this is an essential asset of the business: that all partners should have a say in assigning property to someone outside of the business.

Confessing a Judgment

A judgment occurs at the conclusion of a civil trial, when the jury or judge pronounces a "winner." In the case of confessing a judgment, however, the debtor is agreeing that he or she owes the creditor money without going to court. For a partnership to confess a debt, all the partners must be in agreement; one partner cannot sign a "confession" that binds the other partners.

Acts That Interfere With the Partnership's Business

Submitting a partnership claim to arbitration or doing any other act that would make it impossible to carry out the ordinary business of the partnership is likewise prohibited by the UPA.

Limitation on Partners' Right of Compensation

Students are often surprised to learn that partners do not automatically, or even customarily, receive a salary. In fact, partners serve without compensation for their services unless the partnership agreement provides otherwise. Instead, partners are paid their respective share of the pro�its by taking a draw, meaning that they take from the partnership's account their share of the pro�its. According to the Revised Uniform Partnership Act (RUPA), a partner is also entitled to reasonable compensation for winding up the business after the dissolution of the partnership (RUPA (1997) § 401(h)).

Partners' Capital Contributions

In the event that a partner dies or withdraws from the partnership, that person is entitled to the repayment of his or her capital contribution. Recall that this was the seed money each partner contributed to fund the start of the partnership. Additionally, suppose that a partner made a loan to the partnership or paid a partnership bill out of personal funds. If so, payments or advances to the partnership by any partner above and beyond the agreed-upon initial capital contribution will earn interest for the partner as of the date it is made.

Admission of New Partners

Admission of new partners into an existing partnership agreement can be made only with the unanimous consent of all partners (RUPA (1997) § 401(i)).

Partners' Right to Inspect Partnership's Books

Every partner has the right to inspect the partnership books at any time. The books must be kept at the principal of�ice of the partnership and made available to every partner, at all times, for inspection and copying. RUPA also gives the right to inspect to other interested parties: a partner's agents and attorneys as well as former partners, their agents, and attorneys, pertaining to the period during which they were partners (RUPA (1997) § 403(b)). While this might not seem like an important right, being able to send an assistant (agent) to photocopy hundreds of pages of information can be a signi�icant time- saver for an attorney or partner facing litigation.

Partners' Liability for Partnership Debt

Partners are jointly and severally liable for all partnership debts. This means that partners can be sued individually or together by any person to whom the partnership owes a debt. These include debts that arise from contracts, tort liability, or liability to the state and federal governments for taxes or fees connected with running the business. Thus, each partner is subject to unlimited personal liability for partnership debts. If a single partner is sued by a creditor, the partner must fully discharge the debt out of his or her personal assets and would then be able to seek reimbursement from the other partners for their individual share of the liability. If the other partners are insolvent, however, the solvent partner could be left with no recourse.

New partners admitted to an existing partnership are liable only for partnership debts incurred after they join the partnership, and partners who dissociate themselves from the partnership are liable only for debts incurred up to the time of their dissociation, but not after.

Partners' Property Rights

Because a partnership is an entity distinct from its partners, the partnership holds title to the partnership property. Property that is acquired by or in the name of the partnership is the property of the partnership and does not belong to any individual partner (RUPA § 203). The partnership can hold and dispose of property in the same way in which a corporation or an LLC can hold and dispose of property—in the "name of the partnership," not in the name

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of individual partners. This brings the partnership form of business organization in line with other forms of business organization that are creatures of statute, such as the limited partnership, corporation, and LLC.

Purported Partners

In our discussion of agency by estoppel in Chapter 27 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch27#ch27) , we saw that if a principal misleads a third party into believing that a person who is not an agent is in fact the principal's agent, the principal will be unable to disavow acts of the purported agent. After all, the third party relied on the purported agent's misrepresentations and may have suffered some tangible loss as a consequence. The principal is thereby prevented from denying the existence of the agency or the lack of authority of the purported agent when he or she is sued by an innocent third party, who justi�iably relied on the existence of the agency because of the misrepresentation.

The same common law tenet applies to partnerships. Partners can be prevented from denying a purported partner's partnership status if the partners allow an innocent third party to mistakenly and justi�iably believe that a nonpartner is a partner. In such cases, a partnership by estoppel exists. This means that the partners are prevented (estopped) from denying the nonpartner's partnership status with regard to any innocent third person:

If a person, by words or conduct, purports to be a partner, or consents to being represented by another as a partner . . . the purported partner is liable to a person to whom the representation is made, if that person, relying on the representation, enters into a transaction with the actual or purported partnership. (RUPA § 308(a) (1997))

Partners are also liable for the purported agent's actions as though the person were in fact a partner. Under the common law, UPA, and RUPA, if all partners in the partnership consent to the misrepresentation, all partners are bound by it. However, if fewer than all the partners consent to the misrepresentation, only those partners who consented to the misrepresentation are jointly and severally liable to any innocent third parties who relied on the misrepresentation in dealing with the purported partner (RUPA § 308(b) (1997)). The following examples will illustrate:

Adam tells Betty that he is a partner of Charlene and David. Betty believes him and enters into a contract with Adam to sell the partnership of Adam, Charlene, and David $1,000,000 worth of of�ice supplies and equipment. The contract will not bind Charlene or David, as the statements by Adam were not made in their presence or with their acquiescence. Only Adam is liable under this contract.

Adam tells Betty that he is a partner of Charlene and David in Charlene's presence, and Charlene does not dispute the statement. Betty later enters into a contract with Adam to sell the partnership of Adam, Charlene, and David $1,000,000 worth of of�ice supplies and equipment. The contract will bind Charlene but not David, as the statements by Adam were not made in David's presence or with his acquiescence. Only Adam and Charlene are liable under this contract.

Adam tells Betty that he is a partner of Charlene and David in the presence of both Charlene and David, who do not dispute the statement. Betty later enters into a contract with Adam to sell the partnership of Adam, Charlene, and David $1,000,000 worth of of�ice supplies and equipment. The contract will bind Charlene and David (as well as Adam) because the misrepresentation was made in their presence and was not objected to by either of them.

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28.3 Partnership Dissociation Even if the partners formed their business with the idea that they would continue for many years, it is not uncommon for people to have a falling out. At that juncture, the partners then wonder how to end the partnership that they formed. The name given to ending a partnership is dissociation. There are a number of voluntary and involuntary ways in which a partner may be dissociated from the partnership.

If the partnership is one "at will," then by de�inition, it has no ending date. Any partner can leave the partnership at any time without incurring further liability. Sometimes the partnership agreement states that it will end upon the happening of an event. For example, the partnership agreement might say:

TERM OF THE PARTNERSHIP

This partnership will end when the house at 124 Elm Street is purchased, the renovations complete, and the house is sold to a third-party purchaser.

In such a case, the partnership ends upon the happening of an event that all the partners agreed to upon partnership formation.

Sometimes the actions of a partner are so egregious that the other partners do not want that person associated with the partnership anymore. When this occurs, the partners may expel the partner from the partnership if they have a partnership agreement that provides for such a scenario. Without an agreement, a partner can still be expelled from a partnership, but it must be by unanimous vote of the partners and only for reasons such as "It is unlawful to carry on the partnership business with that partner." If the partnership cannot agree to expel a partner, then the partnership can go to court and seek a judicial determination for a reason such as the partner engaging in wrongful conduct that "adversely and materially affected the partnership business." Both UPA and RUPA have lists of reasons to terminate a partnership. Examples of reasons to terminate a partnership vary from state to state, depending on how that state adopted the UPA. For examples of what two states have adopted as reasons for termination, click here (http://delcode.delaware.gov/title6/c015/index.shtml) (Delaware) and here (http://www.leg.state.nv.us/NRS/NRS-087.html#NRS087Sec4343) (Nevada).

Winding Up

After dissociation, a partnership enters the winding-up period. During this time, the partners may continue to carry out business that is reasonably necessary to complete contracts in progress and to otherwise bring the business affairs to an orderly close. Upon dissociation, partners lose the authority to bind the partnership to new contracts. If a partner enters into new contracts on behalf of the partnership during the winding-up period, the partnership and other partners will not be bound by such contracts; rather, the partner acting without express authority will be personally liable on these contracts in the same way as any agent who exceeds his or her actual authority (see Chapter 27, Section 27.2 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/sec27.2#sec27.2) ).

Even after dissociation and winding up, partners retain unlimited personal liability for partnership debts. If the assets of a dissolved partnership are insuf�icient to cover partnership debts, creditors of the partnership can sue partners individually or jointly for any shortfall.

Notice to Third Parties Upon Dissolution

Because partners are agents of the partnership, when a partnership is dissolved other than by operation of law (such as by the death or bankruptcy of a partner), partners still have apparent authority to bind the partnership with respect to persons who had previously extended credit to the partnership or known of its existence. For this reason, it is essential that notice be given to such persons that the partnership has been dissolved. Until such notice is received, persons who knew of the partnership's existence or who had extended credit to the partnership in the past may still enter into binding contracts with the partnership through any of its partners. Several methods are available for effectively revoking partners' apparent authority to bind the partnership to new contracts:

Persons who have previously extended credit to the partnership must be personally noti�ied of the partnership's dissolution by any reasonable means (e.g., by letter, telephone, telegraph, or in person). If such noti�ication is mailed, it is effective when it is received, even if it is never read.

Noti�ication to persons who might have known of the existence of the partnership but had not extended credit to it previously is suf�icient if it is published in a newspaper of general circulation in the area or areas where the partnership did business.

Partnerships

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for a pdf of this slideshow.

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Key Terms

Click on each key term to see the de�inition.

assigning partnership property for the bene�it of creditors (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

To resolve a debt with a creditor, the partnership transfers its interest in speci�ic partnership property to a creditor.

assumed name (D.B.A.) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A name for a business, other than the owner's real name. Also known as doing business as, or D.B.A.

capital contribution (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The initial amount of money each partner contributes to begin the business; "seed money."

confessing a judgment (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A legally binding agreement in which a party admits that he or she owes another money; thus, the creditor does not have to sue the debtor in court but can use the confession to collect the money from the debtor.

corporation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of business entity that is formed by permission of the secretary of state's of�ice and has shareholders. The law grants a corporation status as an arti�icial being, much like a person, in that it has the right to enter into contracts, loan and borrow money, sue and be sued, hire employees, own assets, and pay taxes.

dissociation (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When a partner leaves a partnership either voluntarily, because of the partnership agreement terms, or owing to egregious conduct. Upon dissociation, partners lose the authority to bind the partnership to new contracts.

draw (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A partner's share of the pro�its, withdrawn on a regular basis from the partnership's account.

federal tax identi�ication number (TIN) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The number the government assigns to a business entity (e.g., a sole proprietorship) in the form of a nine-digit number; used for �iling tax returns.

general partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of business formed by two or more persons for the purpose of engaging in a business for a pro�it. Also can exist de jure (by law).

goodwill (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The intangible "name recognition" of a business that has meaning to customers and, in some cases, may be worth a great deal of money.

joint and several liability (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The concept that partners can be sued individually or collectively for debts the partnership owes or to pay damages in tort lawsuits.

limited liability company (LLC) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of business formed by permission of the secretary of state's of�ice; usually applies to professionals such as doctors or lawyers.

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limited partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of partnership in which there are general partners and limited partners who are investors in the general partnership.

partnership (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of business formed by two or more people in which they are engaged in a business as co-owners with the intent to make a pro�it.

partnership agreement (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The contract entered into by the partners setting forth their respective rights and duties.

partnership books (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The records showing the �inancial transactions of the partnership. The books must be kept at the principal of�ice of the partnership and made available to every partner, at all times, for inspection and copying.

partnership by estoppel (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

When partners are prevented (estopped) from denying the nonpartner's partnership status with regard to any innocent third person who justi�iably relied on the misrepresentation by an apparent partner.

pro�its and losses (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Pro�its refers to the money accrued after paying any debts owed; losses refers to not having any money accrue or having less money after paying debts.

Revised Uniform Partnership Act (RUPA) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

Approved by the National Conference of Commissioner Uniform State Laws (NCCUSL) in 1994 and amended in 1996 to add the Limited Liability Partnership (LLP) provisions. Each state adopted the RUPA on a different date.

sole proprietorship (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A type of business in which the owner personally operates the business and is solely responsible for all aspects of the enterprise.

secretary of state (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

The state of�icial responsible for registering business entities.

testamentary gift (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A gift given through a will.

Uniform Partnership Act (UPA) (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

A set of laws articulating how to create, dissolve, and run a partnership, originally written by the National Conference of Commissioner Uniform State Laws (NCCUSL) and adopted by every state except Louisiana. Each state's adoption of the UPA varies; all states follow the gist of the law, but states may have changed parts of the law in their adoption of it.

unlimited personal liability (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

In a partnership, once the partnership assets are exhausted, the personal assets of the partners are subject to collection by a creditor. For a sole proprietor, all debts incurred by the business are the personal responsibility of the owner.

winding up (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/sections/fm/books/AUBUS670.12.2/section

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The period after dissociation, when partners may continue to carry out business that is reasonably necessary to complete contracts in progress and to otherwise bring the partnership's business affairs to an orderly close.

Chapter 28 Flashcards

Critical Thinking and Discussion Questions

1. What formalities are necessary for the formation of a sole proprietorship?

2. What are the basic bene�its of doing business as a sole proprietorship? What are the drawbacks?

3. What duties do partners owe the partnership? What duties are owed all the partners by the partnership?

4. In the absence of an agreement to the contrary, how are pro�its in a partnership shared? What about expenses?

5. Partners may generally unilaterally bind the partnership to contracts they enter into with third parties on the partnership's behalf in the regular course of business. But some types of acts require unanimous assent by all partners in a partnership. What are they?

6. What types of activities can a partnership engage in during the winding-up period?

7. Robert Nussbaum, a talented college student with a wonderful voice, would like to start his own business selling self-published audiobooks that he will produce himself by reading from works of �iction in the public domain, digitally recording these on his computer and burning them on CDs. He intends to sell his custom collections on eBay and will advertise his collections as Robert Nussbaum's Classic Audiobooks. a. Will Robert be in violation of the law if he starts doing business without �irst seeking a permit from the state?

b. Can Robert name his business Classic Audiobook Productions without getting a state permit?

c. If Robert's state has a sales tax that applies to the sale of audio and music compact discs, can he go into business without informing the state if he believes that most of the sales will come from out of state?

8. Harry and Harriet enter into an agreement to start an antique dealership business as equal partners. Harry agrees to make a $50,000 capital contribution to the business, and Harriet agrees to provide a commercial building that she has inherited worth $150,000 as her capital contribution. The agreement between the partners speci�ically states that business pro�its and losses will be shared equally. After successfully running the business for a number of years, the partners decide they would like to hire someone to manage the daily operation of the business for them. They hire Helen as the general manager of the business. Although Helen is not a part owner of the business, her salary will be based on a share of the business pro�its. And, although all fundamental business decisions are made by Harry and Harriet, they often ask her advice before implementing new policies. a. Is Helen a partner? Explain fully.

b. If the business goes bankrupt and after dissolution its debts exceed its assets by $200,000, what will the responsibility of Harry, Harriet, and Helen be with regard to the debts?

c. Assume that after dissolution, the debts of the business exceed its assets by 100,000 and that Harry is insolvent, but Harriet has personal assets (including her family home) in excess of $100,000. How much of the debt could creditors ask Harriet to bear? Explain.

To resolve a debt with a creditor, the partnership transfers its interest in specific partnership Click card to see term 👆

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Chapter 29

Limited Partnerships The limited partnership form of business organization was primarily created to address one of the worst shortcomings of the traditional partnership form: unlimited personal liability for �inancial obligations incurred by the partnership (see Chapter 28 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch28#ch28) , Sole Proprietorships and Partnerships). Although such liability of partners protects the general public against losses when dealing with a partnership, unlimited personal liability can make individuals less willing to become partners. What the limited partnership form of business organization accomplishes is to create a special class of partner who is merely an investor but does not become involved in the actual running of the business. As an investor, the limited partner is in a position similar to that of a shareholder in a corporation: The only money the partner can lose is his or her investment or capital contribution if the enterprise should fail or be sued.

Unlike the sole proprietorship and partnership forms of business organization, which were recognized at common law, the limited partnership is a creature of statute. This means that a limited partnership can be formed only in accordance with the speci�ic requirements of each state’s limited partnership act. With the exception of Louisiana, all states, Washington, D.C., and the U.S. Virgin Islands have adopted the 1916 and 1976 versions of the Uniform Limited Partnership Act (ULPA). This chapter will concentrate on the 1976 version of the ULPA (as amended in 1985) as it represents the law in the majority of jurisdictions. For the sake of simplicity, the act will be referred to simply as the ULPA from this point on. As always, keep in mind that the law in the individual states may vary and is always subject to change.

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29.1 Formation of a Limited Partnership A limited partnership is a special type of partnership made up of both general and limited partners. There must be at least one or more general partners who manage the business and have unlimited personal liability for partnership debts. In addition, limited partners contribute capital to the business and share in its pro�its, but their liability is limited to their investment in the business. Being a limited partner is desirable because the limited partnership is an investment device. The limited partner is loaning money to the business and is not interested in helping to run or manage it; instead, he or she is doing something more like buying shares of stock with the expectation of a return, as in an oil and gas venture.

Filing a Certificate of Limited Partnership

In order to form a limited partnership, a certi�icate of limited partnership needs to be executed and �iled with the appropriate state of�ice, usually the of�ice of the secretary of state. Once it is �iled, the limited partnership comes into existence. The certi�icate usually includes the following information:

1. The name of the limited partnership;

2. The address of the of�ice;

3. The name and the business address of each general partner; and

4. The latest date upon which the limited partnership is to dissolve

As should be apparent from these requirements, the main purpose of requiring the limited partnership certi�icate to be executed and �iled is to give notice to the general public of the existence of the partnership and the identity of its general partners, who will ultimately retain unlimited personal liability. Once a certi�icate of limited partnership is �iled, it can be amended by duly notifying the secretary of state of any desired changes. Amendments to the certi�icate are mandatory and must be made within 30 days after the admission or withdrawal of a general partner or the continuation of the business after the happening of an event that requires its dissolution, such as the withdrawal of a general partner.

Admission of New Partners

A person may become a limited partner at the time of the original formation of the limited partnership or "at any later time speci�ied in the records of the limited partnership for becoming a limited partner" (ULPA § 301(a)(2)). After originally �iling the certi�icate with the secretary of state, a limited partner may be admitted as provided for in the partnership agreement. Or, if no provision is made in the agreement, that person can be brought in by the unanimous consent of all partners.

General partners may also be admitted after �iling the original certi�icate of limited partnership, either as provided in writing in the partnership agreement or with the written consent of all partners. In most states, corporations are allowed to be general or limited partners in limited partnerships.

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29.2 Rights and Obligations of General and Limited Partners The rights and obligations of general partners in a limited partnership are similar to those of partners in a traditional partnership (see Chapter 28 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch28#ch28) ). General partners are co-owners of the business who owe the business the �iduciary duties of agents and who share in the management and the pro�its of the business, as well as in its debts. Limited partners, on the other hand, share only in the pro�its of the business and are liable for its debts only up to the limit of their capital investment. They are prohibited from participating in the control of the business.

Purported Limited Partners

If a limited partner participates in the control of the business, he or she will be "liable to persons who transact business with the limited partnership reasonably believing, based upon the limited partner’s conduct, that the limited partner is a general partner" (ULPA § 303). In addition, he or she can lose his or her special status and be subject to unlimited liability for the debts of the business to persons who, in the course of good-faith business dealings, believe the limited partner to be a general partner. In other words, a limited partner who becomes involved in the management of the business is estopped from denying he or she is a general partner with regard to persons who might have reasonably believed him or her to be a general partner because of his or her involvement in managing the business. A limited partner who allows his or her name to be used in the name of the partnership (a privilege reserved to general partners) will be liable as a general partner to any person who extends credit to the partnership without actual knowledge that the partner so named is only a limited partner (see also the subsection titled "Purported Partners" in Chapter 28).

Voting Rights

Despite the prohibition on limited partners managing the partnership, limited partners can be granted the right to vote along with general partners on some partnership matters by express provision in the limited partnership agreement. Note, however, that even if they vote on any of the following matters, that does not constitute participating in management of the business:

1. The dissolution and winding up of the limited partnership;

2. The sale, exchange, lease, mortgage, pledge, or other transfer of all or substantially all of the assets of the limited partnership;

3. The incurrence of indebtedness by the limited partnership other than in the ordinary course of its business;

4. A change in the nature of the business;

5. The admission or removal of a general partner;

6. The admission or removal of a limited partner;

7. A transaction involving an actual or potential con�lict of interest between a general partner and the limited partnership or the limited partners;

8. An amendment to the partnership agreement or certi�icate of limited partnership; or

9. Matters related to the business of the limited partnership not otherwise enumerated in this subsection that the partnership agreement states in writing may be subject to the approval or disapproval of limited partners. (ULPA § 303(b)(6))

When corporations are involved as partners, the liability of the corporation for partnership debts will encompass either all assets of the corporation (if the corporation is a general partner) or the capital invested in the partnership (if the corporation is a limited partner). As you will see in chapter 30 (http://content.thuzelearning.com/books/AUBUS670.12.2/sections/ch30#ch30) , in either case, the corporate shareholders (the owners of the corporation) will be insulated from personal liability beyond their investment in the corporation.

Sharing Profits and Losses

Recall that, in a general partnership, the partners shared the pro�its and losses equally unless the partnership agreement stated otherwise. In a limited partnership, by contrast, the pro�its and losses of the limited partners are distributed in proportion to their respective contributions. ULPA states that unless the partnership agreement states otherwise, "pro�its and losses shall be allocated on the basis of the value . . . of the contributions made by each partner."

Withdrawal by General and Limited Partners

A general partner may withdraw from a limited partnership at any time by giving written notice to the other partners. If the partnership agreement prohibits withdrawal, a general partner may still withdraw but in doing so will be in breach of the partnership contract and can be sued for damages by the other partners. Upon the withdrawal of a general partner, the partnership will be dissolved unless the partnership agreement provides for continuation by the remaining partners in such a situation.

Limited partners may also withdraw at any time upon the happening of events noted in the partnership agreement, or at any time by giving not less than six months’ prior written notice of their intention to all partners. If the limited partner’s right to withdraw is limited in the partnership contract, and the limited partner withdraws in violation of such a contract, then he or she may be liable for breach of contract. The withdrawal of a limited partner will not automatically dissolve the partnership unless the limited partnership agreement so provides.

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Assignment of Partnership Interest

General and limited partnership interests are personal property that may be freely assigned in whole or in part in the absence of an agreement to the contrary. Assignment of a partnership interest will not cause dissolution of the partnership. If a limited partnership interest is assigned, the assignee can become a limited partner of the business with all the rights and responsibilities of the assignor (limited partner).

Dissolution of a Limited Partnership

This section will explore the actions and events that may result in the end of a limited partnership, keeping in mind again that the entity is a creature of state statute. Dissolution of a limited partnership may be divided into two types: judicial and nonjudicial.

Nonjudicial dissolution refers to the termination of a limited partnership as the result of the occurrence of an event under ULPA § 801 as follows:

At the time speci�ied in the certi�icate of limited partnership;

Upon the happening of events speci�ied in writing in the partnership agreement;

With the written consent of all partners; or

By an event of withdrawal of a general partner, unless at the time there is at least one other general partner and the written provisions of the partnership agreement permit the business of the limited partnership to be carried on by the remaining general partner, and that partner does so. (The ULPA continues on to state that the limited partnership is not dissolved and is not required to be wound up by reason of any event of withdrawal if, within 90 days after the withdrawal, all partners agree in writing to continue the business of the limited partnership and to the appointment of one or more additional general partners if necessary or desired.)

The second way to terminate a limited partnership is by going to court and requesting that the court intercede and terminate the partnership. In such a case, the court must �ind that "it is reasonably impractical to carry out the business in conformity with the terms of the limited partnership agreement."

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29.3 Foreign Limited Partnerships A foreign limited partnership, despite its name, is merely a domestic limited partnership that is doing business in a state or states other than the one in which it was organized. Foreign limited partnerships must register and submit a form in duplicate to the appropriate of�ice (generally the secretary of state’s of�ice) in every state where they wish to do business and pay the requisite fees. The ULPA requires that the following information be provided in the application for registration to the secretary of state:

1. The name of the foreign limited partnership and, if different, the name under which it proposes to register and transact business in this state;

2. The state and date of its formation;

3. The name and address of any agent for service of process on the foreign limited partnership whom the foreign limited partnership elects to appoint;

4. A statement that the secretary of state is appointed the agent of the foreign limited partnership for service of process if no agent has been appointed;

5. The address of the of�ice required to be maintained in the state of its organization by the laws of that state or, if not so required, of the principal of�ice of the foreign limited partnership;

6. The name and business address of each general partner; and

7. The address of the of�ice at which is kept a list of the names and addresses of the limited partners and their capital contributions, together with an undertaking by the foreign limited partnership to keep those records until the foreign limited partnership’s registration in this state is canceled or withdrawn.

The registration requirements above are meant to protect the citizens of the state in the event that they have claims against a foreign limited partnership by making it easy to sue both the partnership and its individual members. In addition, the registration fee (which varies by state) is a source of income for state governments. If an application to register as a foreign limited partnership is properly completed and accompanied by the appropriate fee (which varies from state to state), the secretary of state issues a certi�icate of registration to transact business to the applicant, returning a copy of the application to the applicant and keeping one on �ile.

When a foreign limited partnership does business in a state without �iling the required certi�icate, ULPA provides that, until it completes the registration process, the partnership will not be allowed to bring any lawsuit in the state seeking civil relief for alleged breaches in contract or torts committed against it. It can, however, enter into valid contracts notwithstanding the failure to register and can be sued by third parties in the state’s courts.