Archive for the ‘Commentary’ Category

Loftium Unwittingly Forms Partnerships with Homebuyers

Wednesday, September 20th, 2017

Yesterday, the New York Times trumpeted a new internet company, Loftium, and its interesting, new-economy business model (which, for the time being, operates only in Seattle):

Loftium will provide prospective homebuyers with up to $50,000 for a down payment, as long as they are willing to continuously list an extra bedroom on Airbnb for one to three years and share most of the income with Loftium over that time.

At first glance, the arrangement between Loftium and participating homebuyers might sound like a loan.  (Indeed, the Times even describes it as such in an infographic.)  But upon a closer look, the arrangement that Loftium contemplates with homebuyers clearly is not a loan.  First of all, Loftium says it is not a loan; rather, according to Loftium, the down payment assistance it provides to homebuyers is “a part of a services agreement” lasting 12-36 months.  Second, and more important, the arrangement between Loftium and homebuyers has none of the characteristics of a traditional (term) loan.  There is no “principal” amount that the homebuyer is required to repay in a set period of time, and Loftium does not charge the homeowner any “interest.”  In fact, the homebuyer is not required to make any payments to Loftium in return for the company’s cash (unless the homeowner breaches the parties’ agreement and stops renting on Airbnb before the term expires).

All the homebuyer must do in exchange for Loftium’s money is (1) list her spare room on Airbnb continuously through the term of her agreement with Loftium, (2) be a decent host (i.e., “not be[] rude to guests”) and (3) split her Airbnb  rental revenue with Loftium (with two-thirds going to the company.)  If, at the end of the term, Loftium has not been repaid its initial investment, the homeowner is not required to repay Loftium’s initial contribution. Hence, if renting out the homeowner’s spare room is not profitable during the term of the parties’ agreement, “Loftium takes full responsibility for that loss.”

Of course, Loftium expects that the total income from renting out a homeowner’s spare room will greatly exceed the amount that it originally provided to the homebuyer, so that both will profit.  If Loftium makes more in rental income than it pays towards the homeowner’s down payment, Loftium will make a profit.

Further, by all appearances, there is no cap on Loftium’s potential profit is its business arrangement with homebuyers.  In fact, Loftium makes clear that it wants to maximize the income that it splits with homebuyers:  Loftium promises that it will work with them “to increase monthly bookings as much as possible, so both sides can benefit from the additional income.”  To that end, Loftium provides homebuyers with some start-up supplies for their spare bedroom (and a keyless entry lock), access to advice and know-how regarding how to rent an Airbnb room, and online tools to help maximize their rental income.

So, if the business arrangement between Loftium and homeowners is not a loan, what is it?  It is almost certainly a general partnership for a term (i.e., a “joint venture”).

What is a Partnership?

Both the original Uniform Partnership Act (UPA) (adopted uniformly by almost every state, but now in effect in only around 13 states) and its successor, the revised Uniform Partnership Act (RUPA) (variations of which have been adopted by perhaps 37 states) define a partnership as an “association of two or more persons to carry on as co-owners a business for profit.”  UPA § 6(a); RUPA § 202.

Hence, creation of a partnership has four elements: (1) an association of two or more (2) persons; (3) who carry on as co-owners; a (4) for-profit business.

The Easy Elements

There can be no doubt that Loftium and the homebuyer are legal persons under the statute.  See UPA § 2 (defining “person” to include corporations like Loftium).  Further, it is clear that leasing an Airbnb apartment year-round is a for-profit business. (Indeed, Loftium advises homebuyers that they must obtain a business license from the city of Seattle.)

As a result, the only elements in question are (1) whether the parties have voluntarily “associated” and (2) whether they are “co-owners” of the for-profit business of renting out the homeowner’s spare room on Airbnb.

The Element of “Co-Ownership”

It might seem, since the homebuyer owns the spare room and Loftium does not, that the two are not “co-owners.”  However, the relevant question is not whether the two are co-owners of the property used to operate the business, but rather, whether the two are co-owners of the Airbnb business.  It is quite common for a partnership to operate a business using the real property of only one partner.  See, e.g., Lupien v. Malsbenden, 477 A.2d 746 (Me. 1984); Peed v. Peed, 325 S.E.2d 275 (N.C. Ct. App. 1985). Indeed, absent express contrary intention, RUPA presumes that personal property of a partner which she allows the partnership to use for the business remains her own property, and is not contributed to the partnership.  See RUPA § 204(d).

UPA and RUPA also provide some guidance for courts in assessing whether persons who operate a business are “owners” of that business.  First, both statutes effectively presume that anyone who shares the profits of a business is an owner of—and thus, a partner in—the business.  See UPA § 7(4) & RUPA § 202(c).  However, that presumption has an important caveat: Receiving a share of the profits of a business is not presumed to make one a partner in that business if “the profits were received in payment … of a debt by installments or otherwise … or of interest … on a loan, even if the amount of payment varies with the profits of the business.” RUPA § 202(c)(1)(i) & (v); accord UPA § 7(4)(a) & (d).  Hence, if Loftium shared the profits of each homeowner’s Airbnb rental business as repayment of a loan to the homeowner, the law would not presume that Loftium was a co-owner of (and partner in) the homeowner’s business.

Yet here, not only has Loftium explicitly denied that it is lending money to homebuyers, its arrangement with homebuyers looks nothing like a traditional loan.  Accordingly, if Loftium were to argue that it was not a homebuyer’s partner because it simply loaned the homebuyer money for the homebuyer’s business, a court would probably reject that argument.  See, e.g., Lupien, supra (holding that an alleged “banker” who took over the business of his “borrower,” and whose “loan” to the business “carried no interest and no fixed payments, but was to be repaid only” out of revenues from the business, was in fact a partner).

Admittedly, Loftium and a homeowner do not exactly split “profits” of their Airbnb rental business; rather, they each contribute different things to the partnership and then split the revenues.  The homeowner contributes some labor, plus the use of her spare room, furnishings and bathroom; Loftium puts in cash, some supplies, its know-how about renting on Airbnb, and other online resources.  Yet, it is not uncommon for one partner to contribute property (or the use thereof) to the partnership while another partner contributes something else to the partnership—and both partners split the partnership’s revenues.  For example, it is common for one partner (the “money partner”) to provide capital (and sometimes, agree to accept all capital losses) and the other partner (the “service partner”) to provide labor and/or expertise.  Accordingly, Loftium and each homebuyer are undoubtedly sharing “profits” of the partnership, not the “gross” (which does not lead to a presumption of partnership, see UPA §7(3)).  Although they do not share the profits (or the losses) from the business equally, that is not required of partners (although it is the default rule in the absence of a contrary agreement).  See RUPA § 401 cmt. 3.

In addition, if one stops to consider why the statutes deem sharing profits as a critical gauge of co-ownership, one realizes that sharing profits—i.e., revenues net expenses—means sharing fully in the risks and rewards of the business.  Unlike a lender, who is paid “off the top,” an equity owner who is paid from the “net” shares the risk that the business’s expenses will exceed its revenues.  However, also unlike a lender, an equity owner shares in any profit that occurs if revenues exceed expenses.

Hence, in assessing whether one co-owns a business and therefore is a partner in it, courts often consider whether she shares fully or only superficially in the risks of the business. See In re KeyTronics, 274 Neb. 936 (2008) (describing co-ownership as whether the parties “share the benefits, risks…of the enterprise” such that they “subjectively view themselves as members of the business rather than as outsiders contracting with it”).  Here, there can be no doubt that Loftium is a co-owner of each homeowner’s Airbnb rental business because—as Loftium freely admits—it takes on all of the risks. If, upon expiration of the term, the Airbnb rental has made no money, the owner owes nothing to Loftium and gets her spare room back; Loftium, by contrast, loses its entire investment.  Further, Loftium’s marketing materials make clear that the company  intends to maximize the Airbnb revenues that it shares with the homeowner  This stands in stark contrast to a lender who only cares whether the business makes enough money to repay its principal with interest (which come “off the top”).

Finally, in assessing whether one is co-owner a business—and as such, is a partner in that business—courts also consider whether the person in question has a right to manage the business.  Cf. UPA § 6 cmt. (“To state that partners are co-owners of a business is to state that they each have the power of ultimate control.”). Loftium satisfies this requirement in spades.  While the owner furnishes and takes care of the premises (and can, if she decides, clean it herself), Loftium plays a critical role in managing the business by setting (and constantly adjusting, to suit market conditions) the price for the homeowner’s spare room on Airbnb.  Further, as described above, Loftium provides some supplies (like the keyless entry lock) and advice for hosting on Airbnb; Loftium also requires homeowners to provide its guests with certain amenities.  Moreover, while the homeowner sets rules for the apartment on Airbnb, Loftium can veto the rules if it considers them “overly restrictive.”

Yet, even if Loftium had no role in managing the Airbnb business, that would not prevent it from being a partner.   The history of “silent” partners in a real estate ventures who merely provide funds (and share profits), but allow another partner to manage the business is a venerable one.  See, e.g., Meinhard v. Salmon, 249 N.Y. 458 (1928) (Cardozo, J.) (perhaps the most famous case in partnership law) (silent partner in New York’s Hotel Bristol provided cash; managing partner operated the business and functioned as its sole public “face”). Donald Trump himself has been involved in similar partnerships (albeit a limited partnership): Back when he actually built buildings, but after he nearly went bankrupt, he sold 70% of his interest in Riverside South to partners from Hong Kong; while The Donald built, operated and was the public face of these buildings, his partners put in the real money.  (Ironically, while he oversaw development, he left himself with no control over key important aspects of the business, including its sale. But I digress.) 

In sum, since Loftium and the homebuyers to whom it provides down payment cash are co-owners of a for-profit business, they undoubtedly are partners.

The Element of “Association”

Yet, what of the final element, “association”?  It means that the parties must partner voluntarily.  See Gangl v. Gangl, 281 N.W.2d 574 (N.D., 1979) (explaining that “association” element “connotes…voluntariness.”).

At first glance, this element seems easily satisfied, because on its website, Loftium repeatedly describes itself as “partnering” with homebuyers to rent out their spare room on Airbnb.  This is a red herring, though. Business people often use the term “partner” colloquially, so labeling oneself a partner in a business does not automatically make one a partner in that business.  See, e.g., Gangl, supra.  Or, as one Texas court famously put it when holding that two people were not partners simply because they described themselves as such: “a duck which is called a horse does not become a horse; a duck is a duck.” City of Corpus Christi v. Bayfront Assocs., Ltd., 814 S.W.2d 98  (Tex. App.—Corpus Christi 1991).

Digging deeper, one discovers that, contrary to Loftium’s careless use of the word “partner” on its website, the company actually has attempted to protect itself from being deemed a partner with homebuyers by contract.  According to the “terms of service” that governs the arrangement between Loftium and homebuyers:

No agency, partnership, joint venture, or employment relationship is created…, and neither party has any authority of any kind to bind the other in any respect.

In short, Loftium and homebuyers will agree by contract that their arrangement is not a partnership.  Although judges often write that the parties’ “intent” is critical to the formation of a partnership, this language is misleading because it does not specify the precise subject of the parties’ intent.  That is to say, this language fails to state exactly what the parties must intend in order to be partners.

Disclaimers of Partnership

According to the settled law, the relevant question is whether the parties intended to be coowners of a for-profit business, not whether they intended to form a relationship known as a “partnership.”  See Byker v. Mannes, 641 N.W.2d 210 (Mich. 2002) (explaining that, if the parties “associated to ‘carry on’ as co-owners a business for profit, they will be deemed to have formed a partnership relationship regardless of their subjective intent to form such a legal relationship”; and that “the statute does not require partners to be aware of their status as ‘partners’ in order to have a legal partnership …. [In ascertaining the existence of a partnership, the proper focus is on whether the parties intended to…’carry on as co-owners a business for profit’ and not on whether the parties subjectively intended to form a partnership.”); Heck & Paetow Claim Service, Inc. v. Heck, 93 Wis.2d 349 (1980)(“The ultimate and controlling test as to the existence of a partnership is the parties’ intention of carrying on a definite business as coowners.”); Bass v. Bass, 814 S.W.2d 38, 41 (Tenn. 1991) (“It is the intent to do the things which constitute a partnership that determines whether individuals are partners, regardless if it is their purpose to create or avoid the relationship.“)  

In short, not only is it possible for two people to form a partnership without any intent to do so, it is possible for two people to form a partnership despite that they intend not to do so.  See RUPA § 202, cmt. 1 (“[A] partnership is created by the association of persons whose intent is to carry on as co-owners a business for profit, regardless of their subjective intention to be “partners.” Indeed, they may inadvertently create a partnership despite their expressed subjective intention not to do so.”).

For this reason, courts have long held—particularly in cases involving claims by third parties against one or more partners (but, as I intend to argue in a subsequent article, also in claims between partners)—disclaimers of partnership are not dispositive if contrary to the facts.  As the New York Court of Appeals explained, in a celebrated case:

Mere words will not blind us to realities. Statements that no partnership is intended are not conclusive. If as a whole a contract contemplates as association of two or more persons to carry on as co-owners a business for profit, a partnership there is.

Martin v. Peyton, 246 N.Y. 213, 217-18 (1927) (Andrews, J.)

Although some cases hold (wrongly, I believe) that parties may define their own relationship by contract, there is little doubt that Martin (which involved a claim made by a creditor against alleged partners) is the rule in lawsuits by third parties.

In sum, even if a court were to decide, in a lawsuit by the homeowner, that the disclaimer of partnership in Loftium’s terms of service precludes formation of a partnership between Loftium and the homeowner, a court would nonetheless be likely to deem the disclaimer ineffective in a lawsuit by a third party. So, for example, if an Airbnb renter who slips and falls in a homebuyer’s spare room (and whose claim exceeds Airbnb’s $1 million liability insurance policy for its subscribers) could probably obtain damages from Loftium.  See UPA § 13(a) & 15(a) (partners are liable for the negligence of another).

A Simple Solution

Although this possibility of liability to third parties (and, if my interpretation of partnership law is correct, to homebuyers) may come as a shock to Loftium, the problem actually has an easy solution.  With respect to third parties, Loftium could substantially limit its potential liability by forming a limited liability company (LLC) with each homebuyer.  A member of (i.e., one with an ownership interest in) an LLC is not liable to third parties for debts of the LLC.  See, e.g., Tex. Bus. Orgs. Code § 101.114.  While this would not allow Loftium to escape liability for its own misconduct (or, if its disclaimers of partnership are ineffective as to homeowners, for lawsuits by homeowners), it would substantially reduce Loftium’s risk of being held liable to a third party for a homeowner’s torts or contractual debts.

Posted by Joe Leahy

Manesh on Dictum & Default Duties

Tuesday, March 12th, 2013


Mohsen Manesh (Oreg.) has a working paper with the alliterative title Damning Dictum: The Default Duty Debate in Delaware” (February 21, 2013)(SSRN). The paper reacts to the Delaware Supreme Court’s opinion in Gatz Properties, LLC. v. Auriga Capital Corp., C.A. 4390 (Del. Nov. 7, 2012)(per curiam), aff’g on other grounds, Auriga Capital Corp. v. Gatz Properties, LLC, 40 A.3d 839 (Del. Ch. 2012) (slip opinion). As discussed in Gatz Properties, LLC. v. Auriga Capital Corp. (Del. 2012): Strine Affirmed on other Grounds and Chastised, in his opinion below, Chancellor Strine had outlined the basis for applying default fiduciary duties to persons managing Delaware LLCs, and the Delaware Supreme Court rebuked him for doing so.

Prof. Manesh criticizes the Delaware Supreme Court’s opinion in Gatz Properties, LLC on several grounds. Two of the most important are:

  • The Court needlessly unsettled expectations that default fiduciary duties apply, except where modified or eliminated by agreement.
  • Not only have both the Delaware Chancery and Supreme courts long used dicta to guide the development of the law, that practice is central to the pre-eminence of those courts, and of Delaware generally, in the law of business organizations.

Gary Rosin

Ethics and Ellipsis. Ly v. Jimmy Carter Commons, LLC (Ga. 2010)

Thursday, February 7th, 2013

Probably, every lawyer has used an ellipsis to show that a portion of the text was left out of a quotation. But what are the ethics of elision and inclusion?

Consider, if you will, the opinion in Ly v. Jimmy Carter Commons, LLC, 286 Ga. 831, 691 S.E.2d 852 (2010). A manager of an LLC (Byun) purported to borrow money on behalf of the LLC in connection with a real estate development. As part of the closing documents, the manager gave the lender a purported “Unanimous Consent of the Manager and Members” that authorized the manager to borrow the money, sign the promissory note, and the mortgage on the LLC’s land to secure payment of the note. As it turned out, one of the signatures was forged. When the LLC defaulted on the note, the LLC sued the lender to enjoin foreclosure, and to void the note and mortgage, on the grounds that the manager lacked the authority to borrow the money, or to sign the note and the mortgage. The trial court granted summary judgment in favor of the LLC. The Georgia Supreme Court reversed, holding that there was a question of fact.

What is interesting about the opinion is not the result; rather it is the reasoning of the opinion, and the way the opinion used the Georgia LLC statute.

* * * … there is still a genuine issue of material fact as to whether Appellants had knowledge that the unanimous consent documents were ineffective and did not give Byun the authority to act alone on behalf of Jimmy Carter Commons.

[T]he act of any manager [of a limited liability company] … binds the limited liability company, unless the manager so acting has, in fact, no authority to act for the limited liability company in the particular matter, and the person with whom he or she is dealing has knowledge of the fact that the manager has no such authority. (Emphasis supplied.)

OCGA § 14-11-301(b)(2). Thus, “[n]o act of a manager … in contravention of a restriction on authority shall bind the limited liability company to persons having knowledge of the restriction.” OCGA § 14-11-301(d).

Consequently, even if Byun acted beyond his authority as a manager of Jimmy Carter Commons, the limited liability company may still be bound by his actions if Appellants did not know that he lacked such authority. In its summary judgment order, the trial court did not cite, and Jimmy Carter Commons has not identified, undisputed evidence showing that Appellants knew that Choi’s signatures on the consent documents were forged. * * *

691 S.E.2d at 853.

Here is the complete text of Section 14-11-301:

§ 14-11-301. Powers, duties, and authority of members and managers

(a) Except as provided in subsection (b) of this Code section, every member is an agent of the limited liability company for the purpose of its business and affairs, and the act of any member, including, but not limited to, the execution in the name of the limited liability company of any instrument for apparently carrying on in the usual way the business and affairs of the limited liability company of which he or she is a member, binds the limited liability company, unless the member so acting has, in fact, no authority to act for the limited liability company in the particular matter, and the person with whom he or she is dealing has knowledge of the fact that the member has no such authority.

(b) If the articles of organization provide that management of the limited liability company is vested in a manager or managers:

(1) No member, acting solely in the capacity as a member, is an agent of the limited liability company; and

(2) Every manager is an agent of the limited liability company for the purpose of its business and affairs, and the act of any manager, including, but not limited to, the execution in the name of the limited liability company of any instrument for apparently carrying on in the usual way the business and affairs of the limited liability company of which he or she is a manager, binds the limited liability company, unless the manager so acting has, in fact, no authority to act for the limited liability company in the particular matter, and the person with whom he or she is dealing has knowledge of the fact that the manager has no such authority.

(c) An act of a manager or a member that is not apparently for the carrying on in the usual way the business or affairs of the limited liability company does not bind the limited liability company unless authorized in accordance with a written operating agreement at the time of the transaction or at any other time.

(d) No act of a manager or member in contravention of a restriction on authority shall bind the limited liability company to persons having knowledge of the restriction.

(emphasis added).

Any partnership lawyer will recognize subsections (a), (b)(2), and (d) as taken from section 9 of the Uniform Partnership Act, and adapted for member-managed and manager-managed LLCs. Any partnership lawyer will also recognize the centrality of the language omitted by the court, especially the portion in bold italics. As written, Section 14-11-301 conditions a manager’s power to bind the LLC by an unauthorized act to acts “apparently carrying on the the usual way the business and affairs of the LLC.” As subsection (c) makes clear, unauthorized acts that are not apparently carrying on in the usual way the business and affairs of the LLC do not bind the LLC. The result of the misquotation–the ellipsis–is a radical expansion of the apparent authority of LLC’s manager: not just usual acts, but any act, without regard to its nature.

This seems to me to be a particularly pernicious use of the ellipsis; one that changes the character of the quotation. Even non-lawyers recognize that intentionally omitting important information is unethical. Thanks to Seinfeld, we even have an expression that describes an elision made in bad faith: “yada, yada.

The question here is whether the justices on the Court knew that a key part of the statute had been dropped out. One might attribute the misquotation to the not-uncommon phenomenon of unfamiliarity with agency principles, and unincorporated business entity law, or, instead, to an overcrowded docket. Still, it is hard to imagine that none of the justices read Section 14-11-301 closely, or that, on close reading, none noticed its limits on apparent authority.

That said, the result–overturning the summary judgment–is probably correct. Whether borrowing money is apparently carrying on in the usual way the LLC’s business is a question of fact that turns on the nature of the LLC’s business. Jimmy Carter Commons, LLC seems to have been a real estate development 0company. Such companies are more likely to be customary frequent borrowers than, say, a company selling advertising slots on a border radio station. See, Burns v. Gonzalez, 439 S.W.2d 128 (Tex Civ. App. 1969).

But, as I suggested in my earlier post, Conflating Tests for Agents and Servants, there is no such thing as a “harmless” misstatement of the law by a court. Given that the misstatement here is by the Georgia Supreme Court, only a later opinion of that court can put Georgia law back on the right course.

Gary Rosin

Conflating Tests for Agents and Servants: Greater Houston Radiation Oncology, P.A. v. Sadler Clinic Association, P.A. (Tex. App. 2012)

Monday, January 28th, 2013

Courts are prone to use “agent” when they mean “servant.” Many opinions involving the application of respondeat superior use “agent,” instead of “servant.” That is a mistake, in that principals are generally not liable for the incidental torts of agents; rather masters are liable for the torts of servants committed in the scope of employment. Such opinions then define “agent” using the test for whether someone is a servant: does the putative master (often also improperly called the principal) have the right to control the conduct of the person or the details of the work?

At this point you might wonder what the problem is: regardless of nomenclature, the court applied the right test for potential respondeat superior liability. Even before the advent of databases of opinions that let you search cases for words, there were Words and Phrases, West head-notes, and the rote application of sentences taken from opinions.

The danger in such opinions is that a later court might use the wrong test for control in a case where the issue is whether a person was an agent. That was one of the issues confronted by the court in Greater Houston Radiation Oncology, P.A. v. Sadler Clinic Association, P.A., 384 S.W.3d 875 (Tex. App. 2012) (slip opinion). Greater Houston Radiation Oncology, P.A. (and its affiliates) agreed to the operate, maintain, and provide professional services for, a radiation oncology center on behalf of Sadler Clinic. The relationship between the two soon deteriorated in claims and counter-claims.

One of the claims was that Greater Houston Radiation Oncology (or one of its affiliates) had breached the fiduciary duties that it owed Sadler Clinic. The court held that no fiduciary duties were owed Sadler Clinic, because none of the Greater Houston Radiation Oncology companies was its agent:

To prove an agency relationship between parties, the party asserting the agency must prove the principal has the right to assign the agent’s task and the right to control the means and details by which the agent will accomplish its assigned task.

Slip Op., at 39 (emphasis added). The two cases relied on by the court, Hanna v. Vastar Res., Inc., 84 S.W.3d 372 (Tex.App. 2002) and O’Bryant v. Century 21 S. Cent. States, Inc., 899 S.W.2d 270 (Tex.App. 1995), were both respondeat superior cases in which the court had incorrectly used “agent,” rather than “servant.”

Greater Houston Radiation Oncology, P.A. v. Sadler Clinic Association, P.A. is similar to Green v. H & R Block, Inc., 355 Md. 488, 735 A.2d 1039 (1999). in Green, taxpayers who had used H & R Block tax preparation services, and who also taken out “Refund Anticipation Loans” arranged by H & R Block, sued H & R Block for breach of fiduciary duty. The trial court dismissed the taxpayers’ claims, on the ground that H & R Block was not their agent. The trial court reasoned that, among other things, the taxpayers did not control the details of H & R Block’s work. The Court of Appeals held that the trial court had improperly applied the test for the master-servant relationship, saying:

H & R Block misconstrues the level of control necessary for establishing a principal-agent relationship. The control a principal must exercise over an agent in order to evidence an agency relationship is not so comprehensive. A principal need not exercise physical control over the actions of its agent in order for an agency relationship to exist; rather, the agent must be subject to the principal’s control over the result or ultimate objectives of the agency relationship.

* * *

The level of control a principal must exercise over the agent becomes more clear when it is contrasted with the control exercised by the master in a master-servant relationship. * * *

* * *

[T]he level of control a principal exercises over an agent is less than the level of control a master has over a servant. Indeed, the level of control a master exercises over a servant is a key factor distinguishing the master-servant subset of the set of principal-agent relationships. In other words, all masters are principals and all servants are agents, but only when the level of control is sufficiently high does a principal become a master and an agent a servant. See Restatement (Second) of Agency § 2 cmt. a (1958) (“A master is a species of principal, and a servant is a species of agent.”). Thus, principals who are not masters exercise a much lesser degree of control over their agents than masters do over their servants.

In sum, the control a principal exercises over its agent is not defined rigidly to mean control over the minutia of the agent’s actions, such as the agent’s physical conduct, as is required for a master-servant relationship. The level of control may be very attenuated with respect to the details. However, the principal must have ultimate responsibility to control the end result of his or her agent’s actions; such control may be exercised by prescribing the agents’ obligations or duties before or after the agent acts, or both.

735 A.2d at 1050-52.

The same result should follow in Greater Houston Radiation Oncology, P.A. v. Sadler Clinic Association, P.A.: setting the task of the Greater Houston Radiation Oncology group of companies is enough control to satisfy the test for agency.

The history of the case shows that a petition for review was filed with the Texas Supreme Court. So, as they say in the NFL, pending further review…. The difference is that the case probably falls under that Court’s discretionary jurisdiction. And, as the history of the single business enterprise doctrine shows, the mere fact that bad law is circulating among the lower courts is not, by itself, a sufficient basis for the Supreme Court to intervene.

Of course, the Texas Supreme Court itself has sometimes been too casual in its use of “agent” and “servant.” See, Arvizu v. Estate of Puckett, 364 S.W.3d 273, 276-77 (Tex. 2012) (per curiam) (citing with approval opinions using “principal, “agent” and the right to control the details of the work in the context of respondeat superior cases).

Gary Rosin

More on Power to Bind by an Unauthorized Act

Friday, August 26th, 2011

In Sources of Apparent Authority, I discussed the apparent authority requires a holding out  (manifestation) by the principal; as a general rule apparent authority cannot be based only on the conduct of an agent.  That said, one of the traditional sources of apparent authority is appointing an agent to a position that, by custom, carries with it certain authority to act for the principal.  In most of the cases involving “power of position,” the principal does not communicate directly with the third person;  the only affirmative act by the principal is the appointment to the position.  That raises the question:  how is that apparent authority, as opposed to estoppel to deny agency power? That question leads to these further observations:

  • The traditional view is that an agent has implied authority to tell third persons the position to which the agent has been appointed.  A statement by the agent–a holding out–“I am the General Manager” (for example)–can be deemed to be a statement by the principal.  In Tutti Mangia Italian Grill v. Amer. Textile Maintenance Co., if the person who signed the contract as General Manager was, in fact, the General Manager (an additional fact), then the holding out by the GM was a holding out by the principal.
  • To the extent that you don’t buy the traditional view, then estoppel to deny agency power can apply.  The principal appoints the agent to a position with customary power.  The principal should reasonably foresee that the agent will tell his position to third persons, who will reasonably believe that the agent has the customary authority.  If the principal limited the agent’s authority, the principal’s failure to warn third parties of that limitation can form the basis of estoppel to deny agency power.
  • Where the agent is a general agent, apparent authority by position would also be inherent agency power (which Restatement Third of Agency rejects).

The point is that the Restatement categories tend to overlap.  Many states, such as California, tend to lump them all together into ostensible authority. 

As I tell my students, all these doctrines are just judges and professors trying to explain the circumstances in which power to bind by an unauthorized act arises.  But, as the Zen koan put its:  the finger that points at the moon is not the moon.

When Learned Hand was pointing at the moon, he probably didn’t intend to invent a new doctrine, inherent agency power.  Because he was the Revered Learned Hand, that’s what happened.  The Restatement Third would abolish the doctrine. Good luck with that.

posted by Gary Rosin


Sources of Apparent Authority: Tutti Mangia Italian Grill v. Amer. Textile Maintenance Co. (Cal. Ct. App.)

Wednesday, August 24th, 2011

In Tutti Mangia Italian Grill v. Amer. Textile Maintenance Co., No. B227191 (Cal. Ct. App. 7/18/11), one of the issues was whether an agent who signed a contract containing an arbitration agreement was authorized to sign the contract.  The Court held that there was substantial evidence to support a finding of “ostensible” authority:

First, Christian signed the written agreement as the “General Manager” for TMIG, and a general manager generally has the authority to enter into agreements for the corporation. Second, the arbitrator found, based upon testimony at the arbitration hearing, that Christian “was in fact holding himself out as the General Manager and as one authorized to sign.” Accordingly, we affirm the trial court‟s finding that Christian was TMIG‟s ostensible agent, and thus, we conclude that there was a valid arbitration clause that required TMIG to arbitrate this matter.

Slip Op., at 12-13 (citations omitted) (emphasis added).

I know that “California’s a brand new game.” But apparent authority, and the other forms of power to bind by an unauthorized act, generally require some sort of conduct (or possibly negligence) on the part of the principal, and not just assertions by the agent alone.  It even says that in Section 2317 of the California Civil Code:

Ostensible authority is such as a principal, intentionally or by want of ordinary care, causes or allows a third person to believe the agent to possess.

So, the the arbitrator, the trial court and the Court of Appeal (Second District, Division 4) all misapplied the law.

But the arbitrator also found some of the facts necessary for a ratification:

There was never any disavowal of said Agreement by [TMIG] who impliedly accepted the benefits of same by operating thereunder.

Slip Op. at 4-5.  The contract was for “the provision of restaurant linens,” id. at 2, so the restaurant presumably took delivery of, and used, the linens.  That’s probably the acceptance of benefits to which the restaurant was not entitled, except under the contract.  The ” no partial ratifications” rule would prevent accepting only part of the contract (the linens), but not the other part (the arbitration agreement). 

That said, the existence of an arbitration clause may be a material fact that might allow the restaurant to “avoid” its implied ratification, if it did not know of the clause.

posted by Gary Rosin

When You’re Alone, You’re Alone: Hillman and Weidner on Partners without Partners

Friday, August 19th, 2011

In a partnership at will, unless the partners otherwise agree, the voluntary withdrawal of a partner (a much nicer word than “dissociation”) automatically causes dissolution of the partnership.  RUPA § 801(1).  For partnerships for a definite term or particular undertaking, after the voluntary withdrawal of a partner only results in dissolution of the partnership by the express will of at least half of the remaining partners.  RUPA § 801(2)(i). If the withdrawal of a partner does not result in dissolution of the partnership, the partnership must purchase the interest of the withdrawn partner.  RUPA §§ 603(a), 701(a).

But what if the partnership had only two partners?  does the remaining partner have the right to buyout the other partner? Robert Hillman (Cal-Davis) and Donald Weidner address this question in an article forthcoming in The Fordham Journal of Corporate and Financial Law, Partners without Partners:  The Legal Status of Single Person Partnerships (SSRN, draft dated Aug. 1, 2011).  Prof. Hillman is of the view that, under RUPA § 101(6),  the partnership dissolves by operation of law:

The core of RUPA’s definition is that a partnership is “an association of two or more persons to carry on as co-owners a business for profit.” If one partner leaves, the predicate association of two or more persons no longer exists, which means a partnership is constituted only for the limited purpose of winding up the business. In other words, the partnership that existed prior to the dissociation is no more.

Id. at 3 (footnotes omitted).  Dean Weidner, who was the Reporter for the RUPA, disagrees:

I obviously think you are asking the definition of partnership to do too much by effectively operating as a special dissolution rule whenever partnerships no longer meet the language of the definition. RUPA contains three separate articles on partnership breakups, defining when and how liquidations versus buyouts are to take place. To attach to the definition substantive breakup consequences would create yet another set of dissolution rules and certainly was not considered in the drafting of the RUPA.

* * *

RUPA’s breakup provisions are much more detailed than the UPA on how a departing partner is to be cashed out. * * *

* * * Section 801, by its terms, lists the “only” events that cause dissolution and winding up, and a departure from a term partnership is not on the list. Both Sections 603(a) and 801, therefore, require a buyout in this situation.

Id. at 6-7 (footnotes omitted).

In a recent opinion, the Third Division of the Fourth District of the California Court of Appeals reasoned that, by definition, a partnership requires at least two partners, and ruled that the withdrawal of one partner in a two-partner partnership automatically caused dissolution.  Corrales v. Corrales, G043598 (Cal. Ct. App. Aug. 10, 2011).

In many ways, this conundrum is a self-inflicted wound, in that it is an artifact of the RUPA generally embracing the “entity” concept.  Under the UPA, the withdrawal of a partner automatically dissolved the partnership, and usually gave each partner the right to liquidation.  But, in a partnership for a term or undertaking, UPA § 38(2)(a) gave the other partners the right to continue the business, either alone, or with others.

In any event, the problem of the partner-less partner under the RUPA illustrates how the entity approach can be a snare; you begin to believe that all partnership-related problems can be solved by the ritual invocation of the entity.  Even the RUPA retains aggregate elements, such as liability of the partners. Partnerships and sole proprietorships are the only business forms that can be formed without filing with the state.  The difference between the two has always been the partnerships were aggregates; it takes at least two to partner.  As Bruce Springsteen sang in When You’re Alone:

When you’re alone you’re alone
When you’re alone you ain’t nothing but alone

Hat tip:  Eric C. Chaffee (Dayton), Jay Adkisson.

Gary Rosin

Doubling Down on Olmstead: Rossignol v. Rossignol (NY App. Div. 2011)

Monday, March 7th, 2011

In Court Decision Weds Business Divorce with Matrimonial Divorce, on New York Business Divorce Blog, Peter Mahler reports on Rossignol v. Rossignol, 2011 NY Slip Op 01560 (3d Dept Mar. 3, 2011).  In Rossignol, husband and wife were members of an LLC.  After wife filed for divorce, the court entered a restraining order against the husband preventing him from accessing funds in both their personal and the LLC’s banking accounts.  When husband then brought a separate action for involuntary dissolution of the LLC, the trial court dismissed the action because the proceeding for the divorce and the division of marital property involved the “same parties for the same cause of action.”  The appellate court affirmed, reasoning as follows:

Inasmuch as the husband and wife are the only owners of the LLC, and both are parties to the divorce action, we see no reason why any issues should be left for resolution after equitable distribution of the parties’ property. Given the availability of complete relief pursuant to Domestic Relations Law § 234 and our public policy of resolving equitable distribution within the context of a divorce action, we conclude that dismissal of the second action was within Supreme Court’s broad discretion….

Slip Op., at 3-4 (citations omitted).

Mahler is rightly concerned about the apparent disregard of the difference between the LLC and its members.  After the Florida Supreme Court’s opinion Olmstead v. FTC, expanding the rights of personal creditors of the single-member on an LLC (see Charging Orders and Two Kinds of Exclusivity), the Court in Rossignol at least opens the door to a similar result in marital dissolution actions where the spouses are the sole members of the LLC.

posted by Gary Rosin

EIRLs: France Adopts Limited Liabiity Sole Propreitorship

Monday, March 7th, 2011

Last year, France adopted legislation allowing sole proprietors to form an EIRL–“Entrepreneur individuel à responsabilité limitée”.   LOI n° 2010-658 du 15 juin 2010 relative à l’entrepreneur individuel à responsabilité limitée.  From my little-used college French, and the literal Google ® translation, the law requires a public filing of a Declaration of Trust identifying assets–and their values–dedicated to the business, as well as annual reports. 

My correspondent, Tadas Klimas, from Lithuania, also sends along this link to the Google ® translation of a post discussing EIRLs on Themis, “le blog sur la justice, la loi et l’équité” (original post).

For a law establishing a new unincorporated business entity, the EIRL law is astonishingly brief.  The law limits post-filing creditors of the business to declared business assets, but I couldn’t find anything about limiting distributions to, or the rights of personal creditors of, the sole proprietor.

As Grace Potter of Grace Potter and the Nocturnals sings, “If I were from Paris / I would say / Oooh la la la la la la.”

posted by Gary Rosin

American Choppers: The Value of Craftsmanship

Friday, December 17th, 2010

The reality show American Choppers involves a custom motorcycle shop and the day-to-day tensions between the founder, and chief owner, and his employees, one of whom is his son.  As it turns out, the son is a 20% owner of the corporation that owns the shop.  After the father fired his son on the air, the network was upset.  To keep American Choppers on the air, father and son signed a letter agreement giving the father

an option to purchase all of [the son’s] shares in [the corporation] for fair market value as determined by a procedure to be agreed to by the parties as soon as practicable.

Within a few months, the father attempted to exercise the option.  In its recent opinion in  Teutul v. Teutul, 2010 NY Slip Op 09248 (2d Dept Dec. 14, 2010) (emphasis added), the court rejected the reasoning of the trial court that fair market value was sufficiently definite in the context of a closely held corporation, threw out the agreement as an agreement to agree.  Peter Mahler’s New York Business Divorce blog has excellent discussions of both the trial court and appellate opinions.

Given the timing of the letter agreement, you would think that they hired a lawyer to advise them. Perhaps a transactional lawyer.  Or even a lawyer who specialized in representing the owners of small businesses, and who presumably would be familiar with issues related to buy-sell agreements.  Perhaps they did all of that.  Perhaps the quoted language was as close as father and son could get to reaching an agreement, and they were told that they really did not have an agreement.  Perhaps not. 

In any event, the case illustrates that craftsmanship is as important in drafting agreements among owners of small businesses as it is in manufacturing custom motorcycles.

Gary Rosin