Bringing Numbers into Basic and Advanced Business Associations Courses:
How and Why to Teach Accounting, Finance, and Tax
Business planners and transactional lawyers know just how much the “number-crunching” disciplines overlap with business law. Even when the law does not require unincorporated business associations and closely held corporations to adopt generally accepted accounting principles, lawyers frequently deal with tax implications in choice of entity, the allocation of ownership interests, and the myriad other planning and dispute resolution circumstances in which accounting comes into play. In practice, unincorporated business association law (as contrasted with corporate law) has tended to be the domain of lawyers with tax and accounting orientation. Yet many law professors still struggle with the reality that their students (and sometimes the professors themselves) are not “numerate” enough to make these important connections. While recognizing the importance of numeracy, the basic course cannot in itself be devoted wholly to primers in accounting, tax, and finance.
The Executive Committee will devote the 2015 annual Section meeting in Washington to the critically important, but much-neglected, topic of effectively incorporating accounting, tax, and finance into courses in the law of business associations. In addition to featuring several invited speakers, we seek speakers (and papers) to address this subject. Within the broad topic, we seek papers dealing with any aspect of incorporating accounting, tax, and finance into the pedagogy of basic or advanced business law courses.
Any full-time faculty member of an AALS member school who has written an unpublished paper, is working on a paper, or who is interested in writing a paper in this area is invited to submit a 1 or 2-page proposal by May 1, 2014 (preferably by April 15, 2014). The Executive Committee will review all submissions and select two papers by May 15, 2014. A very polished draft must be submitted by November 1, 2014. The Executive Committee is exploring publication possibilities, but no commitment on that has been made. All submissions and inquiries should be directed to Jeffrey M. Lipshaw, Associate Professor, Suffolk University Law School email@example.com (617-305-1657).
CALL FOR PAPERS
AALS Section on Agency, Partnerships, LLCs, and Unincorporated Associations
The Scholarship of Professor Larry Ribstein
2013 AALS Annual Meeting
New Orleans, LA
Larry Ribstein was a friend to many and a colleague to all of us in the academy. With his untimely passing, he leaves behind a pioneering and influential body of work across a vast range of subjects, including partnerships and limited liability companies, corporate and securities law, choice of law, financial regulation, white-collar crime, legal ethics, and the legal profession.
The AALS Section on Agency, Partnership, LLCs, and Unincorporated Associations seeks to honor Larry’s legacy by focusing on his work at the 2013 AALS Annual Meeting in New Orleans. We are soliciting papers on a broad range of issues dealing with Larry’s partnership, LLC, and/or “uncorporation” scholarship. Among the topics that might be addressed are:
• An evaluation of the impact of Larry’s scholarship in a particular area;
• A discussion of issues or positions that Larry changed his mind on over time, and how;
• An examination of how Larry’s work in other areas informed his work in the unincorporated sphere, and vice-versa;
• “Larry as blogger” and the influence of his web postings
Submission procedure: A draft paper or proposal may be submitted via email to Professor Douglas Moll at firstname.lastname@example.org.
Deadline date for submission: April 1, 2012
Form and length of paper; submission eligibility: There is no requirement as to the form or length of proposals. Faculty members of AALS member and fee-paid law schools are eligible to submit papers.
Registration fee and expenses: Program participants will be responsible for paying their annual meeting registration fee and expenses.
How will papers be reviewed?: Papers and proposals will be selected after review by the Section’s Executive Committee.
Will the program be published?: The section plans to contact the law reviews at schools where Professor Ribstein taught in the hopes of publishing the papers submitted for the meeting as a symposium. At this time, however, no guarantees of publication can be made.
Contact for submission and inquiries: Professor Douglas Moll, University of Houston Law Center. 713-743-2172 or email@example.com
Time Magazine’s “person of the year” is the “protestor.” Occupy Wall Street’s participants have generated discussion unprecedented in recent years about the role of corporations and their executives in society. The movement has influenced workers and unemployed alike around the world and has clearly shaped the political debate.
But how does a corporation really act? Doesn’t it act through its people? And do those people behave like the members of the homo economicus species acting rationally, selfishly for their greatest material advantage and without consideration about morality, ethics or other people? If so, can a corporation really have a conscience?
In her book Cultivating Conscience: How Good Laws Make Good People, Lynn Stout, a corporate and securities professor at UCLA School of Law argues that the homo economicus model does a poor job of predicting behavior within corporations. Stout takes aim at Oliver Wendell Holmes’ theory of the “bad man” (which forms the basis of homo economicus), Hobbes’ approach in Leviathan, John Stuart Mill’s theory of political economy, and those judges, law professors, regulators and policymakers who focus solely on the law and economics theory that material incentives are the only things that matter.
Citing hundreds of sociological studies that have been replicated around the world over the past fifty years, evolutionary biology, and experimental gaming theory, she concludes that people do not generally behave like the “rational maximizers” that ecomonic theory would predict. In fact other than the 1-3% of the population who are psychopaths, people are “prosocial, ” meaning that they sacrifice to follow ethical rules, or to help or avoid harming others (although interestingly in student studies, economics majors tended to be less prosocial than others).
She recommends a three-factor model for judges, regulators and legislators who want to shape human behavior:
“Unselfish prosocial behavior toward strangers, including unselfish compliance with legal and ethical rules, is triggered by social context, including especially:
(1) instructions from authority
(2) beliefs about others’ prosocial behavior; and
(3) the magnitude of the benefits to others.
Prosocial behavior declines, however, as the personal cost of acting prosocially increases.”
While she focuses on tort, contract and criminal law, her model and criticisms of the homo economicus model may be particularly helpful in the context of understanding corporate behavior. Corporations clearly influence how their people act. Professor Pamela Bucy, for example, argues that government should only be able to convict a corporation if it proves that the corporate ethos encouraged agents of the corporation to commit the criminal act. That corporate ethos results from individuals working together toward corporate goals.
Stout observes that an entire generation of business and political leaders has been taught that people only respond to material incentives, which leads to poor planning that can have devastating results by steering naturally prosocial people to toward unethical or illegal behavior. She warns against “rais[ing] the cost of conscience,” stating that “if we want people to be good, we must not tempt them to be bad.”
In her forthcoming article “Killing Conscience: The Unintended Behavioral Consequences of ‘Pay for Performance,’” she applies behavioral science to incentive based-pay. She points to the savings and loans crisis of the 80's, the recent teacher cheating scandals on standardized tests, Enron, Worldcom, the 2008 credit crisis, which stemmed in part from performance-based bonuses that tempted brokers to approve risky loans, and Bear Sterns and AIG executives who bet on risky derivatives. She disagrees with those who say that that those incentive plans were poorly designed, arguing instead that excessive reliance on even well designed ex-ante incentive plans can “snuff out” or suppress conscience and create “psycopathogenic” environments, and has done so as evidenced by “a disturbing outbreak of executive-driven corporate frauds, scandals and failures.” She further notes that the pay for performance movement has produced less than stellar improvement in the performance and profitability of most US companies.
She advocates instead for trust-based” compensation arrangements, which take into account the parties’ capacity for prosocial behavior rather than leading employees to believe that the employer rewards selfish behavior. This is especially true if that reward tempts employees to engage in fraudulent or opportunistic behavior if that is the only way to realistically achieve the performance metric.
Applying her three factor model looks like this: Does the company’s messaging tell employees that it doesn’t care about ethics? Is it rewarding other people to act in the same way? And is it signaling that there is nothing wrong with unethical behavior or that there are no victims? This theory fits in nicely with the Bucy corporate ethos paradigm described above.
Stout proposes modest, nonmaterial rewards such as greater job responsibilities, public recognition, and more reasonable cash awards based upon subjective, ex post evaluations on the employee’s performance, and cites studies indicating that most employees thrive and are more creative in environments that don’t focus on ex ante monetary incentives. She yearns for the pre 162(m) days when the tax code didn’t require corporations to tie executive pay over one million dollars to performance metrics.
Stout’s application of these behavioral science theories provide guidance that lawmakers and others may want to consider as they look at legislation to prevent or at least mitigate the next corporate scandal. She also provides food for thought for those in corporate America who want to change the dynamics and trust factors within their organizations, and by extension their employee base, shareholders and the general population.
Permalink | Agency Law| Books| Business Ethics| Business Organizations| Contracts| Corporate Governance| Corporate Law| Crime and Criminal Law| Economics| Empirical Legal Studies| Employees| Enron| Junior Scholars| Law & Economics| Law & Society| Management| Organizational Theory| Politics| Sociology| White Collar Crime | TrackBack (0) | Bookmark
I arrived in San Francisco this morning for my first Annual Meeting of the American Law Institute. I have been a member of ALI for five years, but this is the first time I have attended the Annual Meeting. Most of the participants are practicing lawyers, so it's not my usual law conference crowd, but that's actually kind of refreshing. Unfortunately, none of the current ALI projects is in my wheelhouse -- the projects on tap for this year are Model Penal Code: Sentencing; Principles of the Law of Nonprofit Organizations; Restatement of the Law Third, Employment Law; Restatement of the Law Third, Torts: Liability for Physical and Emotional Harm; and Restatement of the Law Third, Trusts -- but the discussion this morning on election law has been interesting and broadening.
The last time ALI touched a topic that was of special interest to me (law of agency), the results were actually quite nice, thanks in large part to Glom Master Deborah Demott (who is sitting nearby), and the Third Restatement is now widely cited by courts. On the other hand, the ALI Principles of Corporate Governance, while interesting as an academic matter, have not had a real-world impact commensurate with the controversy that surrounded their adoption. Obviously, corporate governance has changed dramatically since 1994, when the Principles were adopted, and that change has largely been driven (on the legal side) by actions of Congress, the SEC, and Delaware none of which is particularly susceptible to influence by the ALI.
So where, if anywhere, could ALI be most helpful in the development of business law? Sam Buell from Duke Law just told me that a project on corporate crime may be on the horizon. Good idea?
UPDATE: One member commenting on the Principles of Election Law Project just suggested that the project team look at the experience of corporations with proxy voting over the internet.
Now that I’ve taught my last class for the semester, I thought I’d jot a few posts with reflections on teaching from the semester before I turn attention to grading and then writing.
Watching the SEC’s Goldman suit, the Senate hearings, and the financial reform legislation unfold has left me convinced that we business association teachers should consider teaching agency and partnership in the basic course (if we don’t already do so). Why? It is not just that many actual business entities are the “uncorporations” that Larry Ribstein writes about and not the “inc.s” in many law school class rooms. Consider the following two problems identified in the Goldman hearings or with respect to the financial crisis:
• Conflicts of interest (by Wall Street firms, rating agencies, mortgage brokers, mortgage originators etc.); and
• Lack of disclosure (to mortgage borrowers, investors in asset-backed securities etc.).
Of course there are lots of other potential areas of concern – like financial institution “safety and soundness,” but the two problems above are essentially about agency costs. As are two of the proposed remedies being discussed:
• Greater disclosure.
We can have a discussion about whether these are the most important problems and the most pressing reforms in the wake of the crisis, but they are front–and-center in the current debate. To frame the basic tradeoffs involved, there are two analytical approaches and two approaches to teaching students. The first is to start deep in the weeds of specialized areas of securities and financial regulation. The second is to start with basic building blocks.
The place to go for those building blocks is agency and partnership law. It is funny how much of the public debate on the Goldman suit resembles debates in those chestnut fiduciary duty cases from a Business Associations case book. Could “sophisticated investors” protect themselves against conflicts of interest with greater diligence or harder negotiations on price? Or do they need (or would it be more efficient to give them) the protection afforded by fiduciary duties? And when we talk about fiduciary duties, even the basic Business Associations course should help students see that those duties could vary quite a bit from one context or form of business entity or state to another.
Perhaps it is just my own learning style, but if I had to take a Business Association class again, I’d prefer to start learning the basic concepts that Corporations borrows from Agency and Partnership rather than being parachuted into the world of staggered boards and poison pills. Don’t kids learn basketball by practicing lay-ups before moving to dunks?
We’ll see how I feel in the fall when I teach my first purely Corporations class.
The regulatory fallout of the Bear Stearns bailout just took another interesting twist. Today former investment banker and current Secretary of the Treasury Henry Paulson called for regulation via disclosure for investment banks that want to take advantage of Fed bailouts.
1. I know you know this, but first, Paulson explains that there's a difference between I-banks and commercial banks:
one distinction between banks and investment banks remains particularly important - banks have the advantage that they issue deposits that are insured by the Federal government. A properly designed program of deposit insurance greatly reduces the likelihood of liquidity pressures on depository institutions and as a corollary, makes the funding base of these institutions more stable. The trade-off for this subsidized funding is regulation tailored to protect the taxpayers from moral hazard this insurance creates.
2. Paulson then calls for two disclosure oriented measures, one from the government - a clear "bailout procedure" identified by the Fed - and one by industry, involving information from investment banks, done with SEC and CFTC assistance:
First, the process for obtaining funds by non-banks must continue to be as transparent as possible. The Fed should describe eligible institutions, articulate the situations in which funds will be made available, and the magnitude and pricing structure for the funds....
Second, and perhaps most importantly, the Federal Reserve should have the information about these institutions it deems necessary for making informed lending decisions...[T]he Federal Reserve, the SEC, and the CFTC ... should consider whether a more formalized working agreement should be entered into to reflect these events.....The Federal Reserve's participation could  allow for broader consideration of market stability issues by the SEC and the CFTC. This collaborative process will necessarily have a strong focus on liquidity and funding issues.
3. My quick take: this is a strange combination of the reasonable and the novel. On the one hand, would you make a loan to someone if you didn't know their assets and liabilities? If Paulson thinks that the Fed shouldn't have to make loans to investment banks without access to the balance sheets, then he's not the only one. On the other hand, there's plenty of reasons to speculate wildly about this sort of thing, ranging from theories about turf protection by Treasury banking regulators annoyed that the Fed gets to do everything to raised eyebrows about who would be bringing investment banking within the comfortable ambit of regulated industry.
But in my view, Paulson may just be saying that he supports an effort by other agencies that he doesn't oversee to formalize and coordinate investment bank liquidity disclosure requirements. In time honored regulatory fashion, he may be thinking that the current crisis is the best time to push for the new program. Moreover, the agencies probably need his support to get something new like this done.
The SEC allegedly keeps track of the liquidity of investment banks, by the way (that agency concluded that Bear Stearns had plenty of liquidity when it was collapsing). But Paulson is pretty cagey about when and how often this information would be provided to the Fed. All the time? With supervisors looking over the shoulders of the accountants? Or only when a bailout might be necessary? There's nothing about this in the speech, and really, everything turns on it.
We will have to see what the Fed, SEC, and CFTC come up with. But for now, it shows that the one industry that is growing apace during this crisis is government.
I study international regulators like the Basel Committee on Banking Supervision because they matter today and will matter even more in the future. But there's no question that it means that I have to consume a lot of sonorous nostrums. The Committee just issued a paper on supervision during the current financial crisis. It recommended more stress testing, possibly additional liquidity insurance, and noted that domestic banking regulators take quite different views on safe levels of liquidity, delegation of risk assessment to banks, and so on. Okay, fine. But there's also recommendations like this:
Members highlighted the importance of a nimble approach by supervisors that allowed for the rapid collection and analysis of additional information once stresses had been identified. Many members found that regular reporting frameworks for monitoring liquidity risk were inadequate in content (eg often missing off-balance sheet items and funding pressure points), comparability and timeliness. Other members were satisfied with their ability to gather more comprehensive data quickly during times of stress to supplement information gathered routinely.
So: The Basel Committee recommends that supervisors be "nimble," and notes that some supervisors were nimble enough, but others think they could be even more nimble. It clears up everything, really!
ps. You also won't believe this, but the supervisors have concluded that regulated industry needs their help: "Market disclosure did not always meet the needs of market participants, and in some cases, financial markets sought additional information on the liquidity positions of banks."
If you want to see just how complex it gets in the D.C. Circuit, check out today's grant of a collateral challenge to a prior environmental settlement as ultra vires re: the Army Corps of Engineers, and these cases affording neighbor standing but not bidder standing to plaintiffs who tried to stop the state of Maryland from turning a lovely old army base into a development site. A technical day for environmental lawyers.
The Basle Committee on Banking Supervision - composed of reps from the 12 most important central banks - was started in 1974, after the failure of Bank Herstatt and Franklin Bank, and dedicated to multinational safety and soundness. And ever since, it has been a crisis-driven regulatory effort (but maybe Sarbanes-Oxley and the 33 and 34 acts tell us that this is the case for all financial regulators). Banco d'Ambrosiano, BCCI, and Baring have all prompted movement out of Basle.
So what will be the result of the SocGen fallout? It's the schmanciest institution yet put in this sort of crisis, so I predict a bit more than hand-wringing and a working group. You might expect a weird combination of greater efforts from Basle on, perhaps, inter-central-bank notification in crises, and a re-evaluation of some aspects of the most recent capital accord. Currently, Basle relies on the internal risk models of banks. SocGen's appeared to fail, or at least were circumvented. Perhaps risk models plus, or an (no doubt headache-inducing) alternative minimum? It's also possible that the Fed will make its already slow transition to the latest capital accord regime even slower.
Suing senior government officials in their personal capacity is all the rage these days. Valerie Plame is doing it. Jose Padilla is suing John Yoo. And lots of other war on terror victims are pinning their hopes of the prospect of obtaining monetary damages against Donald Rumsfeld, Karl Rove, and the employees who are detaining them. Roger Alford and Steve Vladeck debate the wisdom of this kind of accountability here and here.
I think that these sorts of suits are pretty new in aspiration, but are likely to have the same result almost all the old kinds of personal liability suits have had: dismissal at an early stage of the litigation. Which makes you wonder: why are government employees purchasing private liability insurance that covers these sorts of claims? Insurance is close enough to a corporate and economic subject to be Glom-worthy, I think.
Well, for one thing, the insurance is cheap - 300 bucks a year, and in many cases, the government will pick up half the tab. Moreover, supervisors who purchase policies are probably a lot more worried about employment discrimination claims than tort suits. And the line bureaucrats who buy insurance are probably overwhelmingly the kind of law enforcement officials who have always had to worry about excessive use of force claims. So I don't know that the increasing popularity of this insurance - some 30,000 employees have it - demonstrates that the new wave of Bivens litigation is affecting government behavior.
I do suspect, however, that the growth in interesting Bivens plaintiffs is interesting because of the, well, plaintiffs. These claimants are largely war on terror related, and I suspect that their Bivens cases are meant to remind everyone that said war is still ongoing, that they are still being detained or calumnied or whatever, and that their non-Bivens legal options are few. And, given the attention paid to these unlikely and often-dismissed claims, the public relations, if not the legal, strategy is working.
One question vexing courts and regulators is what to do about people who allege that a regulation of, say, toxic emissions or airplane maintenance practices, injures them because it increases the risk that they will be injured in the future. The risk, after all, might be tiny - is a.000001% increased chance of getting sick an "injury" that can be used to afford standing? Moreover, the whole point of these sorts of suits is that individuals are trying to sue the government not because of something it has done to them, but because it has failed to adequately regulate someone else. That also seems weird to some, though not that weird to me.
Today the DC Circuit decided that Public Citizen couldn't challenge a NHTSA tire regulation because of an increased risk of harm to its members. The opinion is here, and Public Citizen tried to establish the risk to its members through statistics. The Courts decided that Public Citizen's statistics were bad ("Public Citizen’s calculations are unreliable"), noted that in an en banc case the DC Circuit ought to eliminate the increased risk form of standing entirely, and vowed to until that time to interpret risk standing claims "strictly."
It was, in short, a bad day to be a public interest group - or indeed, anyone who wants to challenge a safety regulation other than a regulated industry that would incur costs because of the regulation. It would be great if Congress would set minimum risk thresholds for citizens who want to sue over the inadequacy of safety regulations, but that is the problem with standing law: it is based on the constitution, and so cuts Congress entirely out of the deal. Still, if Congress doesn't try to set some guidelines here, it may never get the chance.
The DC Circuit doesn't work during the summer, and didn't get out its first opinions until October. This workload is costing the court a seat, which Congress is giving to the Ninth Circuit. But the Court has had a busy December. It has issued 19 opinions. Only three of these were criminal and two discrimination-related. In other words, the DC Circuit issued as many opinions on FERC cases (also three) as it did on routine criminal appeals, or I could draw the same analogy between the FCC and discrimination appeals. You can see why people call it an administrative court.
So how did the government do? Well, DEA lost a license denial appeal to a pharmacy, EPA lost a Clean Air Act rulemaking appeal to Environmental Defense, the FCC lost a phone card reimbursement rulemaking appeal to Qwest, the FAA lost an equipment standards appeal to an equipment maker, DOD lost a facility services appeal to a class of hospitalized veterans, HHS lost a dialysis reimbursement guidance dispute, the CIA lost a FOIA case, and the National Marine Fisheries Service lost a groundfishing rule to an industry group. FERC and the FCC shockingly went undefeated.
The short of it is that the government lost a majority of the administrative law cases appealed to the DC Circuit and decided this month, and lost every rulemaking (which are thought to be the most important cases) so litigated. So perhaps that helps to explain why it still pays to keep people on retainer in this legal market (though yes, yes, selection bias, inadequate sample, &c).
It's not a 30-minute guarantee, exactly, but Domino's wants us to remember the golden days. The problem with the old guarantee was a legal one: Domino's was worried about being held liable for accidents caused by its or its franchisees' delivery people.
Of course, the franchising context raises an interesting issue of agency law because franchisors generally are not vicariously liable for the acts of their franchisee's employees, even though franchisors exert substantial control over their franchisees. I once taught a case on Domino's in Business Organizations called Parker v. Domino's Pizza, Inc., 629 So.2d 1026 (Fla. App. 1993). The case arose from an automobile accident in which the franchisee's delivery person was accused of "operat[ing] a vehicle in a reckless, negligent and careless manner, causing it to strike another vehicle." The plaintiff's were pedestrians who were struck by a third vehicle that hit them while they were helping the victims of the initial accident. The key issue in the case was whether Domino's should be vicariously liable under agency law, and this issue turned on the level of control exercised by Domino's.
The court read the franchise agreement and operating manual, and found control provisions all over the place:
The manual which Domino's provides to its franchisees is a veritable bible for overseeing a Domino's operation. It contains prescriptions for every conceivable facet of the business: from the elements of preparing the perfect pizza to maintaining accurate books; from advertising and promotional ideas to routing and delivery guidelines; from order-taking instructions to oven-tending rules; from organization to sanitation.
Obviously, most franchise guidelines have nothing to do with a delivery accident (and the law here is muddy enough that it's not clear whether that matters!). The court also mentions the 30-minute delivery policy, though more in passing than as a crucial fact. In any event, the court concluded, "The manual literally leaves nothing to chance," and this leads to "the self-evident conclusion that it was error to determine as a matter of law that Domino's does not retain the right to control the means to be used by its franchisee to accomplish the required tasks."
Well, it doesn't seem so self-evident to me, but that sort of reasoning was enough for Domino's. According to the W$J, "After abandoning the guarantee in the wake of the St. Louis lawsuit, Domino's began playing up the taste and quality of the pizzas themselves."
Hmm. The taste and quality of Domino's pizzas?
No wonder they are going back to the 30-minute delivery policy.
If you follow developments in agency law at all, you know that the Restatement (Third) of Agency eliminated "servants." Courts and commentators have been calling them "employees" for years, anyway, so that change seemed inevitable. But did you know that the Restatement (Third) of Agency also eliminated "independent contractors"? Here is the explanation:
The common term "independent contractor" is equivocal in meaning and confusing in usage because some termed "independent contractors" are agents while others are nonagent service providers. The antonym of "independent contractor" is also equivocal because one who is not an independent contractor may be an employee or a nonagent service provider.
All of this seems right to me, but what are we supposed to call people who aren't employees?
Did you guess "nonemployees"? That seems perfectly reasonable, until you consider that "nonemployees" doesn't correct the fundamental problem with "independent contractors," namely, that within this group are both agents and nonagents.
To cure this ambiguity, the drafters of the Restatement (Third) of Agency opted for two terms: "nonemployee agents" and "nonagents." Simple.
I am in the process of revising my Business Organizations casebook for a second edition, and I am integrating insights from the Restatement (Third) of Agency. Deborah DeMott has produced an amazing work, and I find it quite fascinating reading. Seriously.
One of the most noticeable changes in the Restatement as you move from the second to third edition is the purported elimination of "inherent agency power." I always found inherent agency power a useful, if somewhat confusing, concept. It is useful mainly because it makes the notion of "apparent authority" more coherent. The doctrine of apparent authority (and its sibling, estoppel), as articulated by common law judges and the drafters of the Restatement (Second) of Agency, technically required communication between the principal and the third party. In some instances, however, courts have imposed liability on a principal for the acts of an agent, even when the principal and the third party never interact. With respect to such cases, Judge Learned Hand observed that apparent authority "is only a fiction" because the principal "has not communicated with the third person and thus misled him." Kidd v. Thomas A. Edison, Inc., 239 F. 405 (S.D.N.Y. 1917).
Without that connection between principal and third party, why are courts nevertheless willing to hold principals responsible for the acts of their agents? The problem, according to Judge Hand, lies not with the imposition of liability, but rather with the articulation of the doctrines of apparent authority and estoppel. In attempting to base liability in consent of the principal, those doctrines lost the notion that principals could sometimes be held liable merely because of status. In these "cases of customary authority," courts hold principals liable to the extent that custom would justify reliance by a third party. Judge Hand explained the policy rationale underlying this practice as follows:
The considerations which have made the rule survive are apparent. If a man select another to act for him with some discretion, he has by that fact vouched to some extent for his reliability. While it may not be fair to impose upon him the results of a total departure from the general subject of his confidence, the detailed execution of his mandate stands on a different footing. The very purpose of delegated authority is to avoid constant recourse by third persons to the principal, which would be a corollary of denying the agent any latitude beyond his exact instructions. Once a third person has assured himself widely of the character of the agent’s mandate, the very purpose of the relation demands the possibility of the principal’s being bound through the agent’s minor deviations. Thus, as so often happens, archaic ideas continue to serve good, though novel, purposes.
Kidd prompted the drafters of the Restatement (Second) of Agency to add a new section describing an agent's "inherent agency power." Relying on the notion of status, this §8A stated that inherent agency power "is not derived from [actual] authority, apparent authority, or estoppel, but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent." The use of the word "power" rather than "authority" recognizes that the principal has not authorized the agent's action by manifesting consent to either the agent or the third party. Nevertheless, the principal is bound by the agent's action for reasons of "fairness":
It is inevitable that in doing their work, either through negligence or excess of zeal, agents will harm third persons or will deal with them in unauthorized ways. It would be unfair for an enterprise to have the benefit of the work of its agents without making it responsible to some extent for their excesses and failures to act carefully. The answer of the common law has been the creation of special agency powers or, to phrase it otherwise, the imposition of liability upon the principal because of unauthorized or negligent acts of his servants and other agents. Restatement (Second) of Agency §8A, comment a.
Despite the apparent utility of the concept, inherent agency power is infrequently used to decide agency cases and usually surfaces where courts must choose between imposing a loss on an innocent third party and an innocent principal.
Restatement (Third) of Agency abandons inherent agency power, purporting to subsume all of the cases covered thereby with the expanded notion of apparent authority. Nevertheless, the logic of apparent agency does not extend to cases involving so-called "undisclosed principals," which traditionally were decided under the logic of inherent agency power. Courts and the Restatements have long distinguished between "disclosed principals" and "undisclosed principals." This distinction is important because "apparent authority is not present when a third party believes that an interaction is with an actor who is a principal." Restatement (Third) of Agency §2.03, comment f. In other words, apparent authority cannot exist in cases involving an undisclosed principal.
The drafters of the Restatement (Third) of Agency plugged the hole left by the absence of inherent agency power by creating a new section with "no precise counterpart" in the Restatement (Second) of Agency. The new section (§ 2.06) would make undisclosed principals liable for the actions of their agents – acting without actual authority – if a third party detrimentally relies on the agent and the principal does not take reasonable steps to notify the third party of the misplaced reliance. This new section also describes something that looks suspiciously like inherent agency power:
An undisclosed principal may not rely on instructions given an agent that qualify or reduce the agent's authority to less than the authority a third party would reasonably believe the agent to have under the same circumstances if the principal had been disclosed.
So it seems that inherent agency power still lives, if only in a dimly lit corner of agency law.