19 - 131 - 1 Entrepreneurship: Sole Proprietorships

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Entrepreneurship: Sole Proprietorships

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EntrepreneurEntrepreneur

A person who forms and A person who forms and operates a new business operates a new business either by him- or herself or either by him- or herself or with others.with others.

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Entrepreneurial Forms of Conducting Business

Sole Sole ProprietorshipProprietorship General General

PartnershipPartnership

Limited Limited PartnershipPartnership

Limited Liability Limited Liability CompanyCompany

Limited Liability Limited Liability PartnershipPartnership

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Sole Proprietorship• Owner is actually the business.• Business is not a separate legal

entity.• Most common form of business

organization in the United States.

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Advantages of a Sole Proprietorship

• Ease and low cost of formation.• Owner can make all

management decisions.– hiring and firing employees.– No other approvals required.

• Sole proprietor owns all of the business

• Has the right to receive all of the business’s profits.

• Easily transferred or sold

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Disadvantages of a Sole Proprietorship

• Access to capital is limited to:– personal funds plus – any loans he or she can obtain.

• Legally responsible for the business’s contracts

• Responsible for any torts committed in the course of employment.

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Creation of a Sole Proprietorship

• No formalities.• No federal or state government

approval is required.• Some local governments require

a license to do business within the city.

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Personal Liability of a Sole Proprietor

• The sole proprietor bears the risk of loss of the business.– Will lose his or her entire

capital contribution if the business fails.

• The sole proprietor has unlimited personal liability.

• Creditors may recover claims against the business from the sole proprietor’s personal assets.

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Personal Liability of a Sole Proprietor (continued)

Sole Sole Proprietor Proprietor (Owner)(Owner)

Sole Sole ProprietorshipProprietorship Third PartyThird Party

Capital investmentCapital investment

Debt or obligation Debt or obligation owedowed

Personal liability for sole Personal liability for sole proprietorship’s debts and proprietorship’s debts and

obligationsobligations

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Agency Formation and Termination

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The Nature of Agency• Agency relationships are formed

by the mutual consent of a principal and an agent.

• Agency is the fiduciary relationship “which results from the manifestation of consent by one person to another that the other shall act in his behalf and subject to his control, and consent by the other so to act.”

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The Nature of Agency (continued)

• Agency Law – The large body of common law that governs agency.– A mixture of contract law and

tort law.• Principal – The party who

employs another person to act on his or her behalf.

• Agent – The party who agrees to act on behalf of another.

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Cheeseman

The Principal-Agent Relationship

PrincipalPrincipal

AgentAgent

Third PartyThird PartyAgency Agency ContractContract

Contract with third Contract with third party on behalf of party on behalf of

principalprincipal

Principal’s Principal’s obligation to obligation to perform the perform the contractcontract

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Persons Who Can Initiate an Agency Relationship

• Any person who has the capacity to contract can appoint an agent to act on his or her behalf.

• Persons who lack contractual capacity cannot appoint an agent.– e.g., insane persons and

minors

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Persons Who Can Initiate an Agency Relationship (continued)

• An agency can be created only to accomplish a lawful purpose.

• [Agency contracts that are created for illegal purposes or are against public policy are void and unenforceable.]


Cheeseman

Kinds of Employment Relationships

Employer-Employee Employer-Employee RelationshipRelationship

Principal-Agent Principal-Agent RelationshipRelationship

Principal-Independent Principal-Independent Contractor RelationshipContractor Relationship

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Employer-Employee Relationship

• A relationship that results when an employer hires an employee to perform some form of physical service.

• An employee is not an agent unless he or she is specifically empowered to enter into contracts on the principal employer’s behalf.

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Principal-Agent Relationship• An employer hires an employee

and gives that employee authority to act and enter into contracts on his or her behalf.

• The extent of this authority is governed by any express agreement between the parties and implied from the circumstances of the agency.

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Principal-Independent Contractor Relationship

• Principals employ persons or businesses who are not employees to perform certain tasks on their behalf.– These persons and businesses

are called independent contractors.

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Principal-Independent Contractor Relationship (continued)

• A principal can authorize an independent contractor to enter into contracts.– Principals are bound by the authorized

contracts of their independent contractors.

• The crucial factor in determining whether a person is an employee or an independent contractor is the degree of control that the principal has over that person.


Cheeseman

Summary: Kinds of Employment Relationships

Type of Relationship

Description

Employer-Employee

The employer has the right to control the physical conduct of the employee.

Principal-Agent The agent has the authority to act on behalf of the principal as authorized by the principal and implied from the agency.An employee is often the agent of his employer.

Principal-Independent Contractor

The principal has no control over the details of the independent contractor’s conduct.An independent contractor is usually not an agent of the principal.


Cheeseman

Formation of the Agency Relationship

Express Express AgencyAgency

Implied Implied AgencyAgency

Apparent Apparent AgencyAgency

Agency by Agency by RatificationRatification

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Express Agency• An agency that occurs when a

principal and an agent expressly agree to enter into an agency agreement with each other.– Exclusive agency contract– Power of attorney

• Express agency contracts can be either oral or written unless the Statute of Frauds stipulates that they must be written.

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Implied Agency• An agency that occurs when a

principal and an agent do not expressly create an agency.

• The agency is implied from the conduct of the parties.

• The extent of the agent’s authority is determined from the particular facts and circumstances of the particular situation.– Incidental authority is the

implied authority to act.

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Apparent Agency• Agency that arises when a

principal creates the appearance of an agency that in actuality does not exist.

• When an apparent agency is established, the principal is estopped from denying the agency relationship.

• It is the principal’s actions that create an apparent agency.

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Agency by Ratification

An agency that occurs when:1. A person misrepresents himself

or herself as another’s agent when in fact he or she is not, and

2. The purported principal ratifies (accepts) the unauthorized act.


Cheeseman

Summary: Formation of Agency Relationships (1 of 2)

Type of Agency

Definition Enforcement of the Contract

Express Authority is expressly given to the agent by the principal.

Principal and third party are bound to the contract.

Implied Authority is implied from the conduct of the parties, custom and usage of trade, or act incidental to carrying out the agent’s duties.

Principal and third party acts are bound to the contract.


Cheeseman

Summary: Formation of Agency Relationships (2 of 2)

Type of Agency

Definition Enforcement of the Contract

Apparent Authority created when the principal leads a third party into believing that the agent has authority.

Principal and third party are bound to the contract.

By Ratification

Acts of the agent committed outside the scope of his authority.

Principal and third party are not bound to the contract unless the principal ratifies the contract.

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Principal’s Duties• The principal has a duty to

compensate an agent for services provided within a mutually agreeable time.

• If the agent spends his or her own money, on the principal’s behalf, the principal owes a duty to reimburse the agent for all such expenses if they were:1. Authorized by the principal.2. Within the scope of the agency.3. Necessary to discharge the agent’s

duties in carrying out the agency.

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Principal’s Duties (continued)

• A principal owes a duty to indemnify the agent for any losses the agent suffers because of the principal. Such duty arises when the agent is held liable for the principal’s misconduct.

• The principal owes a duty to cooperate with and assist the agent in the performance of the agent’s duties and accomplishments of the agency.

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Agent’s Duties• An agent who enters into a

contract with a principal has two distinct obligations.

• Collectively, these are referred to as the agent’s duty of performance. – Performing the lawful duties

expressed in the contract– Meeting the standards of

reasonable care, skill, and diligence implicit in all contracts.

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Agent’s Duties (continued)

• Duty of notification– The agent’s has a duty to

notify the principal of any information that is important,

– Imputed knowledge

• Duty of accountability– Agent has duty to maintain

accurate accounting of all transactions undertaken on the principal’s behalf.

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Termination of an Agency• An agency contract is similar to

other contracts in that it can be terminated by:– Acts of the parties, or– Operation of law

• Once an agency relationship is terminated, the agent can no longer represent the principal or bind the principal to contracts.

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Termination by Acts of the Parties

An agency may be terminated by the following acts of the parties:

1. Mutual agreement2. Lapse of time3. Purpose achieved4. Occurrence of a specified

event

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Notification Required• The principal is responsible

to give certain third parties notification of the agency termination. – Parties who dealt with the

agent must be given direct notice

– Parties who have knowledge of the agency must be given direct or constructive notice

– Parties who have no knowledge of the agency are owed no notice

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Termination by Operation of Law

An agency is terminated by operation of law, including:

1. Death of the principal or agent2. Insanity of the principal or

agent3. Bankruptcy of the principal4. Impossibility of performance5. Changed circumstances6. War between the principal’s

and agent’s countries

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Wrongful Termination of an Agency or Employment Contract

• The termination of an agency contract in violation of the terms of the agency contract.

• The nonbreaching party may recover damages from the breaching party.

• The distinction between the power and the right to terminate an agency is critical.– Revocation of authority– Renunciation of authority

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Liability of Principals and Agents


Cheeseman

Agent’s Duties to the Principal

PerformancePerformance NotificationNotification

LoyaltyLoyaltyAccountabilityAccountability

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Agent’s Duty of Loyalty to Principal

An agent owes a fiduciary duty not to act adversely to the interests of the principal. Common breaches include:

• Self-Dealing– Agents are generally prohibited

from undisclosed self-dealing with the principal.

• Usurping an Opportunity– An agent cannot usurp an

opportunity that belongs to the principal.

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Agent’s Duty of Loyalty to Principal (continued)

• Competing with the Principal– Agents are prohibited from

competing with the principal.

• Misuse of Confidential Information– The agent is under a legal duty not to

disclose or misuse confidential information during or after course of the agency.

• Dual Agency– An agent cannot meet a duty of

loyalty to two parties with conflicting interests.

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Contract Liability to Third Parties

• A principal who authorizes an agent to enter into a contract with a third party is liable on the contract.

– The third party can enforce the contract and recover damages from the principal .

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Fully Disclosed Agency• When the third party entering

into the contract knows:– That the agent is acting as an

agent for a principal, and– The actual identity of the

principal• The principal is liable to the third

party.• The agent is not liable.

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Partially Disclosed Agency• An agency that occurs if:

– The agent discloses his or her agency status but does not reveal the principal’s identity, and

– The third party does not know the principal’s identity from another source

• Both the principal and the agent are liable to the third party if the principal fails to perform the contract.

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Undisclosed Agency• An agency that occurs when the

third party is unaware of either:– The existence of an agency, or– The principal’s identity

• Both the principal and the agent are liable to the third party if the principal fails to perform the contract.

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Agent Exceeding the Scope of Authority

• An agent who enters into a contract on behalf of another party impliedly warrants that he or she has the authority to do so.

• If the agent exceeds the scope of his or her authority, the principal is not liable on the contract unless the principal ratifies it.

• The agent is liable to the third party for breaching the implied warrant of authority.

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Tort Liability to Third Parties

• The principal and the agent are each personally liable for their own tortious conduct.

• The principal is liable for the tortious conduct of an agent who is acting within the scope of his or her authority.

• The agent only is liable for the tortious conduct of the principal if he or she directly or indirectly participates in or aids and abets the principal’s conduct.

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Negligence• Principals are liable for negligent

conduct of agents acting within the scope of their employment.

• Liability is based on the common law doctrine respondent superior.– This doctrine rests on the principle

that if anyone (principal) expects to derive certain benefits from acting through others (agent), that the person should also bear the liability for injuries caused to the third party by the negligent conduct of an agent who is acting within the scope of their employment.

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Negligence (continued)

• Frolic and Detour– Agents sometimes do things during

the course of his or her employment to further their own interests, rather than the principal’s.

• “Coming and Going” Rule– Principal is generally not liable for

injuries caused by its agents and employees while they are on their way to or from work.

• Dual-Purpose Mission– An errand or other act that principal

requests of an agent while the agent is on his or her own personal business.

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Intentional Torts• The principal is not liable

for intentional torts of agents and employees that are committed outside the principal’s scope of business.

• Two tests to determine the scope of employment boundaries:1. Motivation Test2. Work-Related Test

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Motivation Test

• If the agent’s motivation in committing an intentional tort is to promote the principal’s business, the principal is liable for injuries caused by the tort.

• If agent’s motivation is personal, principal is not liable.

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Misrepresentation• A principal is liable for the

intentional and innocent misrepresentations made by an agent within the scope of employment.– Intentional misrepresentation

occurs when an agent makes statements that he or she knows are untrue.

– Innocent misrepresentation occurs when an agent negligently makes a misrepresentation to a third party.


Cheeseman

Tort Liability of Principals and Agents to Third Parties (1 of 2)

Agent’s Conduct

Agent Liable

Principal Liable

Misrepre-sentation

Yes The principal is liable for the intentional and innocent misrepresentations made by an agent acting within the scope of his or her authority.

Negligence Yes The principal is liable under the doctrine of respondeat superior if the agent’s negligent act was committed within his scope of employment.


Cheeseman

Tort Liability of Principals and Agents to Third Parties (2 of 2)

Agent’s Conduct

Agent Liable

Principal Liable

Intentional Tort

Yes Motivation Test: The principal is liable if the agent’s motivation in committing the intentional tort was to promote the principal’s business.

Intentional Tort

Yes Work-Related Test: The principal is liable if the agent committed the intentional tort within work-related time and space.

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Independent Contractor• Principals often employ outsiders

(persons or businesses who are not employees) to perform certain tasks on their behalf.

Principal

Independent

Contractor

Contract

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Liability for Independent Contractor’s Torts

• A principal is generally not liable for the tortious conduct of independent contractors it hires.

• Independent contractors are personally liable for their own torts.

• The rationale behind this rule is that principals do not control the means by which the results are accomplished.

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Liability for Independent Contractor’s Torts (continued)

• A principal is, however, liable for the tortious conduct of an independent contractor involving:– Inherently dangerous

activities.– The negligent selection of the

independent contractor• Crucial factor is degree of control

Documents

19 - 131 - 1 Entrepreneurship: Sole Proprietorships