DRAFT 7/30/11
AP edits 7/31/11 and 8/1/11
Chapter 1. Introduction to the Firm
Primary Sources Used in this Chapter


Meinhard v. Salmon
Restatement (Third) of Agency
Concepts for this Chapter




Nature of business organizations (firms)
Risks that businesses face and how they are allocated
Fiduciary duties
Role of law (mandatory v. default rules)
Introduction to the Firm
All business organizations – including corporations – serve to allocate risks and decision making
among the participants. Business organizations can be viewed as legal constructs to help bring
together people with money (money capital) and people with management or labor skills (human
capital). This chapter addresses some basic questions:
(1) What are the risks that a business faces and how might the risks be allocated?
(2) What are fiduciary duties and what is their purpose? and
(3) Generally what is the role of law in this area?
One way to help the students begin the class is to start with a simple question:
Question: [Amy: a formatting point. It seems that we’ll keep this visually cleaner with question,
followed by indented answer – I dunno] If two people go into business together, what should
they decide in advance? [great way to start the course]
Answer: One way to answer this question is with the list in the Breakout Box on p. 3
Who should bear the key risks?
How should they divide the profits and the losses?
How should they allocate the authority and responsibilities?
How long should their business and their responsibilities last?
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How should they be able to change or end their relationship?
Most student answers can be categorized under one of these five general categories. If
the students understand these questions, then they will have a feel for the goals of the
class.
We’ve found that students find helpful thinking of the course in modules that address
each of these basic questions. Sometimes it helps in the first class to ask students to turn
to the table of contents and explain the organization of the book – and the course. We
return to and explain this organizational structure to our students as we move from
module to module: Fundamentals / Policy / Corporate Form / Corporate Finance /
Corporate Externalities / Corporate Governance / Fiduciary Duties / Stock Trading /
Corporate Deals.
Meinhard v. Salmon (p. 4)
164 N.E. 545 (N.Y. 1928)
Cardozo, C.J.
Meinhard v. Salmon is one of the most cited cases in the law of U.S. business organizations,
more for the rhetoric of Judge (later, Justice) Cardozo, than its specific result.
The case shows how parties can choose to allocate risks in a firm, as well as how fiduciary duties
work to allocate some of these risks (which the parties may not have allocated themselves).
Facts:
In 1902, Salmon (a real estate developer) obtained a lease on the famous Hotel Bristol in New
York City. The lease was set to run to April 30, 1922. Salmon planned to renovate the hotel
building for use as shops and offices – at a cost of $200,000.
Salmon needed funds and Meinhard (a successful wool merchant) agreed to contribute $100,000
towards the renovation of the property. Salmon would manage the property.
Meinhard was the “capitalist,” and Salmon the “entrepreneur or manager.” They agreed to share
profits (60-40, with more to Salmon, for the first five years and 50-50 thereafter). Eventually, the
real estate venture was profitable.
In January 1922, with the lease coming to its end, the new owner of the Bristol, Elbridge T.
Gerry, approached Salmon. He offered a new 20-year lease, which included other adjoining
properties – a new business opportunity. Salmon (through a new corporation he owned) went
forward and negotiated a long-term lease on the larger site, but without telling Meinhard or
inviting him to participate. When Meinhard found out about the new lease, he demanded that the
lease be held in trust as an asset of his venture with Salmon. When the demand was refused,
Meinhard sued.
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Issue:
Did Salmon owe a duty to Meinhard to disclose the business opportunity, so Meinhard could
compete for the project himself?
Holding:
Yes – Meinhard wins
Judge Cardozo held that Salmon (as manager) was bound to share the business opportunity with
Meinhard, since it arose from their initial venture.
Dissent (Judge Andrews):
In Judge Andrews’ opinion, “[t]here was no general partnership, only a joint venture for a
limited object, to end at a fixed time.” This was not a renewal. Salmon did all he promised
when he distributed profits up to May 1, 1922.
Analysis:
The language of the opinion by Judge Cardozo (1870-1938) is what makes it famous. Some key
quotes from the opinion include:
“Joint adventurers, like co-partners, owe to one another, while the enterprise
continues, the duty of the finest loyalty.”
“A trustee is held to something stricter than the morals of the market place.”
“Not honesty alone, but the punctilio of an honor the most sensitive, is then the
standard of behavior.”
“Uncompromising rigidity has been the attitude of courts of equity when
petitioned to undermine the rule of undivided loyalty”
The case stands for the proposition that accompanying the relationship in a business firm is a
stringent set of fiduciary duties. It also demonstrates that a firm’s success (and the success of its
contributors) hinges largely on intelligent planning. Intelligent planning, in turn, demands
shrewd and judicious utilization of the choices available to allocate sharing when the firm is
formed.
[Amy – this is a masterful “brief” of the case.
Points for Discussion (p. 9)
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Question 1. What Roles? (1) What roles do you think Meinhard and Salmon envisioned that
each would play? (2) How do their expectations about their respective roles affect the judges’
views of their business relationship? (3) Should their expectations matter?
Answer: (1) [Just cutting down on surplussage] Meinhard and Salmon envisioned
specialized roles based on their knowledge, skills, and experience. Salmon offered
managerial skill, as well as knowledge of commercial real estate. Meinhard offered
money capital and maybe additional business contacts. Not surprisingly, Salmon took on
managerial functions to “reconstruct, alter, manage, and operate” the project. Meinhard
supplied start-up capital and bore financial risk by agreeing to variable returns based on
profits, rather than fixed interest or rent.
(2) The parties’ expectations of their respective roles mattered. Meinhard was the riskbearer and Salmon was the manager, which figured in Judge Cardozo’s view of the case.
As Judge Cardozo emphasized, “they were coadventures, subject to fiduciary duties akin
to those of partners.” That Salmon was also a manager imposed (apparently) even greater
fiduciary duties.
The specific relationship of Meinhard and Salmon mattered to Judge Cardozo, but even
more so Judge Andrews, who saw their relationship as having ended by agreement when
the joint venture ended. For Cardozo, that Salmon expected (and had reason to think) the
relationship did not continue after the 20-year term was not conclusive. For Andrews it
was.
(3) Should the law of business organizations merely reflect the parties’ view of their
relationship or should it also impose the law’s vision of that relationship? Should
corporate relationships be seen as private, what the parties agree to – or are they also
public, what the law imposes? In this case, Judge Cardozo may take the view that some
fiduciary duties exist beyond the specific relationship or agreement. But this will be a
constant them of the course – is “choice” wide open or is it subject to legal limits?
Question 2. What risks? (1) How did Meinhard and Salmon divide the risks of their business
relationship? (2) How would you have advised them to divide the risks?
Answer: (1) Meinhard and Salmon allocated risk in two ways.
 First, as to potential losses (beyond their contributions), they agreed to bear them
equally.
 Second, as to profits (remember this is a risk, as well), they agreed to divide them in a
way that preferred Salmon. For his apparent contribution of $100,000 (half of needed
capital) and managerial functions, Salmon got 60% of the profit for the first five years
and 50% thereafter. His greater contributions deserved a more immediate and bigger
payback.
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Meinhard contributed $100,000, assuming 50% of any losses and getting just 40% of
profits for the first 5 years, but he didn’t have managerial functions. Meinhard also had
some assurance that Salmon would want to increase profits, since he shared in them.
(2) How might they have structured things differently?

Lender – Borrower:
If Meinhard lent money and only got fixed interest, he would have put a heavy debt
burden on the project – risking its solvency - and he might not have been fully
compensated for assuming the risk.

Employer – Employee:
If Salmon had not contributed and simply gotten a fixed salary, he would have had less
“skin in the game” and thus less incentives to make the project work and become
profitable.

Instead, they opted for joint ownership:
Both were willing to take risks – though Salmon took more risk than Meinhard.
Bonus Question: [Amy – I really like this. Going beyond the text helps a first-time prof /
gives them a chance to “add value”] Think about the case in terms of partnership, which is
defined in the Revised Uniform Partnership Act Sec. 101(6) as “an association of two or more
persons to carry on a business as co owners for profit.” Were Meinhard and Salmon “partners”?
Answer: Basically, yes. A “joint venture” is a partnership with a limited duration or
scope (see Breakout Box p. 9). In fact, Meinhard v. Salmon is often taught as a
partnership law case.
Note: If you think of this case in terms of what it may teach students about partnership,
you might want to consider Revised Uniform Partnership Act Sec. 404(b)(1), General
Standards of Partner’s Conduct, which provides :
(b) A partner's duty of loyalty to the partnership and the other partners is limited to
the following:
(1) to account to the partnership and hold as trustee for it any property, profit, or
benefit derived by the partner in the conduct and winding up of the partnership
business or derived from a use by the partner of partnership property, including
the appropriation of a partnership opportunity
This is what Meinhard demanded. Fiduciary duties will be covered in much more detail
later in the book. [Amy – at this point we’re not exactly sure how we’ll be doing this, but
for a new prof it makes sense to have specific cross-references. Like “See Chapter 6
(Organizational Choices, pages 141-161; Chapter 29 (Planning in the Close Corporation,
pages 1001-1040)
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A.
Risk Allocation in the Firm
Breakout Box p. 9
Before moving into the next materials, it is helpful to draw students’ attention to the Breakout
Box on p. 9. Although an overall comparison of the various business associations forms is found
in Chapter 6 (Organizational Choices), it is helpful to make sure that students have the basic
vocabulary down from the start:
1.

Partnership: parties have equal financial and management rights (although you may want
to note the limited partnership form, which assigns management rights to a general
partner).

Limited Liability Company: a flexible, hybrid form with both corporate attributes (such
as limited liability) and partnerhip attributes (such as non-transferable shares) and the
terms fixed by agreement among the members.

Corporation: the most common form of business organization for situations in which
many investors come together and seek common management. Its attributes include
perpetual life, centralized management, free transferability of shares, and limited liability.
Nature of Risk
Meinhard v. Salmon is a way to introduce the concept of risk and risk allocation.
Most business firms fail – profit making is hardly assured. What are the reasons that some firms
fail and others succeed? What are the risks they face? A commercial real estate project like the
one in Meinhard v. Salmon is not an unusual business.
Meinhard and Salmon confronted two types of risk: controllable and uncontrollable. There are a
number of examples of the two types at the top of p. 10.
Question: Name some controllable and uncontrollable risks Meinhard and Salmon may have
confronted.
Answer: The possibilities are really endless here. Some examples are:

Uncontrollable: quarry workers strike, leading to cement shortages, and escalating
building prices;

Controllable: Salmon outfits the building with shoddy dry-wall sold by his cousin
from New Jersey [love it!]
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Question: Given the risks of the venture, why did Meinhard and Salmon, and why do any
businesspersons, decide to proceed anyway?
Answer: Meinhard and Salmon thought that the possible return outweighed those risks.
The table (on pp. 10-11) illustrates how risk and returns can be quantified – and actually
are quantified by business professionals – to value an investment.

First, you imagine the returns in all scenarios: the worst-case, probable, and bestcase.

Then, you assign an expected result in each case.

Finally, the expected return column reflects a weighted average of the three
scenarios.
Overall, using the probabilities in the book, Meinhard could expect a profit of
$8,300/year on his $100,000. Would you invest if you were looking at an 8.3% return on
your investment each year?
It’s good for students to see some numbers early on – and not be intimidated. This table,
we point out, represents is the basics for most valuation. Understanding business
associations means being comfortable with mathematical tools, but for our purposes will
not involve anything more than basic arithmetic.
It’s even possible to point out that one of the problems that brought on the Financial
Crisis of 2008 was that valuation models did not anticipate that housing prices might fall.
That is, a scenario with negative numbers was not part of the valuation model.
Question: There are three categories of risk tolerance outlined in the book (p. 11).



Risk Averse: do not risk losing money
Risk Seeker: willing to bet in investments even when safer returns are available
Risk Neutral: decides solely on expected returns
Which was Meinhard?
Answer: We do not really know, although the venture was successful. Consider the
following description of Morton H. Meinhard (1873-1931) by Professor Geoffrey P.
Miller:
Morton founded his own business in 1898. Although described in
Meinhard v. Salmon as a “merchant” in woolen products, Meinhard’s real
occupation was finance. Morton Meinhard & Co. was a factoring
concern; it lent money to clothing manufacturers in the booming New
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York garment industry. …By 1902 Morton Meinhard had cash on hand.
Salmon needed money. A profitable business arrangement was to be had,
and both men recognized it. How Meinhard and Salmon met is not clear.
They did not travel in the same religious or business circles. Nonetheless
the two had something in common: each was an ambitious
young man eager to make a mark on New York City. …
The deal turned out to be a spectacular success. As Salmon predicted,
mid-town Manhattan prospered, and with it came demand for commercial
office space. The Bristol commanded good rents from the start and
increased in profitability over the years. A tax case involving Meinhard
reported that the enterprise lost money only in the first year and showed
ever-increasing profits thereafter. In Meinhard v. Salmon Cardozo states
that the enterprise lost money for a few years before turning a profit.
Regardless, the venture prospered. Over the life of the lease Meinhard and
Salmon each received over $550,000 on their investments of slightly more
than $52,000.
Meinhard v. Salmon, Geoffrey P. Miller, New York University Law and
Economics Working Papers, 9/26/2007, pp. 9-11, available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1017244.
[Amy – when I browsed this first TM, I thought this was the very best part
of it. As a first-time prof, I’d be thinking, “Wow, that’s interesting. I
can’t wait to tell my students. And maybe I’ll look into this paper!” And
since we’ll put the TM online, all the links will be live.]
2.
Methods to Manage Risk
There are four categories of risk management methods for business associations:

Insurance: paying a fee (premium) up front in exchange for a right to payment if a
specified event occurs. This enables parties to pool risks.

Diversification: participating in numerous ventures, each of which involves different
risks.

Internal risk allocation: allocating the risks to the person in the business who is most
willing or best able to bear them (or least able to avoid being allocated the risks).

Externalization: moving the risks to other people outside the business association.
Limited liability externalizes risks (i.e. places the risks on people outside the business)
for losses above the amount that the participants have invested in the business.
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Note: Explaining limited liability – liability only to the extent of a person’s capital contribution –
is important since it is a big part of corporate law.
Question: What kinds of insurance are there?
Answer: Students will most easily be able to identify home, auto and health insurance.
These are the kinds of policies available from private companies with which they are
familiar. The Breakout Box on p. 13, however, provides additional information about
futures contracts, which are, in terms of their economic effect a kind of insurance that can
be purchased on the financial markets.
Question: What kind of private insurance might Meinhard and Salmon have bought?
Answer: One answer would be insurance against the building collapsing, or a subcontractor not finishing the work.
Bonus Question: What kind of futures contract would a modern Meinhard buy to protect
himself against loss in the venture with Salmon? [great question]
Answer: Maybe put options on stock index futures, against the risk of a Wall Street
collapse and a fall in commercial real estate prices.
Question: How might Meinhard and Salmon have protected themselves with diversification?
Answer: They might have invested in non-U.S. real estate, perhaps in London, in case
New York City lost its financial preeminence.
Question: What kind of internal allocation structure could have ameliorated the risk for
Meinhard and Salmon’s venture?
Answer: This is tricky, because Meinhard did not want to manage the venture. Perhaps
they could have issued stock, and given some to a board of directors which then oversaw
Salmon’s performance.
Question: What kind of externalization of risks would have worked for Meinhard and Salmon?
Answer: They could have incorporated their venture to get limited liability so that if the
business failed, contractors and other creditors would only have been able to look to the
business assets, and could not have looked to Meinhard and Salmon to make good their
losses.
3.
Business Firm as Risk Allocation
One of the functions of a business organization is to allocate risk among its parties. In the
simplified two-person firm, assume two parties roughly defined as the:
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 Principal: investor/owner
and
 Agent: manager/employee
Question: What are some goals of principals and agents in a business venture?
Answer:
Principal:
 Maximize the expected return on his investment.
 Extract the most effort by the agent.
 Ensure loyalty of the agent.
Agent:
 Maximize the return on his efforts, given the potential alternatives uses of his time.
 Earn compensation regardless of the success of the venture.
 Expend the least effort needed to make the venture successful.
 Operate free of principal interference.
The agent – principal relationship may be at times be tense. The principal’s efforts to
make sure that the agent fulfills his responsibilities are called monitoring, and if the agent
shirks and does not fulfill his responsibilities, the imposition of sanctions on the agent by
the principal is known as discipline. Monitoring and discipline have costs for the
principal in time and money, and those costs are known as agency costs.
Question: Give some examples of monitoring and discipline that a principal may employ vis a
vis an agent.
Answer:
Monitoring:
 Oversight directly by the principal
 Oversight by a representative (e.g. a board of directors or auditors)
Discipline:
 Firing an agent
 Cutting an agent’s pay
 Bringing a lawsuit against an agent
Question: Different types of business organizations, among other things, allocate risks between
the principal and the agent in different ways. Consider again the three straight-forward business
relationships:


Employer-employee,
Lender-borrower, and
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
Joint ownership.
Assume a loss of $50,000 and then a profit of $200,000 for each scenario, who bears the
risk? (Notice we don’t specify whether the risk – resulting in loss or profit – is
controllable or uncontrollable.) What are the agency costs? How can the risk bearer be
compensated?
Answer:
Employer-employee: Meinhard owns the business and hires Salmon. Meinhard bears
most of the risk (“risk to capitalist”), since Salmon is promised fixed pay. Are there
agency costs? Yes. How is Meinhard compensated? He gets all the profits, but must
monitor and discipline Salmon. He may want to limit Salmon’s authority and discretion
to manage the project, or make his pay dependent on the success of the business.
Lender-borrower: Meinhard no longer owns the business, but lends to Salmon, the owner.
Suddenly, the risks are flipped to Salmon (“risk to manager”), since Meinhard is
promised principal and interest, a fixed financial return. Are there agency costs? Far
fewer, since success is more in Salmon’s hands (assuming Meinhard makes capital
contributions on time or cannot demand pre-payment). How is Salmon compensated?
He gets all the profits, and need not monitor or discipline his lender. Meinhard as the
lender, though, may demand certain oversight rights – like looking at the books to make
sure Salmon isn’t pilfering or being lazy – because Meinhard may have a longer-term
perspective than Salmon.
Joint ownership: They both own the business (“risk to both capitalist and manager”).
Neither gets a fixed payment, both are dependent on firm profits. Are there agency
costs? Yes, either can bind the business and create liability for the other (“choose your
business partners with care”). How can those costs be controlled? Each gets disclosure
rights, each can ask for an accounting, and each has fiduciary duties to the other.
Which is the best structure? It really depends on the likely risks and the risk
profiles of the two people. Which would you recommend if Meinhard and
Salmon were your clients?
4.
Role of Law in Business Firms
The above discussion has focused on risk allocation and firm design that parties can arrange by
contract. However, there are also a number of legal rules that define the relationships among the
parties in a business organization in:



Agency law
Partnership law
Corporate law
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that provide the parties with “off the rack” rules by which to define their relationship.
Some of them are default rules: they apply unless the parties agree otherwise.
Some of them are mandatory: the parties cannot agree otherwise.
Question: Which of the following rules are mandatory, and which are default?
Rule 1 - Every employer shall pay to each of his employees wages at not less than $7.25
an hour.
Rule 2 - An employment, having no specified term, may be terminated at the will of
either party on notice to the other.
Rule 3 - An agent, as fiduciary, must use reasonable efforts to give his principal
information relevant to affairs entrusted to him and which, as the agent has notice, the
principal would desire to have.
Rule 4 - An employee cannot compete with his employer during the term of employment.
After employment terminates, a non -compete covenant will not be implied.
Answer:
Rule 1 – mandatory. You’re desperate for work: “I’ll agree to $4.50/hour. I understand
you won’t hire me otherwise.” Rule 1 does not permit this – it’s a mandatory rule. Why?
Because we fear employer exploitation.
Rule 2 – default. The employer specifies the following: “Employee will work as day
laborer for the next year.” Why was one-year a default term in agrarian England but
became at-will in the industrial US? It kept workers on farm for complete agricultural
cycle.
Rule 3 – default. Notice the rather vague terms –”reasonable” and “relevant.” Are the
vague terms intentional? Does the rule vary with the relationship? Does a manager of a
restaurant, for example, owe more duties to tell the owner about a new restaurant across
street than would a dishwasher at the restaurant? Yes.
Rule 4 – default. Who has the burden to obtain a non-compete covenant? Does this force
the employer to disclose that the employee may learn valuable skills? Yes.
As discussed in the Breakout Box on p. 22, mandatory rules protect parties too weak to
bargain for that protection themselves, or are used in situations when private bargaining
might cause social harm. Default rules are used to allow for private autonomy.
B.
Fiduciary Duties
1.
Theory of Fiduciary Duties
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Meinhard v. Salmon is the ultimate statement on fiduciary duties in the business firm —the
implicit duties that the participants in a firm owe each other.
Question: What are fiduciary duties?
Answer: These duties fill in the gaps of the parties’ relationship and serve to control
agency costs. They’re the “golden rule” in business organizations that you put the
business interests ahead of your own interests (to be lazy or to be opportunistic).
Question: Where do fiduciary duties come from?
Answer: Judges articulate them. But there’s some question whether they arise as an
implicit part of the parties’ agreement, suggesting they can be waived or modified. Or
whether they arise as a matter of law, suggesting they are not modifiable by agreement.
Question: What is the remedy for breach?
Answer: That varies according to the context, but essentially the idea is to put the
beneficiary back in the position as though there had been no breach. Sometimes that
means undoing a deal, other times it means reformulating the deal to remove the breach.
Here again judges exercise a lot of discretion in fashioning remedies.
Note: The question of “what, exactly, are fiduciary duties?” will be frustrating for some students.
You may want to discuss the ALI’s Restatement (3rd) of Agency and its attempt to express the
law of agents’ duties to their principals in Sec. 801 (General Fiduciary Principle) and the
subsequent sections in Title B (Duties of Loyalty) and C (Duties of Performance).
[Amy – we should either have links or include the actual language when we refer to
statutes]
§ 8.01 General Fiduciary Principle
An agent has a fiduciary duty to act loyally for the principal's benefit in all matters connected with the
agency relationship.
Title B. Duties of Loyalty
§ 8.02 Material Benefit Arising Out Of Position
An agent has a duty not to acquire a material benefit from a third party in connection with transactions conducted or other actions taken on behalf of the principal or otherwise through the agent's use of the agent's
position.
§ 8.03 Acting As Or On Behalf Of An Adverse Party
An agent has a duty not to deal with the principal as or on behalf of an adverse party in a transaction connected with the agency relationship.
§ 8.04 Competition
Throughout the duration of an agency relationship, an agent has a duty to refrain from competing with the
principal and from taking action on behalf of or otherwise assisting the principal's competitors. During that
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time, an agent may take action, not otherwise wrongful, to prepare for competition following termination of
the agency relationship.
§ 8.05 Use Of Principal's Property; Use Of Confidential Information
An agent has a duty (1) not to use property of the principal for the agent's own purposes or those of a third
party; and (2) not to use or communicate confidential information of the principal for the agent's own
purposes or those of a third party.
§ 8.06 Principal's Consent
(1) Conduct by an agent that would otherwise constitute a breach of duty as stated in §§ 8.01, 8.02, 8.03,
8.04, and 8.05 does not constitute a breach of duty if the principal consents to the conduct, …
Title C. Duties Of Performance
§ 8.07 Duty Created By Contract
An agent has a duty to act in accordance with the express and implied terms of any contract between the
agent and the principal.
§ 8.08 Duties Of Care, Competence, And Diligence
Subject to any agreement with the principal, an agent has a duty to the principal to act with the care, competence, and diligence normally exercised by agents in similar circumstances. Special skills or knowledge
possessed by an agent are circumstances to be taken into account in determining whether the agent acted with
due care and diligence. If an agent claims to possess special skills or knowledge, the agent has a duty to the
principal to act with the care, competence, and diligence normally exercised by agents with such skills or
knowledge.
§ 8.09 Duty To Act Only Within Scope Of Actual Authority And To Comply With Principal's Lawful
Instructions
(1) An agent has a duty to take action only within the scope of the agent's actual authority.
(2) An agent has a duty to comply with all lawful instructions received from the principal and persons
desig- nated by the principal concerning the agent's actions on behalf of the principal.
§ 8.10 Duty Of Good Conduct
An agent has a duty, within the scope of the agency relationship, to act reasonably and to refrain from conduct that is likely to damage the principal's enterprise.
§ 8.11 Duty To Provide Information
An agent has a duty to use reasonable effort to provide the principal with facts that the agent knows, has
reason to know, or should know when
(1) subject to any manifestation by the principal, the agent knows or has reason to know that the principal
would wish to have the facts or the facts are material to the agent's duties to the principal; and
(2) the facts can be provided to the principal without violating a superior duty owed by the agent to another
person.
Bonus question: How does US corporate law compare to company law in Europe – more
regulatory or more enabling?
Answer: A comparison of corporate law rules in the United States with “company” law
rules in the European Union revealed a couple of things: (1) many of Europe’s company
law rules are not part of US corporate law, and (2) Europe’s company law is more
regulatory than US corporate law. William J. Carney, The Political Economy of
Competition for Corporate Charters, 26 J. LEGAL STUD. 303, 321 (1997), available at
http://www.jstor.org/pss/10.1086/467997.
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For example, of the 131 rules in the EU directives on company law (“directives” are the
mandates that EU institutions direct at member states to implement), most (96) appear in
the corporate law of no US state, while 22 appear in some US states and only 14 appear
in all US states. Most of these rules deal with the capital structure (“money in and money
out”) of the company.
2.
What about the nature of these EU company law rules? The same study identified that
most (67) of the 131 rules in the EU directives are mandatory. The parties cannot
contract around them. Of these 67 rules, most (54) are found in the corporate law of no
US state, a few (9) are found in some US states, and only a handful (4) are found in all
US states.
Meaning of Meinhard v. Salmon
Meinhard v. Salmon presents a fundamental issue in the law of business associations and in the
free-market capitalist system generally: What protection are “owners/capitalists” such as
Meinhard entitled to when they delegate operational discretion to “agents/managers” such as
Salmon?
The case confronts the following questions:
Question: Who owes and to whom are fiduciary duties owed?
Answer: Here is it is “co-adventurers” – it’s just part of their deal. What is the difference
between co-venturers and partners? A joint venture is for a specific purpose or term (like
writing a law book together) as opposed to a partnership (such as agreement to sell corn
dogs in front of the law school and share profits indefinitely).
Question: How does Cardozo define fiduciary duties?
Answer: “Finest loyalty … stricter than the morals of the marketplace” What does this
mean? It’s not part of an arms-length relationship between strangers. There is an
intimacy. And it’s not just telling the truth, “but a punctilio of honor” (Latin for the finest
point).
For example, can a fiduciary say “I’m going to personally sell to our business overpriced
door knobs, because I can get away with it.”? No. The sale might be truthful, it might be
what some merchants do, but it’s not what a fiduciary should do.
Question: Can the parties choose not to have fiduciary rules?
Answer: Apparently not, according to Cardozo. The standard must be applied “with
uncompromising rigidity.” Fiduciaries should err on the side of caution, without excuse
or justification.
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Note: The dissent in Meinhard v. Salmon is important – and we include dissents in the ICB only
when relevant. The dissent exposes students to a different view of fiduciary duties –actually one
that has gotten a lot of modern play among some academics and courts. In dissent Judge
Andrews argues that fiduciary duties are defined by the parties’ particular relationship. Andrews
(and two other dissenting judges) characterizes Meinhard and Salmon’s relationship as a timelimited “joint venture” – their fiduciary duties ending with the venture’s term.
Question: In the end, what happened to Meinhard, Salmon and the Hotel Bristol?
Answer: The Breakout Box on p. 23 tells the end of the story: Salmon Tower lost a
great deal of money during the Depression with the losses, thanks to Judge Cardozo’s
opinion, borne equally by Meinhard and Salmon. No wonder Salmon showed his
appreciation to Cardozo by sending flowers for having brought him someone to share the
losses.
Bonus Question: Think about the case in terms of agency: what did Salmon do wrong?
Answer: Salmon got the opportunity because of his agency (manager). He looked like
the owner of the venture in his own right. Salmon excluded his co-adventurer from any
chance to compete, from any chance to enjoy the opportunity for benefit that had come to
him solely by virtue of his agency. (Rsmt (3rd) Agency, Sec. 8.02: Material Benefit
Arising Out of Position)
Points for Discussion p. 24
Question 1. Extra-contractual nature Could the parties have agreed otherwise?
Answer: Cardozo hints, no. Andrews seems to say their agreement defines their duties.
The debate continues to this day. Are there some things – like good faith in contract law
-- that are beyond negotiation? Or should everything be open to agreement in a business
firm?
Question 2. Judge-made law What is the role of the statutes?
Answer: No mention is made of the partnership statute. But this is not to say statutes
play no role in corporate fiduciary norms. As we will see, some statutes allow
corporations to get rid of certain fiduciary duties in the corporate documents – duty of
good faith, business opportunity doctrine.
Question 3. Gap-filling function Did Meinhard pay for the additional right to share in an
extension of their venture?
Answer: It seems unlikely that he did. He contributed half the capital and got about half
the profits (after paying in the first five years for Salmon’s start-up management efforts).
It’s hard to imagine that he paid for an “option” to participate in an extension.
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Question 4. Utility of Fiduciary Duties Why do we have fiduciary duties?
Answer: They avoid parties having to negotiate exactly how they will treat each other
(and talk about the uncomfortable details). Fiduciary duties thus avoid bargaining costs.
They reflect the bargaining power of capital – people who put money into a business,
expecting a share of profits, can expect loyal managers.
Summary [Amy – this is a great way to end each chapter. At one point we thought of adding
this to the ICB, but it’s probably better for a prof to make the points in class. Or to ask the
students to make them.]
The main points of Chapter 1 are:

Some business risks cannot be avoided (non-controllable or systemic) while others can be
reduced by the parties (controllable)

Business risks can be quantified using models that identify magnitude and probability to
calculate expected returns

Business parties have different risk tolerances: wealthy parties may be risk-seeking and
non-wealthy parties may be risk-averse

Business risks can be allocated in business firms through different ownership structures

Other means of allocating risks include insurance, diversification, internal controls, and
externalization

Fiduciary duties are judge-made and fill in gaps in parties’ relationship – they go beyond
the “morals of the marketplace”

Partners owe a duty (“punctilio of honor”) to share information about opportunities that
relate to their venture