MOTIONS OF GERALD K. SMITH TO AMEND THE TEXT
COMMENTARY OF § 5.04 OF TENTATIVE DRAFT NO. 6
OF THE RESTATEMENT OF THE LAW OF AGENCY
MOTION 1.
I move that
the text of § 5.04 be amended by substituting for “intending to act
solely” for his own or another’s purpose the language of Tentative Draft No. 4
(March 17, 2003), which more broadly provided that the adverse interest
exception applies “if the agent acts adversely to the principal in a
transaction or matter for the agent’s own purposes or those of another person.”
For purposes of
determining a principal’s legal relations with a third party, notice of a fact
that an agent knows or has reason to know is not imputed to the principal if
the agent acts adversely to the principal in a transaction or matter, intending
to act solely for the agent’s own purposes or those of another person.
MOTION 2.
I move that the
second sentence of Comment c of § 5.04
be deleted:
When an agent
acts adversely to a principal. The term “adversely” is not free of ambiguity. However, for purposes of common-law
agency, the fact that an action taken by an agent has unfavorable results for
the principal is not relevant.
MOTION 3.
I move that Comment d be amended by adding after the
second sentence “Thus, if a principal sues to enforce an agreement obtained by
an agent through fraud on a third party
d. Benefit of agent’s action knowingly retained by principal. The
adverse-interest exception serves to shield a principal against imputation of
notice of facts known to an agent who acts adversely to the principal. The
exception should not serve as a sword that enables a principal knowingly to
retain the benefits of its agent’s wrongdoing. Thus, if a principal sues to enforce an agreement obtained by an
agent through fraud on a third party
Illustration 8
would read as follows:
8. Same facts as
Illustration 7, except that T pays P Corporation for the furnace, paying 50
percent more than the list price, as demanded by A. After the furnace is delivered to T, T
discovers that its condition is as stated on the price list. T demands that P
Corporation return the payment made by T in exchange for the furnace. P Corporation’s sales managers investigate,
discover the facts of A’s conduct,
MOTION 4.
I move that the
Comment to § 5.04 include a discussion of the adverse domination doctrine by
the addition of Comment e of § 5.04
of Tentative Draft No. 4.
Section 5.04
(“An agent who acts adversely to a principal”) creates an exception to the
general rule regarding imputation of an agent’s knowledge to the principal. Tentative
Draft No. 6 would limit the exception to situations in which the agent is
determined to have “intended to act solely” for his own or another’s
purpose.
Application of
this narrowly defined “subjective intent” test, which applies only when the
intent is to act “solely” for the agent’s own purposes would make it far too
easy for third parties, such as auditors, to escape liability to the
corporation. Under the current draft, when any subjective intent to
benefit the principal is found, the case is closed. This rule could have
devastating effects in the typical corporate fraud case in which corrupt
corporate insiders falsely overstate the corporation’s financial condition. The
corporation appears to be growing and profitable, when it is in fact insolvent
and sinking ever deeper into debt. Case law throughout the country has
recognized that artificially prolonging a corporation’s life is a detriment, not
a benefit, to the corporation.
Under the
narrow and rigid language of the present draft, imputation would be the order
of the day, even if the primary purpose of the insider in question was to loot,
steal, and dissipate the corporation’s assets or conceal previous wrongdoing.
Moreover, the
law of imputation which has developed has not focused on an analysis of
the corrupt corporate insider’s motivations in order to determine his or her
“subjective intent”; rather, as set forth in the seminal cases of Schacht and
Cenco, the analysis of whether imputation is proper is quite different.
Instead of focusing on the intent of the corporate insiders, Schacht
employs the following analysis, and addresses the following considerations:
·
As a
threshold matter, have the managers of the corporation turned the company “into
an engine of theft against outsiders?” 711 F.2d at 1347.
·
Has the
corporate insiders’ misconduct “clearly benefited the corporation,” thereby
making the case “ripe for an analysis of whether the directors’ knowledge of
the fraud should be imputed to the benefited corporation”? 711 F.2d at 1347.
(In the absence of such a benefit to the corporation, Schacht held that
the “Cenco analysis, which seeks to determine the propriety of imputing
to the corporation the directors’ knowledge of fraud,” was not “even
trigger[ed].”
·
Assuming
that the “engine of theft” and “benefit to the corporation” thresholds have
been met, will “a judgment in favor of the plaintiff corporation … properly
compensate the victims of the wrongdoing, and … deter future wrongdoing”? 711
F.2d at 1348.
Thus, in
neither of what are generally considered to be the two leading cases on
imputation — Schacht and Cenco — does the court follow the
“agent’s subjective intent” approach, as set forth in the Draft, which focuses
entirely on whether the trier of fact can be persuaded that the corporate
insider had the requisite “one percent of subjective motivation” to benefit the
corporation. Rather, the analysis in these cases, and in the majority of cases
which followed them, runs along well-considered lines of public policy and
equity. In other words, given the totality of the circumstances, would the
public, including the innocent shareholders and creditors of the corporation,
be better served by allowing the corporation to bring suit against these third
parties, or was the corporation nothing but an “engine of theft” or a “Ponzi
scheme,” or so thoroughly dominated by corrupt directors and officers, that it
would indeed be inequitable and poor public policy to allow such an entity to
bring claims against its proverbial partners in crime?
Comment c states that “the fact that an action
taken by an agent has unfavorable results for the principal is not relevant.”
This sentence should be deleted from the Comment. The results of the agent’s
acts and the harm to the principal are relevant to establish that the agent’s
acts were adverse and that the agent acted for his own or another’s purpose.
Prior drafts
of § 5.04 (including Draft No. 4) included Comments and Illustrations which
clearly stated that ratification of an agent’s adverse acts applied when the
principal had actual knowledge of the misconduct. These Comments and Illustrations
have been removed from Draft No. 6, suggesting that a principal may ratify
conduct adverse to it even it if is unaware of the agent’s adverse
activities.
This is a
significant departure from the current state of the law. Restatement Second of
Agency § 282 requires that the principal “knowingly” retain a benefit of an
agent’s adverse act.
The Proposed
Amendment includes a Comment on the adverse domination doctrine that was included
in Tentative Draft No. 4. The adverse domination doctrine holds that the
statute of limitations does not begin to run until a corporation has a majority
of its directors who are not culpable. This Comment should be included because
it is helpful in understanding the adverse interest exception and its
relationship to the adverse domination doctrine.