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The Essential Roles of Agency Law Michigan Law Review Volume 118 Issue 4 2020 The Essential Roles of Agency Law Gabriel Rauterberg University of Michigan Law School, [email protected] Follow this and additional works at: https://repository.law.umich.edu/mlr Part of the Agency Commons, and the Public Law and Legal Theory Commons Recommended Citation Gabriel Rauterberg, The Essential Roles of Agency Law, 118 MICH. L. REV. 609 (2020). Available at: https://repository.law.umich.edu/mlr/vol118/iss4/3 https://doi.org/10.36644/mlr.118.4.essential This Article is brought to you for free and open access by the Michigan Law Review at University of Michigan Law School Scholarship Repository. It has been accepted for inclusion in Michigan Law Review by an authorized editor of University of Michigan Law School Scholarship Repository. For more information, please contact [email protected]. THE ESSENTIAL ROLES OF AGENCY LAW Gabriel Rauterberg* This Article suggests a fundamental shift in how we think about agency. The essential function of agency law lies not only in enabling the delegation of au- thority, as is widely suggested, but as significantly in its effect on creditors’ rights through asset partitioning. There is an increasing temptation in legal scholarship to treat agency law as a sideshow confined to the first day of cor- porations class. This is because much of what agency law does in commerce could simply be accomplished through standard-form contracts that provide default terms for the relationships among firms, their managers, and third parties. Even agency’s much-vaunted fiduciary duties can easily be altered or waived by contract—and often are. This Article identifies the essential roles of agency law, which parties could not contractually replicate, and the im- portant efficiencies that flow from them. Agency’s essential roles in commercial enterprise are twofold: first, to permit one person to attribute the legal significance of his or her acts to another, and second, to facilitate asset partitioning. Just as limited liability partitions off the assets of a firm’s owners from the assets of the firm itself, agency law par- titions off the assets of a firm’s managers from the firm’s own assets. Recog- nizing this function reframes the usual staging of contractual disputes in agency as a zero-sum balancing act between the interests of third parties and of principals. Whether owners or managers should be liable for a firm’s un- paid contracts is not just a win-lose distributional question—pitting the firm’s creditors against insiders—but rather can be socially efficient. Through simplifying and specializing asset pools, asset partitioning lowers the cost of monitoring the firm’s assets and thus the cost of credit. To illustrate the asset partitioning role of agency law, I unearth two doctrines ignored by scholar- ship—the “veil piercing” doctrines of agency. Understanding agency’s asset partitioning role has extensive implications for theory and practice. In addition to providing a unifying account of agency law, the analysis resolves current disputes in the interpretation of its doctrine. Most importantly, recognizing the essential roles of agency demonstrates its ongoing significance to commercial and corporate law. * Assistant Professor of Law, University of Michigan Law School. For particularly helpful comments, I am grateful to John Armour, Samuel Bray, Anthony Casey, Anne Choike, Barry Cushman, Tsilly Dagan, Merritt Fox, Andrew Gold, Zohar Goshen, Monica Hakimi, Don Herzog, Henry Hansmann, Vic Khanna, Kyle Logue, Paul Miller, Peter Molk, John Mor- ley, James Nelson, J.J. Prescott, Joseph Raz, Sarath Sanga, Robert Sitkoff, Henry Smith, Holger Spamann, Richard Squire, Andrew Verstein, and participants at workshops at the Annual Con- ference of the International Society for New Institutional Economics, Columbia Law School, and Notre Dame Law School. 609 610 Michigan Law Review [Vol. 118:609 TABLE OF CONTENTS INTRODUCTION..............................................................................................611 I. RETHINKING THE CONVENTIONAL WISDOM ...............................616 A. Background Concepts...............................................................616 B. The Standard Account of Agency Law...................................617 II. AGENCY LAW AS ASSET PARTITIONING ........................................619 A. The Theory of Asset Partitioning ............................................620 B. How Agency Law Establishes Attribution Rules and Asset Partitioning .....................................................................623 1. Attribution Rules ..............................................................624 2. Attribution Rules, Asset Partitioning, and the Role of Agency Law..........................................................625 3. Equitable Remedies for Piercing Agent and Principal Shielding ...........................................................627 4. Some Relationships Between Entity and Agency Law .......................................................................629 C. Benefits of Agency as Asset Partitioning ................................630 1. Reducing Creditor Monitoring Costs............................630 2. Economies of Risk Bearing and Decisionmaking ........632 3. Incentives...........................................................................634 III. AGENCY LAW IS ESSENTIAL TO ASSET PARTITIONING ................635 A. Principal and Agent Shielding ................................................636 1. Why Law Is Essential .......................................................636 2. How Doctrine Reflects Agency Law’s Essential Role...639 B. Does Agency Law Serve Other Essential Functions?.............641 1. The Duties of Agent and Principal.................................641 2. The Liability of Principal and Agent to Third Parties......................................................................643 C. Agency Outside the Firm .........................................................644 1. Convergence Between Manager and Owner Partitioning........................................................................644 2. Agency Outside Entities ..................................................646 IV. IMPLICATIONS ..................................................................................648 A. Contract Versus Tort................................................................648 B. The Pattern of Agency Doctrine..............................................650 C. Agency and Technology ...........................................................651 D. Agency and Business Outcomes ..............................................651 February 2020] The Essential Roles of Agency Law 611 E. Agency and the Role of Law in Commerce ............................652 C ONCLUSION.................................................................................................653 INTRODUCTION The agency relationship is a foundation of modern commerce. Every large firm manages its business activities through a dizzying array of agents who carry out the firm’s affairs and bind it by the contracts they enter.1 Di- rectors, CEOs, managing partners—all are agents authorized to transact on some firm’s behalf. As the Supreme Court noted in Hobby Lobby, “[c]orporations, ‘separate and apart from’ the human beings who own, run, and are employed by them, cannot do anything at all.”2 Given the im- portance of agency law, the Supreme Court and federal circuit courts pre- dictably remain preoccupied with disputes over the interpretation of its doctrine.3 Yet, scholarly understanding of agency law has not kept pace with its continuing significance to commercial and corporate activity. In fact, the most noticeable feature of the scholarship addressing agency law is how little there is. Ever since Oliver Wendell Holmes, Jr., attacked agency doctrine a century ago as “the resultant of a conflict between logic and good sense,” ac- ademics have almost universally neglected the topic in both law and eco- nomics.4 While a sophisticated literature explores the economic concept of “agency costs,” the concepts of agency law have often been neglected.5 Though there has been a renewed theoretical focus on the functions of legal 1. Many economists and legal scholars have noted the pervasive role played by agents in modern commercial life. See, e.g., WILLIAM A. GREGORY, THE LAW OF AGENCY AND PARTNERSHIP 2 (3d ed. 2001) (“[M]ost of the world’s work is performed by agents.”); Kenneth J. Arrow, The Economics of Moral Hazard: Further Comment, 58 AM. ECON. REV. 537, 538 (1968) (“The principal-agent relation is very pervasive in all economies and especially in mod- ern ones . .”). 2. See Burwell v. Hobby Lobby Stores, Inc., 573 U.S. 682, 707 (2014) (quoting Conesto- ga Wood Specialties Corp. v. Sec’y of U.S. Dep’t of Health & Human Servs., 724 F.3d 377, 385 (3d Cir. 2013)); St. Clair v. Cox, 106 U.S. 350, 353 (1882). 3. For just the Supreme Court, this includes the famous Hobby Lobby decision, and the recent decisions in Vance v. Ball State University, 570 U.S. 421 (2013); Maples v. Thomas, 565 U.S. 266 (2012); and Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), all of which grappled with important agency law issues. 4. See Oliver Wendell Holmes, Jr., Agency (pt. 2), 5 HARV. L. REV. 1, 14 (1891); see also Oliver Wendell Holmes, Jr., Agency (pt. 1), 4 HARV. L. REV. 345 (1891). But see infra note 44 and accompanying text. 5. Agency costs are “the sum of the costs of designing, implementing, and maintaining
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