Martin v. Peyton: Rich Investors, Risky Investment, and the Line between Lenders and Undisclosed Partners
William A. Klein
University of California, Los Angeles (UCLA) - School of Law
CORPORATE LAW STORIES, Mark Ramseyer, ed., NY: Foundation Press, 2008
UCLA School of Law, Law-Econ Research Paper No. 08-01
This essay explores the background, the facts, and the legal and policy implications of the 1927 decision of the New York Court of Appeals in Martin v. Peyton. The fleshed-out facts, which could have come from the pages of a novel by Henry James or Edith Wharton, reveal messy realities of the sort that are typically encountered by practicing lawyers but are understandably omitted or adumbrated in published opinions. The case involved an investment by a small group of wealthy and socially prominent New Yorkers in an investment banking firm that was badly managed and on the threshold of insolvency. The decision in the case turns on the distinction between lenders and partners, or, more broadly, between debt and equity. The essay shows how the unique terms of the deal, with elements of both pure debt and pure equity, were dictated by the circumstances that gave rise to it. In particular, the risky nature of the investment and the thin, or nonexistent, equity cushion led to the would-be lenders accepting a contingent return and, as a corollary, some elements of control. An analysis of the briefs in the case reveals that the outcome may have been determined by a bold factual claim of the plaintiff that failed of proof and was rejected by the court. Finally, the essay examines the policy justification for the rule making silent partners liable for the firm's debts - a rule analogous to vicarious liability of employers for the torts of their employees and to the agency-law principle that makes undisclosed principals liable for unauthorized debts incurred by their agents. In addressing policy, fairness is a commonly claimed and generally admirable goal, but for market transactions it is generally not instructive, as Martin illustrates. Economic efficiency is likely to be a more meaningful policy criterion, as, again, Martin illustrates. But, as Martin also illustrates, economic efficiency, largely relying on unproven, and possibly unprovable, conjectures, can be a fickle and inconclusive criterion.
Number of Pages in PDF File: 23
Keywords: finance, partnership, liability of partners, equity and debt, lenders and partners, risk and control, risk and return, respondeat superior, inherent agency powerAccepted Paper Series
Date posted: February 6, 2008
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