Ebook The legal environment of business (9th edition): Part 2

(BQ) Part 2 book The legal environment of business has contents: Small business organizations, limited liability business forms, employment relationships, employment discrimination, consumer protection, environmental law, investor protection and corporate governance,...and other contents.

Unit Four The Business Environment Contents 17  Small Business Organizations 18  Limited Liability Business Forms 19 Corporations Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 17 Small Business Organizations O ne of the goals of many business students is to become an ­entrepreneur, one who initiates and assumes the financial risk of a new business enterprise and undertakes to provide or control its management One of the first decisions an entrepreneur must make is which form of business organization will be most appropriate for the new endeavor In selecting an organizational form, the entrepreneur will consider a number of factors, including (1) ease of creation, (2) the liability of the owners, (3) tax considerations, and (4) the ability to raise capital Keep these factors in mind as you read this unit and learn about the various forms of business organization You may find it helpful to refer to Exhibit 19–3 in Chapter 19, which compares the major business forms in use today Remember, SECTION Sole Proprietorships The simplest form of business is a sole proprietorship In this form, the owner is the business Thus, anyone who does business without creating a separate business organization has a sole proprietorship More than two-thirds of all U.S businesses are sole proprietorships They are usually small enterprises—about 99 percent of the sole proprietorships in the United States have revenues of less than $1 million per year Sole proprietors can own and manage any type of business from an informal, home-office or Web-based undertaking to a large restaurant or construction firm Advantages of the Sole Proprietorship A major advantage of the sole proprietorship is that the proprietor owns the entire business and receives all of the profits (because she or he assumes all of the risk) In addition, starting a sole proprietorship is often easier and less costly than starting any other kind of business, as few legal formalities are required too, in considering these business forms that the primary motive of an entrepreneur is to make profits Traditionally, entrepreneurs have used three major business forms—the sole proprietorship, the partnership, and the corporation In this chapter, we examine sole proprietorships and also look at franchises Although the franchise is not strictly speaking a business organizational form, it is widely used today by entrepreneurs Generally, no documents need to be filed with the government to start a sole proprietorship.1 Flexibility  This form of business organization also offers more flexibility than does a partnership or a corporation The sole proprietor is free to make any decision he or she wishes concerning the business— such as whom to hire, when to take a vacation, and what kind of business to pursue The sole proprietor can sell or transfer all or part of the business to another party at any time and does not need approval from anyone else (In contrast, approval is typically required from partners in a partnership and from shareholders in a corporation.) Sometimes, a sole proprietor can even benefit in a lawsuit from the fact that the business is indistinguishable from the owner ▶  Case in Point 17.1  James Ferguson operated “Jim’s 11-E Auto Sales” as a sole proprietorship and obtained insurance from Consumers Insurance Company The policy was issued to “Jim Ferguson, Jim’s 11-E Auto Sales.” Later, Although starting a sole proprietorship involves fewer legal formalities than other business organizational forms, even a small sole proprietorship may need to comply with zoning requirements, obtain a state business license, and the like 394 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 17  Small Business Organizations  Ferguson bought a motorcycle in his own name, intending to repair and sell it through his dealership One day when he was riding the motorcycle, he was struck by a car and seriously injured When Ferguson sued Consumers Insurance, the insurer argued that because Ferguson bought the motorcycle in his own name and was riding it at the time of the accident, it was his personal vehicle and was not covered under the dealership’s policy The court, however, held that the policy covered Ferguson’s injuries “Because the business is operated as a sole proprietorship, Jim Ferguson and ‘Jim’s 11-E Auto Sales’ are one and the same.”2  ◀ Taxes  A sole proprietor pays only personal income taxes (including Social Security and Medicare taxes— see Chapter 21) on the business’s profits, which are Ferguson v Jenkins, 204 S.W.3d 779 (Tenn.App 2006) 395 reported as personal income on the proprietor’s personal income tax return Sole proprietors are also allowed to establish certain retirement accounts that are tax-exempt until the funds are withdrawn Disadvantages of the Sole Proprietorship The major disadvantage of the sole proprietorship is that the proprietor alone bears the burden of any losses or liabilities incurred by the business enterprise In other words, the sole proprietor has unlimited liability, or legal responsibility, for all obligations that arise in doing business Any lawsuit against the business or its employees can lead to unlimited personal liability for the owner of a sole proprietorship The personal liability of the owner of a sole proprietorship was at issue in the following case Case 17.1 Quality Car & Truck Leasing, Inc v Sark Court of Appeals of Ohio, Fourth District, 2013 -Ohio- 44, 2013 WL 139359 (2013) BACKGROUND AND FACTS  Michael Sark operated a logging business as a sole proprietorship To acquire equipment for the business, Sark and his wife, Paula, borrowed funds from Quality Car & Truck Leasing, Inc When his business encountered financial difficulties, Sark became unable to pay his creditors, including Quality The Sarks sold their house (valued at $203,500) to their son, Michael, Jr., for one dollar but continued to live in it Three months later, Quality obtained a judgment in an Ohio state court against the Sarks for $150,481.85 and then filed a claim to set aside the transfer of the house to Michael, Jr., as a fraudulent conveyance From a decision in Quality’s favor, the Sarks appealed, arguing that they did not intend to defraud Quality and that they were not actually Quality’s debtors in the language of the court KLINE, J [Judge] * * * * The trial court found that summary judgment was proper under [Ohio Revised Code (R.C.) Section] 1336.04(A)(2)(a) That statute provides as follows: A transfer made or an obligation incurred by a debtor is fraudulent as to a creditor, whether the claim of the creditor arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation * * * without receiving a reasonably equivalent value in exchange for the transfer or obligation, and * * * the debtor was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction The trial court found “that Michael Senior and Paula made a transfer without the exchange of reasonably equivalent value and that the debtor was engaged or was about to engage in a business * * * transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction.” * * * The Sarks argue that summary judgment was not proper because there is a genuine issue of material fact regarding whether they intended to defraud Quality Leasing The Sarks’ CASE 17.1 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 396  Unit Four  The Business Environment CASE 17.1 CONTINUEd argument fails because intent is not relevant to an analysis under R.C Section 1336.04(A) (2)(a) A creditor does not need to show that a transfer was made with intent to defraud in order to prevail under R.C Section 1336.04(A)(2)(a) Thus, the Sarks cannot defeat summary judgment by showing that they did not act with fraudulent intent when Michael Senior and Paula transferred the Property to Michael Junior [Emphasis added.] The Sarks also claim that summary judgment was improper because there is an issue of fact regarding whether Michael Senior and Paula are actually Quality Leasing’s debtors Michael Senior apparently returned the equipment that secured the debts owed to Quality Leasing According to the Sarks, Quality Leasing’s appraisals of the equipment showed that the value of the equipment would be enough to satisfy the debts The Sarks’ argument, however, does not address the fact that they are clearly judgment debtors to Quality Leasing and that the judgment has not been satisfied * * * The Sarks have not challenged the validity of the judgment against them nor have they shown that the judgment has been satisfied Thus, there is no genuine issue of material fact regarding whether Paula and Michael Senior are debtors to Quality Leasing In conclusion, there is no genuine issue as to any material fact Quality Leasing is entitled to judgment as a matter of law DECISION AND REMEDY  A state intermediate appellate court affirmed the lower court’s judgment in Quality’s favor “Reasonable minds can come to only one conclusion, and that conclusion is adverse to the Sarks,” said the court The Sarks “are clearly judgment debtors to Quality Leasing and  .  the judgment has not been satisfied.” THE economic DIMENSION  What might the Sarks have done to avoid this dispute, as well as the loss of their home and their apparently declining business? THE ethical DIMENSION  Why did the Sarks take the unethical step of fraudulently conveying their home to their son? What should they have done instead? Personal Assets at Risk  Creditors can pursue the owner’s personal assets to satisfy any business debts Although sole proprietors may obtain insurance to protect the business, liability can easily exceed policy limits This unlimited liability is a major factor to be considered in choosing a business form ▶  Example 17.2  Sheila Fowler operates a golf shop near a world-class golf course as a sole proprietorship One of Fowler’s employees fails to secure a display of golf clubs They fall on Dean Maheesh, a professional golfer, and seriously injure him If Maheesh sues Fowler’s shop and wins, Fowler’s personal liability could easily exceed the limits of her insurance policy Fowler could lose not only her business, but also her house, car, and any other personal assets that can be attached to pay the judgment.  ◀ Lack of Continuity  The sole proprietorship also has the disadvantage of lacking continuity after the death of the proprietor When the owner dies, so does the business—it is automatically dissolved Another disadvantage is that in raising capital, the proprietor is limited to his or her personal funds and funds from any loans that he or she can obtain for the business SECTION Partnerships A partnership arises from an agreement, express or implied, between two or more persons to carry on a business for a profit Partners are co-owners of the business and have joint control over its operation and the right to share in its profits Partnerships are governed both by common law concepts—in particular, those relating to agency—and by statutory law As in so many other areas of business law, the National Conference of Commissioners on Uniform State Laws has drafted uniform laws for partnerships, and these have been widely adopted by the states Agency Concepts and Partnership Law When two or more persons agree to business as partners, they enter into a special relationship with one another To an extent, their relationship is similar to an agency relationship because each partner is deemed to be the agent of the other partners and of Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 17  Small Business Organizations  the partnership The agency concepts that you will read about in Chapter 20 thus apply—specifically, the imputation of knowledge of, and responsibility for, acts carried out within the scope of the partnership relationship In their relationships with one another, partners, like agents, are bound by fiduciary ties In one important way, however, partnership law differs from agency law The partners in a partnership agree to commit funds or other assets, labor, and skills to the business with the understanding that profits and losses will be shared Thus, each partner has an ownership interest in the firm In a nonpartnership agency relationship, the agent usually does not have an ownership interest in the business and is not obligated to bear a portion of ordinary business losses The Uniform Partnership Act The Uniform Partnership Act (UPA) governs the operation of partnerships in the absence of express agreement and has done much to reduce controversies in the law relating to partnerships A majority of the states have enacted the most recent version of the UPA (as amended in 1997) to provide limited liability for partners in a limited liability partnership.3 We therefore base our discussion of the UPA in this chapter on the 1997 version of the act and refer to older versions of the UPA in footnotes when appropriate Definition of a Partnership The UPA defines a partnership as “an association of two or more persons to carry on as co-owners a business for profit” [UPA 101(6)] Note that the UPA’s definition of person includes corporations, so a corporation can be a partner in a partnership [UPA 101(10)] The intent to associate is a key element of a partnership, and one cannot join a partnership unless all other partners consent [UPA 401(i)] Essential Elements of a Partnership Conflicts sometimes arise over whether a business enterprise is a legal partnership, especially when there is no formal, written partnership agreement To determine whether a partnership exists, courts usually look for the following three essential elements, which are implicit in the UPA’s definition: At the time this book went to press, more than two-thirds of the states, as well as the District of Columbia, Puerto Rico, and the U.S Virgin Islands, had adopted the UPA with the 1997 amendments 397 A sharing of profits or losses A joint ownership of the business An equal right to be involved in the management of the business If the evidence in a particular case is insufficient to establish all three factors, the UPA provides a set of guidelines to be used The Sharing of Profits and Losses  The sharing of both profits and losses from a business creates a presumption (legal inference) that a partnership exists ▶  Example 17.3  Syd and Drake start a business that sells fruit smoothies near a college campus They open a joint bank account from which they pay for supplies and expenses, and they share the proceeds (and losses) that the smoothie stand generates If a conflict arises as to their business relationship, a court will assume that a partnership exists unless the parties prove otherwise.  ◀ A court will not presume that a partnership exists, however, if shared profits were received as payment of any of the following [UPA 202(c)(3)]: A debt by installments or interest on a loan Wages of an employee or for the services of an independent contractor Rent to a landlord An annuity to a surviving spouse or representative of a deceased partner A sale of the goodwill (the valuable reputation of a business viewed as an intangible asset) of a business or property ▶  Example 17.4  Mason Snopel owes a creditor, Alice Burns, $5,000 on an unsecured debt They agree that Mason will pay 10 percent of his monthly business profits to Alice until the loan with interest has been repaid Although Mason and Alice are sharing profits from the business, they are not presumed to be partners.  ◀ Joint Property Ownership Joint ownership of property does not in and of itself create a partnership [UPA 202(c)(1) and (2)] The parties’ intentions are key ▶  Example 17.5  Chiang and Burke jointly own farmland and lease it to a farmer for a share of the profits from the farming operation in lieu of fixed rental payments This arrangement normally would not make Chiang, Burke, and the farmer partners.  ◀ Entity versus Aggregate At common law, a partnership was treated only as an aggregate of individuals and never as a separate legal entity Thus, at common law a lawsuit could never be Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 398  Unit Four  The Business Environment brought by or against the firm in its own name Each individual partner had to sue or be sued Today, in contrast, a majority of the states follow the UPA and treat a partnership as an entity for most purposes For instance, a partnership usually can sue or be sued, collect judgments, and have all accounting performed in the name of the partnership entity [UPA 201, 307(a)] As an entity, a partnership may hold the title to real or personal property in its name rather than in the names of the individual partners Additionally, federal procedural laws permit the partnership to be treated as an entity in suits in federal courts and bankruptcy proceedings Tax Treatment of Partnerships Modern law does treat a partnership as an aggregate of the individual partners rather than a separate legal entity in one situation—for federal income tax purposes The partnership is a pass-through entity and not a taxpaying entity A pass-through entity is a business entity that has no tax liability—the entity’s income is passed through to the owners of the entity, who pay income taxes on it Thus, the income or losses the partnership incurs are “passed through” the entity framework and attributed to the partners on their individual tax returns The partnership itself pays no taxes and is responsible only for filing an information return with the Internal Revenue Service A partner’s profit from the partnership (whether distributed or not) is taxed as individual income to the individual partner Similarly, partners can deduct a share of the partnership’s losses on their individual tax returns (in proportion to their partnership interests) Partnership Formation As a general rule, agreements to form a partnership can be oral, written, or implied by conduct Some partnership agreements, however, such as one authorizing partners to transfer interests in real property, must be in writing (or in an electronic record) to be legally enforceable (see Chapter 9) A partnership agreement, also known as articles of partnership, can include almost any terms that the parties wish, unless they are illegal or contrary to public policy or statute [UPA 103] The terms commonly included in a partnership agreement are listed in Exhibit 17–1 on the facing page The rights and duties of partners are governed largely by the specific terms of their partnership agreement In the absence of provisions to the contrary in the partnership agreement, the law imposes certain rights and duties, as discussed in the following subsections The character and nature of the partnership business generally influence the application of these rights and duties Duration of the Partnership The partnership agreement can specify the duration of the partnership by stating that it will continue until a designated date or until the completion of a particular project This is called a partnership for a term Generally, withdrawal from a partnership for a term prematurely (before the expiration date) constitutes a breach of the agreement, and the responsible partner can be held liable for any resulting losses [UPA 602(b)(2)] If no fixed duration is specified, the partnership is a partnership at will, which means that the partnership can be dissolved at any time Partnership by Estoppel Occasionally, persons who are not partners nevertheless hold themselves out as partners and make representations that third parties rely on in dealing with them Liability Imposed.  When a third person has reasonably and detrimentally relied on the representation that a nonpartner was part of a partnership, a court may ­ stoppel exists and conclude that a partnership by e impose liability—but not partnership rights—on the alleged partner Similarly, a partnership by estoppel may be imposed when a partner represents, expressly or impliedly, that a nonpartner is a member of the firm Nonpartner Agents.  When a partnership by estoppel is deemed to exist, the nonpartner is regarded as an agent whose acts are binding on the partnership [UPA 308] ▶  Case in Point 17.6  Jackson Paper Manufacturing Company makes paper that is used by Stonewall Packaging, LLC Jackson and Stonewall have officers and directors in common, and they share employees, property, and equipment In reliance on Jackson’s business reputation, Best Cartage, Inc., agreed to provide transportation services for Stonewall and bought thirty-seven tractor-trailers to use in fulfilling the contract Best provided the services until Stonewall terminated the agreement Best filed a suit for breach of contract against Stonewall and Jackson, seeking $500,678 in unpaid invoices and consequential damages of $1,315,336 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 17  Small Business Organizations  399 EXHIBIT 17–1  Common Terms Included in a Partnership Agreement Term Description Basic Structure Name of the partnership Names of the partners Location of the business and the state law under which the partnership is organized Purpose of the partnership Duration of the partnership Capital Contributions Amount of capital that each partner is contributing The agreed-on value of any real or personal property that is contributed instead of cash How losses and gains on contributed capital will be allocated, and whether contributions will earn interest Sharing of Profits and Losses Percentage of the profits and losses of the business that each partner will receive When distributions of profit will be made and how net profit will be calculated Management and Control How management responsibilities will be divided among the partners Name(s) of the managing partner or partners, and whether other partners have voting rights Accounting and Partnership Records Name of the bank in which the partnership will maintain its business and checking accounts Statement that an accounting of partnership records will be maintained and that any partner or her or his agent can review these records at any time The dates of the partnership’s fiscal year (if used) and when the annual audit of the books will take place Dissociation and Dissolution Events that will cause the dissociation of a partner or dissolve the partnership, such as the retirement, death, or incapacity of any partner How partnership property will be valued and apportioned on dissociation and dissolution Whether an arbitrator will determine the value of partnership property on dissociation and dissolution and whether that determination will be binding Arbitration Whether arbitration is required for any dispute relating to the partnership agreement for the tractor-trailers it had purchased Best argued that Stonewall and Jackson had a partnership by estoppel The court agreed, finding that “defendants combined labor, skills, and property to advance their alleged business partnership.” Jackson had negotiated the agreement on Stonewall’s behalf, and a news release stated that Jackson had sought tax incentives for Stonewall Jackson also had bought real estate, equipment, and general supplies for Stonewall with no expectation of payment from Stonewall to Jackson This was sufficient to prove a partnership by estoppel.4  ◀ Rights of Partners The rights of partners in a partnership relate to the following areas: management, interest in the partnership, compensation, inspection of books, accounting, and property Management Rights  In a general partnership, all partners have equal rights in managing the partnership [UPA 401(f)] Unless the partners agree otherwise, each partner has one vote in management matters regardless of the proportional size of his or her interest in the firm In a large partnership, partners often agree to delegate daily management responsibilities to a management committee made up of one or more of the partners For Ordinary Decisions.  The majority rule controls decisions on ordinary matters connected with partnership business, unless otherwise specified in the agreement Decisions that significantly affect the nature of the partnership or that are outside the ordinary course of the partnership business, however, require the unanimous consent of the partners [UPA 301(2), 401(i), 401(j)] When Unanimous Consent May Be Required.  Unanimous consent is likely to be required for any decision to: Best Cartage, Inc v Stonewall Packaging, LLC, 727 S.E.2d 291 (N.C.App 2012) Alter the essential nature of the firm’s business as expressed in the partnership agreement Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 400  Unit Four  The Business Environment Change the capital structure of the partnership Amend the terms of the partnership agreement Admit a new partner Engage in a completely new business Assign partnership property to a trust for the benefit of creditors, or allow a creditor to enter a judgment against the partnership, for an agreed sum, without the use of legal proceedings Dispose of the partnership’s goodwill (defined on page 397) Submit partnership claims to arbitration Undertake any act that would make further conduct of the partnership business impossible Interest in the Partnership  Each partner is entitled to the proportion of business profits and losses that is specified in the partnership agreement If the agreement does not apportion profits (indicate how the profits will be shared), the UPA provides that profits will be shared equally If the agreement does not apportion losses, losses will be shared in the same ratio as profits [UPA 401(b)] ▶  Example 17.7  Rimi and Brett form a partnership The partnership agreement provides for capital contributions of $60,000 from Rimi and $40,000 from Brett, but it is silent as to how they will share profits or losses In this situation, they will share both profits and losses equally If their partnership agreement had provided that they would share profits in the same ratio as capital contributions, however, 60 percent of the profits would go to Rimi, and 40 percent would go to Brett If the agreement was silent as to losses, losses would be shared in the same ratio as profits (60 percent and 40 percent, respectively).  ◀ Compensation  Devoting time, skill, and energy to partnership business is a partner’s duty and generally is not a compensable service Rather, as mentioned, a partner’s income from the partnership takes the form of a distribution of profits according to the partner’s share in the business Partners can, of course, agree otherwise For instance, the managing partner of a law firm often receives a salary—in addition to her or his share of profits—for performing special administrative or managerial duties Inspection of the Books  Partnership books and records must be kept accessible to all partners Each partner has the right to receive (and the corresponding duty to produce) full and complete information concerning the conduct of all aspects of partnership business [UPA 403] Each firm retains books for recording and securing such information Partners contribute the information, and a bookkeeper typically has the duty to preserve it The partnership books must be kept at the firm’s principal business office (unless the partners agree otherwise) Every partner is entitled to inspect all books and records on demand and can make copies of the materials The personal representative of a deceased partner’s estate has the same right of access to partnership books and records that the decedent would have had [UPA 403] Accounting of Partnership Assets or Profits  An accounting of partnership assets or profits is required to determine the value of each partner’s share in the partnership An accounting can be performed voluntarily, or it can be compelled by court order Under UPA 405(b), a partner has the right to bring an action for an accounting during the term of the partnership, as well as on the partnership’s dissolution and winding up Property Rights  Property acquired by a partnership is the property of the partnership and not of the partners individually [UPA 203] Partnership property includes all property that was originally contributed to the partnership and anything later purchased by the partnership or in the partnership’s name (except in rare circumstances) [UPA 204] A partner may use or possess partnership property only on behalf of the partnership [UPA 401(g)] A partner is not a co-owner of partnership property and has no right to sell, mortgage, or transfer partnership property to another [UPA 501].5 In other words, partnership property is owned by the partnership as an entity and not by the individual partners Thus, partnership property cannot be used to satisfy the personal debt of an individual partner That partner’s creditor, however, can petition a court for a charging order to attach the partner’s ­interest in the partnership to satisfy the partner’s obligation [UPA 502] A partner’s interest in the partnership includes her or his proportionate share of the profits and losses and the right to receive distributions (A partner can also assign her or his right to a share of the partnership profits to another to satisfy a debt.) Under the previous version of the UPA, partners were tenants in ­partnership This meant that every partner was a co-owner with all other partners of the partnership property The current UPA does not recognize this concept Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 17  Small Business Organizations  Duties and Liabilities of Partners The duties and liabilities of partners are derived from agency law Each partner is an agent of every other partner and acts as both a principal and an agent in any business transaction within the scope of the partnership agreement Each partner is also a general agent of the partnership in carrying out the usual business of the firm “or business of the kind carried on by the partnership” [UPA 301(1)] Thus, every act of a partner concerning partnership business and “business of the kind” and every contract signed in the partnership’s name bind the firm Fiduciary Duties  The fiduciary duties that a partner owes to the partnership and to the other partners are the duty of care and the duty of loyalty [UPA 404(a)] Under the UPA, a partner’s duty of care is limited to refraining from “grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law” [UPA 404(c)].6 A partner is not liable to the partnership for simple negligence or honest errors in judgment in conducting partnership business The duty of loyalty requires a partner to account to the partnership for “any property, profit, or benefit” derived by the partner in the conduct of the partnership’s business or from the use of its property A partner must also refrain from competing with the partnership in business or dealing with the firm as an adverse party [UPA 404(b)] The duty of loyalty can be breached by self-dealing, misusing partnership property, disclosing trade secrets, or usurping a partnership business opportunity Breach and Waiver of Fiduciary Duties  A partner’s fiduciary duties may not be waived or eliminated in the partnership agreement In fulfilling them, each partner must act consistently with the obligation of good faith and fair dealing [UPA 103(b), 404(d)] The agreement can specify acts that the partners agree will violate a fiduciary duty Note that a partner may pursue his or her own interests without automatically violating these duties [UPA 404(e)] The key is whether the partner has disclosed the interest to the other partners ▶  Example 17.8  Jayne Trell, a partner at Jacoby & Meyers, owns a shopping mall Trell may vote against a partnership proposal to open a competing mall, provided that she has fully dis6 The previous version of the UPA touched only briefly on the duty of loyalty and left the details of the partners’ fiduciary duties to be developed under the law of agency 401 closed her interest in the existing shopping mall to the other partners at the firm. ◀ A partner cannot make secret profits or put self-interest before his or her duty to the interest of the partnership, however Authority of Partners  The UPA affirms general principles of agency law that pertain to a partner’s authority to bind a partnership in contract A partner may also subject the partnership to tort liability under agency principles When a partner is carrying on partnership business with third parties in the usual way, apparent authority exists, and both the partner and the firm share liability If a partner acts within the scope of her or his authority, the partnership is legally bound to honor the partner’s commitments to third parties The partnership will not be liable, however, if the third parties know that the partner has no such authority Limitations on Authority.  A partnership may limit a partner’s capacity to act as the firm’s agent or transfer property on its behalf by filing a “statement of partnership authority” in a designated state office [UPA 105, 303] Such limits on a partner’s authority normally are effective only with respect to third parties who are notified of the limitation (An exception is made in real estate transactions when the statement has been recorded with the appropriate state office— see Chapter 26.) The Scope of Implied Powers.  The agency concepts relating to apparent authority, actual authority, and ratification that will be discussed in Chapter 20 also apply to partnerships The extent of implied authority generally is broader for partners than for ordinary agents, however In an ordinary partnership, the partners can exercise all implied powers reasonably necessary and customary to carry on that particular business Some customarily implied powers include the authority to make warranties on goods in the sales business and the power to enter into contracts consistent with the firm’s regular course of business ▶  Example 17.9  Jamie Schwab is a partner in a firm that operates a retail tire store He regularly promises that “each tire will be warranted for normal wear for 40,000 miles.” Because Schwab has authority to make warranties, the partnership is bound to honor the warranty Schwab would not, however, have the authority to sell the partnership’s office equipment or other property without the consent of all of the other partners.  ◀ Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 402  Unit Four  The Business Environment Liability of Partners  One significant disadvantage associated with a traditional partnership is that the partners are personally liable for the debts of the partnership Moreover, in most states, the liability is essentially unlimited because the acts of one partner in the ordinary course of business subject the other partners to personal liability [UPA 305] Joint Liability.  At one time, each partner in a partnership generally was jointly liable for the partnership’s obligations Joint liability means that a third party must sue all of the partners as a group, but each partner can be held liable for the full amount.7 If, for instance, a third party sues one partner on a partnership contract, that partner has the right to demand that the other partners be sued with her or him In fact, if the third party does not name all of the partners in the lawsuit, the assets of the partnership cannot be used to satisfy the judgment With joint liability, the partnership’s assets must be exhausted before creditors can reach the partners’ individual assets.8 Joint and Several Liability.  In the majority of the states, under UPA 306(a), partners are both jointly and severally (separately, or individually) liable for all partnership obligations, including contracts, torts, and breaches of trust Joint and several liability means that a third party has the option of suing all of the partners together (jointly) or one or more of the partners separately (severally) All partners in a partnership can be held liable even if a particular partner did not participate in, know about, or ratify the conduct that gave rise to the cause of action Normally, though, the partnership’s assets must be exhausted before a creditor can enforce a judgment against a partner’s separate assets [UPA 307(d)] A judgment against one partner severally (separately) does not extinguish the others’ liability (Similarly, a release of one partner does not discharge the partners’ several liability.) Those not sued in the first action normally may be sued subsequently, unless the court in the first action held that the partnership was in no way liable If a plaintiff is successful in a suit against a partner or partners, he or she may collect on the judgment only against the assets of those partners named as defendants Under the prior version of the UPA, which is still in effect in a few states, partners were subject to joint liability on partnership debts and contracts, but not on partnership debts arising from torts For a case applying joint liability to a partnership, see Shar’s Cars, LLC v Elder, 97 P.3d 724 (Utah App 2004) Indemnification.  With joint and several liability, a partner who commits a tort can be required to indemnify (reimburse) the partnership for any damages it pays Indemnification will typically be granted unless the tort was committed in the ordinary course of the partnership’s business ▶  Case in Point 17.10  Nicole Moren was a partner in Jax Restaurant After work one day, Moren was called back to the restaurant to help in the kitchen She brought her two-year-old son, Remington, and placed him on the kitchen counter While she was making pizzas, Remington reached into the dough press His hand was crushed, causing permanent injuries Through his father, Remington filed a suit against the partnership for negligence The partnership filed a complaint against Moren, arguing that it was entitled to indemnification from her for her negligence The court held in favor of Moren and ordered the partnership to pay damages to Remington Moren was not required to indemnify the partnership because her negligence occurred in the ordinary course of the partnership’s business.9  ◀ Liability of Incoming Partners.  A partner newly admitted to an existing partnership is not personally liable for any partnership obligations incurred before the person became a partner [UPA 306(b)] In other words, the new partner’s liability to existing creditors of the partnership is limited to her or his capital contribution to the firm ▶  Example 17.11  Smartclub, an existing partnership with four members, admits a new partner, Alex Jaff He contributes $100,000 to the partnership Smartclub has debts amounting to $600,000 at the time Jaff joins the firm Although Jaff’s capital contribution of $100,000 can be used to satisfy Smartclub’s obligations, Jaff is not personally liable for partnership debts incurred before he became a partner Thus, his personal assets cannot be used to satisfy the partnership’s preexisting debt If, however, the partnership incurs additional debts after Jaff becomes a partner, he will be personally liable for those amounts, along with all the other partners.  ◀ Dissociation of a Partner Dissociation occurs when a partner ceases to be associated in the carrying on of the partnership business Although a partner always has the power to dis9 Moren v Jax Restaurant, 679 N.W.2d 165 (Minn.App 2004) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 17  Small Business Organizations  sociate from the firm, he or she may not have the right to dissociate Dissociation normally entitles the partner to have his or her interest purchased by the partnership It also terminates the partner’s actual authority to act for the partnership and to participate in running its business The partnership may continue to business without the dissociated partner.10 Events That Cause Dissociation  Under UPA 601, a partner can be dissociated from a partnership in any of the following ways: By the partner’s voluntarily giving notice of an “express will to withdraw.” (When a partner gives notice of intent to withdraw, the remaining partners must decide whether to continue the partnership business If they decide not to continue, the voluntary dissociation of a partner will dissolve the firm [UPA 801(1)].) By the occurrence of an event specified in the partnership agreement By a unanimous vote of the other partners under certain circumstances, such as when a partner transfers substantially all of her or his interest in the partnership, or when it becomes unlawful to carry on partnership business with that partner By order of a court or arbitrator if the partner has engaged in wrongful conduct that affects the partnership business The court may order dissociation if a partner breached the partnership agreement, violated a duty owed to the partnership or to the other partners, or engaged in conduct that makes it “not reasonably practicable to carry on the business in partnership with the partner” [UPA 601(5)] By the partner’s declaring bankruptcy, assigning his or her interest in the partnership for the benefit of creditors, or becoming physically or mentally incapacitated, or by the partner’s death Wrongful Dissociation  As mentioned, a partner has the power to dissociate from a partnership at any time, but if she or he lacks the right to dissociate, then the dissociation is considered wrongful under the law [UPA 602] When a partner’s dissociation breaches a partnership agreement, for instance, it is wrongful 10 Under the previous version of the UPA, when a partner withdrew from a partnership, the partnership was considered dissolved, and the business had to end The new UPA dramatically changed the law governing partnership breakups by no longer requiring that a partnership end if one partner dissociates 403 ▶  Example 17.12  Jenkins & Whalen’s partnership agreement states that it is a breach of the agreement for any partner to assign partnership property to a creditor without the consent of the other partners If Kenzie, a partner, makes such an assignment, she has not only breached the agreement but has also wrongfully dissociated from the partnership.  ◀ A partner who wrongfully dissociates is liable to the partnership and to the other partners for damages caused by the dissociation This liability is in addition to any other obligation of the partner to the partnership or to the other partners Effects of Dissociation  Dissociation (rightful or wrongful) terminates some of the rights of the dissociated partner, requires that the partnership purchase his or her interest, and alters the liability of the parties to third parties Rights and Duties.  On a partner’s dissociation, his or her right to participate in the management and conduct of the partnership business terminates [UPA 603] The partner’s duty of loyalty also ends A partner’s duty of care continues only with respect to events that occurred before dissociation, unless the partner participates in winding up the partnership’s business (discussed shortly) Buyouts.  After a partner’s dissociation, his or her interest in the partnership must be purchased according to the rules in UPA 701 The buyout price is based on the amount that would have been distributed to the partner if the partnership had been wound up on the date of dissociation Offset against the price are amounts owed by the partner to the partnership, including damages for wrongful dissociation ▶  Case in Point 17.13  Wilbur and Dee Warnick and their son Randall bought a ranch for $335,000 and formed a partnership to operate it The partners’ initial capital contributions totaled $60,000, of which Randall paid 34 percent Over the next twenty years, each partner contributed funds to the operation and received cash distributions from the partnership In 1999, Randall dissociated from the partnership When the parties could not agree on a buyout price, Randall filed a lawsuit The court awarded Randall $115,783.13—the amount of his cash contributions, plus 34 percent of the increase in the value of the partnership’s assets above all partners’ cash contributions Randall’s parents appealed, arguing that $50,000 should be deducted from the appraised value of the assets for the estimated expenses of selling Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 404  Unit Four  The Business Environment them The court affirmed the buyout price, however, because “purely hypothetical costs of sale are not a required deduction in valuing partnership assets” to determine a buyout price.11  ◀ Liability to Third Parties.  For two years after a partner dissociates from a continuing partnership, the partnership may be bound by the acts of the dissociated partner based on apparent authority [UPA 702] In other words, if a third party reasonably believed at the time of a transaction that the dissociated partner was still a partner, the partnership may be liable Also, a dissociated partner may be liable for partnership obligations entered into during a two-year period following dissociation [UPA 703] To avoid this possible liability, a partnership should notify its creditors, customers, and clients of a partner’s dissociation In addition, either the partnership or the dissociated partner can file a statement of dissociation in the appropriate state office to limit the dissociated partner’s authority to ninety days after the filing [UPA 704] Filing this statement helps to minimize the firm’s potential liability for the former partner and vice versa Partnership Termination The same events that cause dissociation can result in the end of the partnership if the remaining partners no longer wish to (or are unable to) continue the partnership business Only certain departures of a partner will end the partnership, though, and generally the partnership can continue if the remaining partners consent [UPA 801] The termination of a partnership is referred to as dissolution, which essentially means the commencement of the winding up process Winding up is the actual process of collecting, liquidating, and distributing the partnership assets Dissolution  Dissolution of a partnership generally can be brought about by acts of the partners, by operation of law, or by judicial decree [UPA 801] Any partnership (including one for a fixed term) can be dissolved by the partners’ agreement If the partnership agreement states that it will dissolve on a certain event, such as a partner’s death or bankruptcy, then the occurrence of that event will dissolve the partnership A partnership for a fixed term or a particular undertaking is dissolved by operation 11 Warnick v Warnick, 2006 WY 58, 133 P.3d 997 (2006) of law at the expiration of the term or on the completion of the undertaking Illegality or Impracticality.  Any event that makes it unlawful for the partnership to continue its business will result in dissolution [UPA 801(4)] Under the UPA, a court may order dissolution when it becomes obviously impractical for the firm to continue—for instance, if the business can only be operated at a loss [UPA 801(5)] Even when one partner has brought a court action seeking to dissolve a ­partnership, the ­partnership continues to exist until it is legally dissolved by the court or by the parties’ agreement.12 Good Faith.  Each partner must exercise good faith when dissolving a partnership Some state statutes allow partners injured by another partner’s bad faith to file a tort claim for wrongful dissolution of a partnership ▶  Case in Point 17.14  Attorneys Randall Jordan and Mary Helen Moses formed a two-member partnership Although the partnership was for an indefinite term, Jordan ended the partnership three years later and asked the court for declarations concerning the partners’ financial obligations Moses, who had objected to ending the partnership, filed a claim against Jordan for wrongful dissolution and for appropriating $180,000 in fees that should have gone to the partnership Ultimately, the court held in favor of Moses A claim for wrongful dissolution of a partnership may be based on the excluded partner’s loss of “an existing, or continuing, business opportunity” or of income and material assets Because Jordan had attempted to appropriate partnership assets through dissolution, Moses could sue for wrongful dissolution.13  ◀ Winding Up and Distribution of Assets  After dissolution, the partnership continues for the limited purpose of winding up the business The partners cannot create new obligations on behalf of the partnership They have authority only to complete transactions begun but not finished at the time of dissolution and to wind up the business of the partnership [UPA 803, 804(1)] Duties and Compensation.  Winding up includes collecting and preserving partnership assets, discharging liabilities (paying debts), and accounting to each part12 See, for example, Curley v Kaiser, 112 Conn.App 213, 962 A.2d 167 (2009) 13 Jordan v Moses, 291 Ga 39, 727 S.E.2d 469 (2012) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 17  Small Business Organizations  ner for the value of his or her interest in the partnership Partners continue to have fiduciary duties to one another and to the firm during this process UPA 401(h) provides that a partner is entitled to compensation for services in winding up partnership affairs above and apart from his or her share in the partnership profits A partner may also receive reimbursement for expenses incurred in the process Creditors’ Claims.  Both creditors of the partnership and creditors of the individual partners can make claims on the partnership’s assets In general, partnership creditors share proportionately with the partners’ individual creditors in the partners’ assets, which include their interests in the partnership A partnership’s assets are distributed according to the following priorities [UPA 807]: Payment of debts, including those owed to partner and nonpartner creditors Return of capital contributions and distribution of profits to partners.14 If the partnership’s liabilities are greater than its assets, the partners bear the losses—in the absence of a contrary agreement—in the same proportion in which they shared the profits (rather than, for example, in proportion to their contributions to the partnership’s capital) 14 Under the previous version of the UPA, creditors of the partnership had priority over creditors of the individual partners Also, in distributing partnership assets, third party creditors were paid before partner creditors, and capital contributions were returned before profits 405 Partnership Buy-Sell Agreements Before entering into a partnership, partners should agree on how the assets will be valued and divided in the event that the partnership dissolves A buysell agreement, sometimes called simply a buyout ­agreement, provides for one or more partners to buy out the other or others, should the situation warrant Agreeing beforehand on who buys what, under what circumstances, and, if possible, at what price may eliminate costly negotiations or litigation later Alternatively, the agreement may specify that one or more partners will determine the value of the interest being sold and that the other or others will decide whether to buy or sell Under UPA 701(a), if a partner’s dissociation does not result in a dissolution of the partnership, a buyout of the partner’s interest is mandatory The UPA contains an extensive set of buyout rules that apply when the partners not have a buyout agreement Basically, a withdrawing partner receives the same amount through a buyout that he or she would receive if the business were winding up [UPA 701(b)] In the following case, one of the three partners in an agricultural partnership died Despite provisions in the partnership agreement that required its dissolution on a certain date or on a partner’s death, whichever came first, the remaining partners did not dissolve the firm and did not liquidate the assets C AS E ANALY S IS Case 17.2 Estate of Webster v Thomas Appellate Court of Illinois, Fifth District, 2013 IL App (5th) 120121-U, 2013 WL 164041 (2013) In the language of the court Justice wexstten delivered the opinion of the court: * * * * Clyde L Webster, Jr., who formed T & T Agri-Partners Company with partners [James] Theis and [Larry] Thomas, died September 18, 2002 The T & T Agri-Partners Company owns approximately 180 acres of farmland in Christian County [Illinois] subject to mortgage liability to the Rochester State Bank and/or Farm Credit Services of Central Illinois This farmland constitutes T & T Agri-Partners Company’s only asset The September 1, 1997, partnership agreement executed by Clyde, Theis, and Thomas * * * issued 180 partnership units, with Thomas holding 40 (22.2%), Theis holding 80 (44.5%), and Clyde holding 60 (33.3%) The partnership agreement further provided as follows: * * * Unless extended by the written consent of those Partners whose combined ownership interest equals at least one hundred twenty (120) Partnership units, the Partnership shall continue until the first to CASE 17.2 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 406  Unit Four  The Business Environment CASE 17.2 CONTINUEd occur of January 31, 2010 A.D., or the earlier dissolution of the Partnership * * * * * * * If a Partner dies, the Partnership will be dissolved, unless those Partners owning at least one hundred twenty (120) Partnership units including the personal representative of the deceased Partner’s estate * * * vote to continue the Partnership within one hundred twenty (120) days of the date of the deceased Partner’s death Upon dissolution, the assets of the Partnership shall be liquidated and distributed Any Partner who shall violate any of the terms of this Agreement * * * shall indemnify and hold harmless the Partnership, and all other Partners from any and all * * * losses, * * * including but not limited to attorneys’ fees On October 14, 2008, [the Estate of Webster through its personal representative Joseph Webster (the plaintiff)] filed its complaint [in an Illinois state circuit court] against [Theis, Thomas, and the partnership (the defendants)] The plaintiff’s complaint sought a declaratory judgment ordering the partnership assets to be distributed based upon the thencurrent value of the acreage * * * * On December 9, 2009, the circuit court entered an order granting summary judgment on * * * the plaintiff’s complaint [But the defendants did not liquidate the partnership, and the case went to trial.] * * * * On September 2, 2011, after the * * * trial, the circuit court entered its order, finding that the partnership expired by its terms on January 31, 2010, and despite demand by the plaintiff, the partnership had failed and refused to liquidate the assets and disburse funds to the plaintiff according to * * * the partnership agreement The circuit court thereby ordered the defendants to liquidate the partnership * * * * The circuit court further * * * ordered [the defendants to pay] reasonable attorney fees and costs incurred by the plaintiff * * * On March 8, 2012, the defendants filed a notice of appeal [arguing that the circuit court erred in ordering them to pay the plaintiff’s attorney fees] * * * * The partnership agreement clearly provided that upon Clyde’s death and the partners’ failure to vote to continue the partnership, the partnership dissolved Pursuant to the plain language of the partnership agreement, the assets upon dissolution were to be liquidated and distributed by paying the partners in proportion to their capital accounts Yet, the defendants failed to so [Emphasis added.] On December 9, 2009, seven years after Clyde’s death, the circuit court entered summary judgment on * * * the plaintiff’s complaint and construed the partnership agreement by determining that upon dissolution, which occurred at Clyde’s death on September 18, 2002, and as a result of the remaining partners not agreeing to continue partnership, the assets of the partnership were to be liquidated and distributed * * *  Again, however, despite the agreement’s language and despite the circuit court’s order, the defendants failed to liquidate the partnership assets In failing to so, they violated the partnership agreement and were liable for the plaintiff’s attorney fees pursuant to the same agreement * * * * * * * The judgment of the * * * court of Christian County is affirmed Legal Reasoning Questions What did the partnership agreement at the center of this case require on the death of a partner and the dissolution of the firm? What conduct by which parties triggered this litigation? On what did the court base its order regarding attorneys’ fees? What might the defendants have done to avoid the dispute that arose from the circumstances of this case? SECTION Franchises Instead of setting up a sole proprietorship to market their own products or services, many entrepreneurs opt to purchase a franchise A franchise is an arrangement in which the owner of intellectual property—such as a trademark, a trade name, or a copy- right—licenses others to use it in the selling of goods or services A franchisee (a purchaser of a franchise) is generally legally independent of the franchisor (the seller of the franchise) At the same time, the franchisee is economically dependent on the franchisor’s integrated business system In other words, a franchisee can operate as an independent businessperson but still obtain the advantages of a regional or national organization Today, Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 17  Small Business Organizations  franchising companies and their franchisees account for a significant portion of all retail sales in this country Well-known franchises include McDonald’s, 7-Eleven, and Holiday Inn Franchising has also become a popular way for businesses to expand their operations internationally without violating the legal restrictions that many nations impose on foreign ownership of businesses Types of Franchises Many different kinds of businesses now sell franchises, and numerous types of franchises are available Generally, though, franchises fall into one of three classifications: distributorships, chain-style business operations, and manufacturing arrangements Distributorship  In a distributorship, a manufacturer (the franchisor) licenses a dealer (the franchisee) to sell its product Often, a distributorship covers an exclusive territory Automobile dealerships and beer distributorships are common examples ▶  Example 17.15  Black Butte Beer Company distributes its brands of beer through a network of authorized wholesale distributors, each with an assigned territory Marik signs a distributorship contract for the area from Gainesville to Ocala, Florida If the contract states that Marik is the exclusive distributor in that area, then no other franchisee may distribute Black Butte beer in that region.  ◀ Chain-Style Business Operation  In a chain-style business operation, a franchise operates under a franchisor’s trade name and is identified as a member of a select group of dealers that engage in the franchisor’s business The franchisee is generally required to follow standardized or prescribed methods of operation Often, the franchisor insists that the franchisee maintain certain standards of performance In addition, the franchisee may be required to obtain materials and supplies exclusively from the franchisor McDonald’s and most other fast-food chains are examples of this type of franchise Chainstyle franchises are also common in service-related businesses, including real estate brokerage firms, such as Century 21, and tax-preparing services, such as H&R Block, Inc Manufacturing Arrangement  In a manufacturing, or processing-plant, arrangement, the franchisor transmits to the franchisee the essential ingredients 407 or formula to make a particular product The franchisee then markets the product either at wholesale or at retail in accordance with the franchisor’s standards Examples of this type of franchise include Pepsi-Cola and other soft-drink bottling companies Laws Governing Franchising Because a franchise relationship is primarily a contractual relationship, it is governed by contract law If the franchise exists primarily for the sale of products manufactured by the franchisor, the law governing sales contracts as expressed in Article of the Uniform Commercial Code applies (see Chapter 11) Additionally, the federal government and most states have enacted laws governing certain aspects of franchising Generally, these laws are designed to protect prospective franchisees from dishonest franchisors and to prevent franchisors from terminating franchises without good cause Federal Regulation of Franchises  The federal government regulates franchising through laws that apply to specific industries and through the Franchise Rule, created by the Federal Trade Commission (FTC) Industry-Specific Standards. Congress has enacted laws that protect franchisees in certain industries, such as automobile dealerships and service stations These laws protect the franchisee from unreasonable demands and bad faith terminations of the franchise by the franchisor An automobile manufacturer–franchisor cannot make unreasonable demands of dealer-franchisees or set unrealistically high sales quotas If an automobile manufacturer–franchisor terminates a franchise because of a dealer-franchisee’s failure to comply with unreasonable demands, the manufacturer may be liable for damages.15 Similarly, federal law prescribes the conditions under which a franchisor of service stations can terminate the franchise.16 Federal antitrust laws (discussed in Chapter 27) also apply in certain circumstances to prohibit certain types of anticompetitive agreements 15 Automobile Dealers’ Franchise Act of 1965, also known as the Automobile Dealers’ Day in Court Act, 15 U.S.C Sections 1221 et seq 16 Petroleum Marketing Practices Act (PMPA) of 1979, 15 U.S.C Sections 2801 et seq Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 408  Unit Four  The Business Environment The Franchise Rule.  The FTC’s Franchise Rule requires franchisors to disclose certain material facts that a prospective franchisee needs in order to make an informed decision concerning the purchase of a franchise.17 The Franchise Rule requires the following: Written (or electronically recorded) disclosures The franchisor must make numerous disclosures, such as the range of goods and services included and the value and estimated profitability of the franchise Disclosures can be in writing or done electronically online Prospective franchisees must be able to download or save all electronic disclosure documents Reasonable basis for any representations To prevent deception, all representations made to a prospective franchisee must have a reasonable basis at the time they are made Projected earnings figures If a franchisor provides projected earnings figures, the franchisor must indicate whether the figures are based on actual data or hypothetical examples (The Franchise Rule does not require franchisors to provide potential earnings figures, however, as discussed in the Insight into Ethics feature on the next page.) Actual data If a franchisor makes sales or earnings projections based on actual data for a specific franchise location, the franchisor must disclose the number and percentage of its existing franchises that have achieved this result Explanation of terms Franchisors are also required to explain termination, cancellation, and renewal provisions of the franchise contract to potential franchisees before the agreement is signed Those who violate the Franchise Rule are subject to substantial civil penalties, and the FTC can sue on behalf of injured parties to recover damages State Regulation of Franchising  State legislation varies but often is aimed at protecting franchisees from unfair practices and bad faith terminations by franchisors State Disclosures.  Approximately fifteen states have laws similar to the federal rules that require franchisors to provide presale disclosures to prospective franchisees.18 Many state laws also require that a disclosure document (known as the Franchise Disclosure 17 16 C.F.R Section 436.1 18 These states include California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington, and Wisconsin Document, or FDD) be registered or filed with a state official State laws may also require that a franchisor submit advertising aimed at prospective franchisees to the state for approval To protect franchisees, a state law might require the disclosure of information such as the actual costs of operation, recurring expenses, and profits earned, along with facts substantiating these figures State deceptive trade practices acts (see Chapter 24) may also apply and prohibit certain types of actions by franchisors May Require Good Cause to Terminate the Franchise.  To protect franchisees against arbitrary or bad faith terminations, state law may prohibit termination without “good cause” or require that certain procedures be followed in terminating a franchise ▶  Case in Point 17.16  FMS, Inc., entered into a franchise agreement with Samsung Construction Equipment North America to become an authorized dealership selling Samsung construction equipment Then Samsung sold its equipment business to Volvo Construction Equipment North America, Inc., which was to continue selling Samsung brand equipment Later, Volvo rebranded the construction equipment under its own name and canceled FMS’s franchise FMS sued, claiming Volvo had terminated the franchise without “good cause” in violation of state law Because Volvo was no longer manufacturing the Samsung brand equipment, however, the court found that Volvo had good cause to terminate FMS’s franchise If Volvo had continued making the Samsung equipment, though, it could not have terminated the franchise.19  ◀ The Franchise Contract The franchise relationship is defined by the contract between the franchisor and the franchisee The franchise contract specifies the terms and conditions of the franchise and spells out the rights and duties of the franchisor and the franchisee If either party fails to perform its contractual duties, that party may be subject to a lawsuit for breach of contract Furthermore, if a franchisee is induced to enter into a franchise contract by the franchisor’s fraudulent misrepresentation, the franchisor may be liable for damages Generally, statutes and the case law governing franchising tend to emphasize the 19 FMS, Inc v Volvo Construction Equipment North America, Inc., 557 F.3d 758 (7th Cir 2009) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 17  Small Business Organizations  409 Insight into Ethics Should Franchisors Have to Give Prospective Franchisees Information about Potential Earnings? Entrepreneurs who are thinking about investing in a franchise almost invariably ask, “How much will I make?” Surprisingly, current law does not require franchisors to provide any information about the earnings potential of a franchise Voluntary Disclosure of Earnings Data Franchisors can voluntarily choose to provide projected earnings in their disclosures but are not required to so If franchisors include earnings data, they must indicate whether these figures are actual or hypothetical and have a reasonable basis for these claims About 75 percent of franchisors choose not to provide information about earnings potential Franchisee Complaints The failure of the FTC’s Franchise Rule to require disclosure of earnings potential has led to many complaints from franchisees After all, some franchisees invest their life savings in franchises that ultimately fail because of unrealistic earnings expectations Moreover, the franchisee may be legally obliged to continue paying the franchisor even when the business is not turning a profit For instance, Thomas Anderson asked the franchisor, Rocky Mountain Chocolate Factory, Inc (RMCF), and five of its franchisees for earnings information before he entered into a franchise agreement, but he did not receive any data Although his chocolate franchise failed to become profitable, a court ordered Anderson and his partner to pay $33,109 in past due royalties and interest to RMCF (plus court costs and expenses).a Legal Critical Thinking Insight into the Business Environment If the law required franchisors to provide estimates of potential earnings, would there be more or less growth in the number of franchises? Explain your answer a Rocky Mountain Chocolate Factory, Inc v SDMS, Inc., 2009 WL 579516 (D.Colo 2009) importance of good faith and fair dealing in franchise relationships Because each type of franchise relationship has its own characteristics, franchise contracts tend to differ Nonetheless, certain major issues typically are addressed in a franchise contract We look at some of them next Business Premises  The franchise agreement may specify whether the premises for the business must be leased or purchased outright Sometimes, a building must be constructed to meet the terms of the agreement The agreement will specify whether the franchisor or the franchisee is responsible for supplying equipment and furnishings for the premises Payment for the Franchise  The franchisee ordinarily pays an initial fee or lump-sum price for the franchise license (the privilege of being granted a franchise) This fee is separate from the various products that the franchisee purchases from or through the franchisor The franchise agreement may also require the franchisee to pay a percentage of the franchisor’s advertising costs and certain administrative expenses In some industries, the franchisor relies heavily on the initial sale of the franchise for realizing a profit In other industries, the continued dealing between the parties brings profit to both Generally, the franchisor receives a stated percentage of the annual (or monthly) sales or volume of business done by the franchisee Location of the Franchise  Typically, the franchisor determines the territory to be served Some franchise contracts give the franchisee exclusive rights, or “territorial rights,” to a certain geographic area Other franchise contracts, while defining the territory allotted to a particular franchise, either specifically state that the franchise is nonexclusive or are silent on the issue of territorial rights Many franchise cases involve disputes over territorial rights, and the implied covenant of good faith and fair dealing often comes into play in this area of franchising If the franchise contract does not grant the franchisee exclusive territorial rights and the franchisor allows a competing franchise to be established nearby, the franchisee may suffer a significant loss in Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 410  Unit Four  The Business Environment profits In this situation, a court may hold that the franchisor breached an implied covenant of good faith and fair dealing Business Organization  The franchisor may require that the business use a particular organizational form and capital structure The franchise agreement may also set out standards such as sales quotas and recordkeeping requirements Additionally, a franchisor may retain stringent control over the training of personnel involved in the operation and over administrative aspects of the business Quality Control  The day-to-day operation of the franchise business normally is left up to the franchisee Nonetheless, the franchise agreement may specify that the franchisor will provide some degree of supervision and control so that it can protect the franchise’s name and reputation Means of Control.  When the franchise prepares a product, such as food, or provides a service, such as motel accommodations, the contract often states that the franchisor will establish certain standards for the facility Typically, the contract will state that the franchisor is permitted to make periodic inspections to ensure that the standards are being maintained As a means of controlling quality, franchise agreements also typically limit the franchisee’s ability to sell the franchise to another party ▶  Example 17.17  Mark Keller, Inc., an authorized Jaguar franchise, contracts to sell its dealership to Henrique Autos West A Jaguar franchise generally cannot be sold without Jaguar Cars’ permission Prospective franchisees must meet Jaguar’s customer satisfaction standards If Henrique Autos fails to meet those standards, Jaguar can refuse to allow the sale and can terminate the franchise.20  ◀ Degree of Control.  As a general rule, the validity of a provision permitting the franchisor to establish and enforce certain quality standards is unquestioned The franchisor has a legitimate interest in maintaining the quality of the product or service to protect its name and reputation If a franchisor exercises too much control over the operations of its franchisees, however, the franchisor risks potential liability A franchisor may occasionally be held liable—under the doctrine of respondeat 20 For example, see Midwest Automotive III, LLC v Iowa Department of Transportation, 646 N.W.2d 417 (Iowa 2002) superior (see Chapter 20)—for the tortious acts of the franchisees’ employees Pricing Arrangements Franchises provide the franchisor with an outlet for the firm’s goods and services Depending on the nature of the business, the franchisor may require the franchisee to purchase certain supplies from the franchisor at an established price.21 A franchisor cannot, however, set the prices at which the franchisee will resell the goods because such price setting may be a violation of state or federal antitrust laws, or both A franchisor can suggest retail prices but cannot mandate them Franchise Termination The duration of the franchise is a matter to be determined between the parties Sometimes, a franchise relationship starts with a short trial period, such as a year, so that the franchisee and the franchisor can determine whether they want to stay in business with each another Other times, the duration of the franchise contract correlates with the term of the lease for the business premises, and both are renewable at the end of that period Grounds for Termination Set by Franchise Contract  Usually, the franchise agreement specifies that termination must be “for cause” and then defines the grounds for termination Cause might include, for instance, the death or disability of the franchisee, insolvency of the franchisee, breach of the franchise agreement, or failure to meet specified sales quotas Notice Requirements.  Most franchise contracts provide that notice of termination must be given If no set time for termination is specified, then a reasonable time, with notice, is implied A franchisee must be given reasonable time to wind up the business— that is, to the accounting and return the copyright or trademark or any other property of the franchisor Opportunity to Cure a Breach.  A franchise agreement may state that the franchisee may attempt to cure an ordinary, curable breach within a certain period of time after notice so as to postpone, or even avoid, the termination of the contract Even when a contract contains a notice-and-cure provision, however, a 21 Although a franchisor can require franchisees to purchase supplies from it, requiring a franchisee to purchase exclusively from the franchisor may violate federal antitrust laws (see Chapter 27) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 17  Small Business Organizations  franchisee’s breach of the duty of honesty and fidelity may be enough to allow the franchisor to terminate the franchise ▶  Case in Point 17.18  Pilot Air Freight Corporation is a franchisor that moves freight through its network of operations at airports and other sites LJL Transportation, Inc., was a franchisee The franchise agreement required LJL to assign all shipments to the Pilot network The agreement also provided that “Pilot shall allow Franchisee an opportunity to cure a default within ninety (90) days of receipt of written notice.” After eight years as a Pilot franchisee, LJL began to divert shipments to Northeast Transportation, a competing service owned by LJL’s owners Pilot then terminated the franchise agreement LJL filed a lawsuit claiming that it should be allowed to cure its breach, but the court ruled in favor of Pilot A franchise agreement may be terminated immediately when there is a material breach so serious that it goes directly to the heart and essence of the contract.22  ◀ Wrongful Termination Because a franchisor’s termination of a franchise often has adverse consequences for the franchisee, much franchise litigation involves claims of wrongful termination Generally, the termination provisions of contracts are more favorable to the franchisor than to the franchisee 22 LJL Transportation, Inc v Pilot Air Freight Corp., 599 Pa 546, 962 A.2d 639 (Pa.Sup.Ct 2009) SP TLIGHT 411 This means that the franchisee, who normally invests a substantial amount of time and financial resources in making the franchise operation successful, may receive little or nothing for the business on termination The franchisor owns the trademark and hence the business It is in this area that statutory and case law become important The federal and state laws discussed earlier attempt, among other things, to protect franchisees from the arbitrary or unfair termination of their franchises by the franchisors The Importance of Good Faith and Fair Dealing  Generally, both statutory law and case law emphasize the importance of good faith and fair dealing in terminating a franchise relationship In determining whether a franchisor has acted in good faith when terminating a franchise agreement, the courts usually try to balance the rights of both parties If a court perceives that a franchisor has arbitrarily or unfairly terminated a franchise, the franchisee will be provided with a remedy for wrongful termination If a franchisor’s decision to terminate a franchise was made in the normal course of business, however, and reasonable notice of termination was given, a court will be less likely to consider the termination wrongful The importance of good faith and fair dealing in a franchise relationship is underscored by the consequences of the franchisor’s acts in the following case on Holiday Inns Case 17.3 Holiday Inn Franchising, Inc v Hotel Associates, Inc Court of Appeals of Arkansas, 2011 Ark.App 147, 382 S.W.3d (2011) BACKGROUND AND FACTS  Buddy House was in the construction business in Arkansas and Texas For decades, he collaborated on projects with Holiday Inn Franchising, Inc Their relationship was characterized by good faith—many projects were undertaken without written contracts At Holiday Inn’s request, House inspected a hotel in Wichita Falls, Texas, to estimate the cost of getting it into shape Holiday Inn wanted House to renovate the hotel and operate it as a Holiday Inn House estimated that recovering the cost of renovation would take him more than ten years, so he asked for a franchise term longer than Holiday Inn’s usual ten years Holiday Inn refused, but said that if the hotel was run ­“appropriately,” the term would be extended at the end of ten years House bought the hotel, renovated it, and operated it as Hotel Associates, Inc (HAI), generating substantial profits He refused offers to sell it for as much as $15 million Before the ten years had passed, Greg Aden, a Holiday Inn executive, developed a plan to license a different local hotel as a Holiday Inn instead of renewing House’s franchise license Aden stood to earn a CASE 17.3 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 412  Unit Four  The Business Environment CASE 17.3 CONTINUEd commission from licensing the other hotel No one informed House of Aden’s plan When the time came, HAI applied for an extension of its franchise, and Holiday Inn asked for major renovations HAI spent $3 million to comply with this request Holiday Inn did not renew HAI’s license, however, but instead granted a franchise to the other hotel HAI sold its hotel for
$5 million and filed a suit in an Arkansas state court against Holiday Inn, asserting fraud The court awarded HAI compensatory and punitive damages Holiday Inn appealed IN THE Language OF THE COURT Raymond R ABRAMSON, Judge * * * * Generally, a mere failure to volunteer information does not constitute fraud But silence can amount to actionable fraud in some circumstances where the parties have a relation of trust or confidence, where there is inequality of condition and knowledge, or where there are other attendant circumstances [Emphasis added.] In this case, substantial evidence supports the existence of a
duty on Holiday Inn’s part to disclose the Aden [plan] to HAI Buddy House had a long-term relationship with Holiday Inn characterized by honesty, trust, and the free flow of pertinent information He testified that [Holiday Inn’s] assurances at the onset of licensure [the granting of the license] led him to believe that he would be relicensed after
ten years if the hotel was operated appropriately Yet, despite Holiday Inn’s having provided such an assurance to House, it failed to apprise House of an internal business plan * * * that advocated licensure of another facility instead of the renewal of his license A duty of disclosure may exist where information is peculiarly within the knowledge of one party and is of such a nature that the other party is justified
in assuming its nonexistence Given House’s history with Holiday Inn and the assurance he received, we are convinced he was justified in assuming that no obstacles had arisen that jeopardized his relicensure [Emphasis added.] Holiday Inn asserts that it would have provided Buddy House
with the Aden [plan] if he had asked for it But, Holiday Inn cannot satisfactorily explain why House should have been charged with the responsibility of inquiring about a plan that he did not know existed Moreover, several Holiday Inn personnel testified that Buddy House
in fact should have been provided with the Aden plan Aden himself stated that * * * House should have been given the plan * * * In light of these circumstances, we see no ground for reversal on this aspect of HAI’s cause of action for fraud DECISION AND REMEDY  The state intermediate appellate court affirmed the lower court’s judgment and its award of compensatory damages The appellate court increased the amount of punitive damages, however, citing Holiday Inn’s “degree of reprehensibility.” THE LEGAL ENVIRONMENT DIMENSION  Why should House and HAI have been advised of Holiday Inn’s plan to grant a franchise to a different hotel in their territory? the economic dimension  A jury awarded HAI $12 million in punitive damages The court reduced this award to $1 million, but the appellate court reinstated the original award What is the purpose of punitive damages? Did Holiday Inn’s conduct warrant this award? Explain Reviewing: Small Business Organizations Grace Tarnavsky and her sons, Manny and Jason, bought a ranch known as the Cowboy Palace in March 2009, and the three verbally agreed to share the business for five years Grace contributed 50 percent of the investment, and each son contributed 25 percent Manny agreed to handle the livestock, and Jason Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 17  Small Business Organizations  413 agreed to handle the bookkeeping The Tarnavskys took out joint loans and opened a joint bank account into which they deposited the ranch’s proceeds and from which they made payments for property, cattle, equipment, and supplies In September 2013, Manny severely injured his back while baling hay and became permanently unable to handle livestock Manny therefore hired additional laborers to tend the livestock, causing the Cowboy Palace to incur significant debt In September 2014, Al’s Feed Barn filed a lawsuit against Jason to collect $32,400 in unpaid debts Using the information presented in the chapter, answer the following questions Was this relationship a partnership for a term or a partnership at will? Did Manny have the authority to hire additional laborers to work at the ranch after his injury? Why or why not? Under the current UPA, can Al’s Feed Barn bring an action against Jason individually for the Cowboy Palace’s debt? Why or why not? Suppose that after his back injury in 2013, Manny sent his mother and brother a notice indicating his intent to withdraw from the partnership Can he still be held liable for the debt to Al’s Feed Barn? Why or why not? Debate This  All franchisors should be required by law to provide a comprehensive estimate of the profitability of a prospective franchise based on the experiences of their existing franchisees Terms and Concepts articles of partnership 398 buyout price 403 buy-sell agreement 405 charging order 400 dissociation 402 dissolution 404 entrepreneur 394 franchise 406 franchisee 406 franchisor 406 goodwill 397 information return 398 joint and several liability 402 joint liability 402 partnership 397 partnership by estoppel 398 pass-through entity 398 sole proprietorship 394 winding up 404 ExamPrep Issue Spotters Darnell and Eliana are partners in D&E Designs, an architectural firm When Darnell dies, his widow claims that as Darnell’s heir, she is entitled to take his place as Eliana’s partner or to receive a share of the firm’s assets Is she right? Why or why not? (See page 402.) Anchor Bottling Company and U.S Beverages, Inc (USB), enter into a franchise agreement that states the franchise may be terminated at any time “for cause.” Anchor fails to meet USB’s specified sales quota Does this constitute “cause” for termination? Why or why not? (See page 410.) •  Check your answers to the Issue Spotters against the answers provided in Appendix E at the end of this text Before the Test  Go to www.cengagebrain.com, enter the ISBN 9781285428949, and click on “Find” to locate this textbook’s Web site Then, click on “Access Now” under “Study Tools,” and select Chapter 17 at the top There, you will find an Interactive Quiz that you can take to assess your mastery of the concepts in this chapter, as well as Flashcards and a Glossary of important terms Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 414  Unit Four  The Business Environment Business Scenarios 17–1. Partnership Formation.  Daniel is the owner of a chain of shoe stores He hires Rubya to be the manager of a new store, which is to open in Grand Rapids, Michigan Daniel, by written contract, agrees to pay Rubya a monthly salary and 20 percent of the profits Without Daniel’s knowledge, Rubya represents himself to Classen as Daniel’s partner and shows Classen the agreement to share profits Classen extends credit to Rubya Rubya defaults Discuss whether Classen can hold Daniel liable as a partner (See page 398.) 17–2.  Control of a Franchise.  National Foods, Inc., sells franchises to its fast-food restaurants, known as Chicky–D’s Under the franchise agreement, franchisees agree to hire and train employees strictly according to Chicky-D’s standards Chicky-D’s regional supervisors are required to approve all job candidates before they are hired and all general policies affecting those employees Chicky-D’s reserves the right to terminate a franchise for violating the franchisor’s rules In practice, however, Chicky-D’s regional supervisors routinely approve new employees and individual franchisees’ policies After several incidents of racist comments and conduct by Tim, a recently hired assistant manager at a Chicky-D’s, Sharon, a counterperson at the restaurant, resigns Sharon files a suit in a federal district court against National National files a motion for summary judgment, arguing that it is not liable for harassment by franchise employees Will the court grant National’s motion? Why or why not? (See page 410.) Business Case Problems 17–3. Spotlight on McDonald’s—Franchise Termination. J.C., Inc., had a franchise agreement with McDonald’s Corp to operate McDonald’s restaurants in Lancaster, Ohio The agreement required J.C to make monthly payments of certain percentages of the gross sales to McDonald’s If any payment was more than thirty days late, McDonald’s had the right to terminate the franchise The agreement also stated that even if McDonald’s accepted a late payment, that would not “constitute a waiver of any subsequent breach.” McDonald’s sometimes accepted J.C.’s late payments, but when J.C defaulted on the payments in July 2010, McDonald’s gave notice of thirty days to comply or surrender possession of the restaurants J.C missed the deadline McDonald’s demanded that J.C vacate the restaurants, but J.C refused McDonald’s alleged that J.C had violated the franchise agreement J.C claimed that McDonald’s had breached the implied covenant of good faith and fair dealing Which party should prevail and why? [McDonald’s Corp v C.B Management Co.,13 F.Supp.2d 705 (N.D.Ill 1998)] (See page 410.) 17–4. Fiduciary Duties of Partners.  Karl Horvath, Hein Rüsen, and Carl Thomas formed a partnership, HRT Enterprises, to buy a manufacturing plant Rüsen and Thomas leased the plant to their own company, Merkur Steel Merkur then sublet the premises to other companies owned by Rüsen and Thomas The rent that these companies paid to Merkur was higher than the rent that Merkur paid to HRT Rüsen and Thomas did not tell Horvath about the subleases Did Rüsen and Thomas breach their fiduciary duties to HRT and Horvath? Discuss [Horvath v HRT Enterprises, 489 Mich.App 992, 800 N.W.2d 595 (2011)] (See page 401.) 17–5. Franchise Termination. George Oshana and GTO Investments, Inc., operated a Mobil gas station franchise in Itasca, Illinois In 2010, Oshana and GTO became involved in a rental dispute with Buchanan Energy, to which Mobil had assigned the lease In November 2011, Buchanan terminated the franchise because Oshana and GTO had failed to pay the rent Oshana and GTO, however, alleged that they were “ready, willing, and able to pay the rent” but that Buchanan failed to accept their electronic fund transfer Have Oshana and GTO stated a claim for wrongful termination of their franchise? Why or why not? [Oshana v Buchanan Energy, 2012 WL 426921 (N.D.Ill 2012)] (See page 410.) 17–6.  Business Case Problem with Sample Answer:  Partnership Formation Patricia Garcia and Bernardo Lucero were in a romantic relationship While they were seeing each other, Garcia and Lucero acquired an electronics service center, paying $30,000 apiece Two years later, they purchased an apartment complex The property was deeded to Lucero, but neither Garcia nor Lucero made a down payment The couple considered both properties to be owned “50/50,” and they agreed to share profits, losses, and management rights When the couple’s romantic relationship ended, Garcia asked a court to declare that she had a partnership with Lucero In court, Lucero argued that the couple did not have a written partnership agreement Did they have a partnership? Why or why not? [Garcia v Lucero, 366 S.W.3d 275 (Tex.App 2012)] (See page 398.) • For a sample answer to Problem 17–6, go to Appendix F at the end of this text 17–7. Quality Control. JTH Tax, Inc., doing business as Liberty Tax Service, provides tax preparation and related loan services through company-owned and franchised stores Liberty’s agreement with its franchisees reserved the right to control their ads In operations manuals, Liberty provided step-by-step instructions, directions, and Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 17  Small Business Organizations  limitations regarding the franchisees’ ads and retained the right to unilaterally modify the steps at any time The California attorney general filed a suit in a California state court against Liberty, alleging that its franchisees had used misleading or deceptive ads regarding refund anticipation loans and e-refund checks Can Liberty be held liable? Discuss [People v JTH Tax, Inc., 212 Cal.App.4th 1219, 151 Cal.Rptr.3d 728 (1 Dist 2013)] (See page 410.) 17–8.  Winding Up and Distribution of Assets. Dan and Lori Cole operated a Curves franchise exercise facility in Angola, Indiana, as a partnership The firm leased commercial space from Flying Cat, LLC, for a renewable threeyear term and renewed the lease for a second three-year term But two years after the renewal, the Coles divorced By the end of the second term, Flying Cat was owed more than $21,000 on the lease Without telling the landlord about the divorce, Lori signed another extension More rent went unpaid Flying Cat obtained a judgment in an Indiana state court against the partnership for almost $50,000 Can Dan be held liable? Why or why not? [Curves for Women Angola v Flying Cat, LLC, 983 N.E.2d 629 (Ind App 2013)] (See page 404.) 415 17–9.  A QUESTION OF ETHICS:  Wrongful Dissociation Elliot Willensky and Beverly Moran formed a partnership to buy, renovate, and sell a house Moran agreed to finance the effort, which was to cost no more than $60,000 Willensky agreed to oversee the work, which was to be done in six months Willensky lived in the house during the renovation As the project progressed, Willensky incurred excessive and unnecessary expenses, misappropriated funds for his personal use, did not pay bills on time, and did not keep Moran informed of the costs More than a year later, the renovation was still not completed, and Willensky walked off the project Moran completed the renovation, which ultimately cost $311,222, and sold the house Moran then sued to dissolve the partnership and recover damages from Willensky for breach of contract and wrongful dissociation [Moran v Willensky, 395 S.W.3d 651 (Tenn.Ct.App 2010)] (See page 403.) (a) Moran alleged that Willensky had wrongfully dissociated from the partnership When did this dissociation occur? Why was his dissociation wrongful? (b) Which of Willensky’s actions simply represent unethical behavior or bad management, and which constitute a breach of the agreement? Legal Reasoning Group Activity 17–10. Liability of Partners. At least six months before the Summer Olympic Games in Atlanta, Georgia, Stafford Fontenot and four others agreed to sell Cajun food at the games and began making preparations On May 19, the group (calling themselves “Prairie Cajun Seafood Catering of Louisiana”) applied for a business license from the county health department Later, Ted Norris sold a mobile kitchen to them for $40,000 They gave Norris an $8,000 check drawn on the “Prairie Cajun Seafood Catering of Louisiana” account and two promissory notes, one for $12,000 and the other for $20,000 The notes, which were dated June 12, listed only Fontenot “d/b/a Prairie Cajun Seafood” as the maker (d/b/a is an abbreviation for “doing business as”)      On July 31, Fontenot and his friends signed a partnership agreement, which listed specific percentages of profits and losses They drove the mobile kitchen to Atlanta, but business was “disastrous.” When the notes were not paid, Norris filed a suit in a Louisiana state court against Fontenot, seeking payment (See page 402.) (a) The first group will discuss the elements of a partnership and determine whether a partnership exists among Fontenot and the others (b) The second group will determine who can be held liable on the notes and why Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 18 Limited Liability Business Forms I n the previous chapter, we examined sole proprietorships, franchises, and traditional partnerships Here, we examine a relatively new form of business organization called the limited liability company (LLC) LLCs have become the organizational form of choice among businesspersons We also examine business forms designed to limit the liability of partners This chapter begins with a discussion of the important aspects of an LLC, including its formation, jurisdictional requirements, and the advantages and disadvantages of choosing to business as an LLC This is followed by an examination of its management and operation options We then look at a similar type of entity that is also relatively new—the limited liability Section The Limited Liability Company A limited liability company (LLC) is a hybrid that combines the limited liability aspects of a corporation and the tax advantages of a partnership The LLC has been available for only a few decades, but it has become the preferred structure for many small businesses LLCs are governed by state statutes, which vary from state to state In an attempt to create more uniformity, the National Conference of Commissioners on Uniform State Laws issued the Uniform Limited Liability Company Act (ULLCA) Less than one-fifth of the states have adopted it, though Thus, the law governing LLCs remains far from uniform Some provisions are common to most state statutes, however, and we base our discussion of LLCs in this section on these common elements The Nature of the LLC LLCs share many characteristics with corporations Like corporations, LLCs must be formed and operated in compliance with state law Like the shareholders of partnership (LLP) This chapter concludes with a discussion of the limited partnership (LP), a special type of partnership in which some of the partners have limited liability, and the limited liability limited partnership (LLLP) a corporation, the owners of an LLC, who are called members, enjoy limited liability [ULLCA 303].1 Limited Liability of Members  Members of LLCs are shielded from personal liability in many situations, even sometimes when sued by employees of the firm ▶  Case in Point 18.1  Penny McFarland was the activities director at a retirement community in Virginia that was owned by an LLC Her supervisor told her to take the residents outside for a walk when the temperature was 95 degrees McFarland complained to the state health department and was fired from her job She sued a number of managers and members of the LLC for wrongful discharge The court held that under Virginia state law, members, managers, and agents of an LLC are not responsible for its liabilities “solely” by virtue of their status Only those who “have played a key role in contributing to the company’s tortious conduct” can be part of a wrongful discharge claim The court therefore dismissed the action against all but one defendant.2  ◀ Members of an LLC can also bring derivative actions, which you will read about in Chapter 19, on behalf of the LLC [ULLCA 101] As with a corporate shareholder’s derivative suit, any damages recovered go to the LLC, not to the members personally McFarland v Virginia Retirement Services of Chesterfield, LLC, 477 F.Supp.2d 727 (2007) 416 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 18  Limited Liability Business Forms  Liability under the Alter-Ego Theory Sometimes, when a corporation is deemed to be merely an “alter ego” of the shareholder-owner, a court will pierce the corporate veil and hold the shareholder-owner personally liable (see Chapter 19) A court may apply the 417 alter-ego theory when a shareholder commingles personal and corporate funds or fails to observe required corporate formalities Whether the alter-ego theory should be applied to an LLC was at issue in the following case C as e Analy A naly s is Case 18.1 ORX Resources, Inc v MBW Exploration, LLC Court of Appeal of Louisiana, Fourth Circuit, 32 So.3d 931 (2010) IN THE LANGUAGE OF THE COURT Charles R JONES, Judge * * * * On January 16, 2003, ORX [Resources, Inc.,] entered into the “Clovelly Purchase Agreement” with Coastline Oil & Gas, Inc Pursuant to this Agreement, ORX purchased certain oil, gas and mineral leases/ interests in a tract of land located in Lafourche Parish, known as the “Clovelly Prospect.” ORX partnered with other entities, including MBW [Exploration, LLC], to share in the expense and potential profits of the venture to explore and develop the Clovelly Prospect The partnering parties entered into a Joint Operating Agreement (“JOA”) and the Clovelly Prospect Participation Agreement (“Participation Agreement”) Mr [Mark] Washauer signed these documents in October of 2003 and December of 2004, respectively, on behalf of MBW, in his capacity as a “Managing Member.” However, MBW did not come into existence until July of 2005, when its articles of organization were filed with the Louisiana Secretary of State The JOA provided that ORX was to serve as the “Operator” drilling a well within the Clovelly Prospect It further provided that the nonoperating working interest partners, like MBW, would pay their proportionate share of the costs in exchange for a corresponding working interest ownership share in the Clovelly Prospect The drilled well was governed by the Participation Agreement, which provided that MBW had a working interest in the Clovelly Prospect whereby MBW would share in 2.5% of the costs incurred, and would gain a proportionate share of the returns, if any, produced by the well Later, ORX submitted an Authorization for Expenditure (“AFE”) to MBW for approval, which Mr Washauer signed in his own name Additionally, he paid MBW’s participation fee with a check drawn from the account of another entity, MBW Properties, LLC In 2006, ORX, as the well Operator, began planning the Allain LeBreton Well No in the Clovelly Prospect, (“the Well”), which was the “initial well” called for in the Participation Agreement * * * Mr Washauer paid the full amount of MBW’s share of an ORX cash call invoice of $59,325 with a personal check The well proved to be unsuccessful, and was ultimately plugged MBW’s unpaid share of expenses for said project amounted to $84,220.01, for which ORX demanded payment via correspondence, but to no avail As a result, ORX filed suit for breach of contract against both MBW and Mr Washauer (“the Appellants”) * * * [The trial court—a state district court—determined that Washauer operated MBW as his alter ego and allowed ORX to pierce the veil of the LLC The court granted summary judgment in favor of ORX, holding that Washauer and MBW were liable, jointly and severally, to ORX in the amount of $84,220.01.] The Appellants timely filed [an] appeal from this judgment * * * * We first address whether the district court erred in ruling that the alter ego theory of the corporate veil piercing applied to Louisiana limited liability companies * * * * The provisions of La R.S [Louisiana Revised Statutes] 12:1320(D) provide for the piercing of an LLC’s veil when the situation so warrants * * * * * * * Piercing the veil of an LLC is justified to prevent the use of the LLC form to defraud creditors Under our * * * review, we find that the district court did not err in determining that the alter ego theory of corporate veil piercing applies to a Louisiana limited liability company, under the facts of this case, where it appears that Mr Washauer used MBW as a shell CASE 18.1 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 418  Unit Four  The Business Environment CASE 18.1 CONTINUEd and tried to avoid paying a legitimate debt of the LLC [Emphasis added.] * * * * The Louisiana Supreme Court has identified five nonexclusive factors to be used in determining whether to apply the alter ego doctrine: [commingling of corporate and shareholder funds; failure to follow statutory formalities for incorporating and transacting corporate affairs; undercapitalization; failure to provide separate bank accounts and bookkeeping records; and failure to hold regular shareholder and director meetings] [Emphasis added.] * * * * In applying [these] factors, * * * we find that Mr Washauer’s activities on behalf of MBW merit the piercing of the veil of this LLC Commingling of the LLC’s funds occurred with the funds of Mr Washauer and a separate company of his This commingling occurred because MBW was undercapitalized and did not have a separate bank account to transact its own affairs Furthermore, at the time MBW began contracting with ORX, it was not yet recognized as an LLC by the Louisiana Secretary of State Lastly, while LLCs are not bound by corpo- rate laws to hold regular meetings, the fact that MBW has not had a meeting in over a year further evidences that Mr Washauer was operating MBW at his leisure and direction Thus, we find that the district court did not err in determining that MBW was being operated as the alter ego of Mr Washauer under the [abovementioned] factors, and therefore, he can be held personally liable jointly and solidarily [severally] with MBW For the foregoing reasons,* * * the judgment of the district court is affirmed * * *  Legal Reasoning Questions 1.  One of the advantages of the LLC is that its members enjoy limited personal liability for the company’s obligations In view of this fact, does the possibility that a court may hold an LLC member personally liable for the LLC’s debts reduce the utility of the LLC form of business organization? Explain 2.  What does jointly and severally mean in terms of liability? Would ORX prefer that Washauer and MBW be held personally liable jointly and severally or that Washauer alone be held personally liable? Explain 3.  How might members of LLCs avoid the liability to which Washauer was subject in this case? 4.  MBW appears to have been a one-member LLC If the firm had had more members, how might that have affected the result in this case? Other Similarities to Corporations Another similarity between corporations and LLCs is that LLCs are legal entities apart from their owners As a legal person, the LLC can sue or be sued, enter into contracts, and hold title to property [ULLCA 201] The terminology used to describe LLCs formed in other states or nations is also similar to that used in corporate law For instance, an LLC formed in one state but doing business in another state is referred to in the second state as a foreign LLC The Formation of the LLC LLCs are creatures of statute and thus must follow state statutory requirements To form an LLC, ­articles of organization must be filed with a central state agency—usually the secretary of state’s office [ULLCA 202].3 In addition to requiring articles of organization to be filed, a few states require that a notice of the intention to form an LLC be published in a local newspaper Contents of the Articles  Typically, the articles of organization must include the name of the business, its principal address, the name and address of a registered agent, the members’ names, and how the LLC will be managed [ULLCA 203] The business’s name must include the words Limited Liability Company or the initials LLC [ULLCA 105(a)] Although a majority of the states permit one-member LLCs, some states require at least two members Preformation Contracts  Businesspersons sometimes enter into contracts on behalf of a business organization that is not yet formed As you will read in Chapter 19, persons who are forming a corporation may enter into contracts during the process of incorporation but before the corporation becomes a legal entity These contracts are referred to as ­preincorporation contracts Once the corporation is formed and adopts the preincorporation contracts (by means of a novation, discussed in Chapter 10), it can enforce the contract terms Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 18  Limited Liability Business Forms  In dealing with the preorganization contracts of LLCs, courts may apply the well-established principles of corporate law relating to preincorporation contracts ▶  Case in Point 18.2  607 South Park, LLC, entered into an agreement to sell a hotel to 607 Park View Associates, Ltd., which then assigned the rights to the purchase to another company, 02 Development, LLC At the time, 02 Development did not yet exist—it was legally created several months later 607 South Park subsequently refused to sell the hotel to 02 Development, and 02 Development sued for breach of the purchase agreement A California appellate court ruled that LLCs should be treated the same as corporations with respect to preorganization contracts Although 02 Development did not exist when the agreement was executed, once it came into existence, it could enforce any preorganization contract made on its behalf.4  ◀ Jurisdictional Requirements As we have seen, LLCs and corporations share several characteristics, but a significant difference between these organizational forms involves federal jurisdictional requirements Under the federal jurisdiction statute, a corporation is deemed to be a citizen of the state where it is incorporated and maintains its principal place of business The statute does not mention the state citizenship of partnerships, LLCs, and other unincorporated associations, but the courts have tended to regard these entities as citizens of every state of which their members are citizens The state citizenship of an LLC may come into play when a party sues the LLC based on diversity of citizenship Remember from Chapter that when parties to a lawsuit are from different states and the amount in controversy exceeds $75,000, a federal court can exercise diversity jurisdiction Total diversity of citizenship must exist, however ▶  Example 18.3  Jen Fong, a citizen of New York, wishes to bring a suit against Skycel, an LLC formed under the laws of Connecticut One of Skycel’s members also lives in New York Fong will not be able to bring a suit against Skycel in federal court on the basis of diversity jurisdiction because the defendant LLC is also a citizen of New York The same would be true if Fong was bringing a suit against multiple defendants and one of the defendants lived in New York.  ◀ 02 Development, LLC v 607 South Park, LLC, 159 Cal.App.4th 609, 71 Cal.Rptr.3d 608 (2008) 419 Advantages of the LLC The LLC offers many advantages to businesspersons, which is why this form of business organization has become increasingly popular Limited Liability  A key advantage of the LLC is that the liability of members is limited to the amount of their investments Although the LLC as an entity can be held liable for any loss or injury caused by the wrongful acts or omissions of its members, the members themselves generally are not personally liable Flexibility in Taxation  Another advantage of the LLC is its flexibility in regard to taxation An LLC that has two or more members can choose to be taxed as either a partnership or a corporation As will be discussed in Chapter 19, a corporate entity must pay income taxes on its profits, and the shareholders pay personal income taxes on profits distributed as dividends An LLC that wants to distribute profits to its members may prefer to be taxed as a partnership to avoid the “double taxation” that is characteristic of the corporate entity Unless an LLC indicates that it wishes to be taxed as a corporation, the Internal Revenue Service (IRS) automatically taxes it as a partnership This means that the LLC, as an entity, pays no taxes Rather, as in a partnership, profits are “passed through” the LLC to the members, who then personally pay taxes on the profits If an LLC’s members want to reinvest profits in the business rather than distribute the profits to members, however, they may prefer to be taxed as a corporation Corporate income tax rates may be lower than personal tax rates Part of the attractiveness of the LLC is this flexibility with respect to taxation An LLC that has only one member cannot be taxed as a partnership For federal income tax purposes, one-member LLCs are automatically taxed as sole proprietorships unless they indicate that they wish to be taxed as corporations With respect to state taxes, most states follow the IRS rules Management and Foreign Investors Another advantage of the LLC for businesspersons is the flexibility it offers in terms of business operations and management—as will be discussed shortly Foreign investors are allowed to become LLC members, so organizing as an LLC can enable a business to attract investors from other countries Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 420  Unit Four  The Business Environment Disadvantages of the LLC The main disadvantage of the LLC is that state LLC statutes are not uniform Therefore, businesses that operate in more than one state may not receive consistent treatment in these states Generally, most states apply to a foreign LLC (an LLC formed in another state) the law of the state where the LLC was formed Difficulties can arise, though, when one state’s court must interpret and apply another state’s laws Section LLC Management and Operation The members of an LLC have considerable flexibility in managing and operating the business Here, we discuss management options, fiduciary duties owed, and the operating agreement and general operating procedures of LLCs Management of an LLC Basically, LLC members have two options for managing the firm It can be either a “member-managed” LLC or a “manager-managed” LLC Most state LLC statutes and the ULLCA provide that unless the articles of organization specify otherwise, an LLC is assumed to be member managed [ULLCA 203(a)(6)] In a member-managed LLC, all of the members participate in management, and decisions are made by majority vote [ULLCA 404(a)] In a managermanaged LLC, the members designate a group of persons to manage the firm The management group may consist of only members, both members and nonmembers, or only nonmembers Fiduciary Duties Under the ULLCA, managers in a manager-managed LLC owe fiduciary duties (the duty of loyalty and the duty of care) to the LLC and its members [ULLCA 409(a), 409(h)] (As you will read in Chapter 19, this same rule applies in corporate law—corporate directors and officers owe fiduciary duties to the corporation and its shareholders.) Because not all states have adopted the ULLCA, though, some state statutes provide that managers owe fiduciary duties only to the LLC and not to the LLC’s members Although to whom the duty is owed may seem insignificant at first glance, it can have a dramatic effect on the outcome of litigation In Alabama, where the following case arose, managers owe fiduciary duties to the LLC and to its members Case 18.2 Polk v Polk Court of Civil Appeals of Alabama, 70 So.3d 363 (2011) BACKGROUND AND FACTS  Leslie Polk and his children, Yurii and Dusty Polk and Lezanne Proctor, formed Polk Plumbing, LLC, in Alabama Leslie, Dusty, and Yurii performed commercial plumbing work, and Lezanne, an accountant, maintained the financial records and served as the office manager After a couple of years, Yurii quit the firm Eighteen months later, Leslie “fired” Dusty and Lezanne He denied them access to the LLC’s books and offices but continued to operate the business Dusty and Lezanne filed a suit in an Alabama state court against Leslie, claiming breach of fiduciary duty The court submitted the claim to a jury with the instruction that in Alabama employment relationships are “at will” (see Chapter 21) The court also told the jury that it could not consider the plaintiffs’ “firing” as part of their claim The jury awarded Dusty and Lezanne one dollar each in damages They appealed, arguing that the judge’s instructions to the jury were prejudicial—that is, that the instructions had substantially affected the outcome of the trial IN THE LANGUAGE OF THE COURT MOORE, Judge * * * * In this case, Dusty and Lezanne served as managers of the LLC The LLC’s Operating Agreement * * * provided that the Members may elect one or more of the Members to serve as Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 18  Limited Liability Business Forms  CASE 18.2 CONTINUEd 421 Managers of the Company for the purpose of handling the day to day details of the Company * * * The Managers shall serve for a period of one year or until their replacement or recall is voted by a majority of the Members Based on the evidence presented at trial showing that the parties continued to act as managers of the LLC after the first year of operation, the foregoing contractual provision guaranteed that Dusty and Lezanne would remain managers until replaced or recalled by a vote of the majority of the members Hence, their employment as managers of the LLC was not at will and the trial court erred in instructing the jury that it was [Emphasis added.] The trial court further erred in not allowing the jury to consider the circumstances of Dusty and Lezanne’s “firing” as part of their breach-of-fiduciary-duty claim * * * The record contains no evidence indicating that a vote was ever held to recall or replace Dusty and Lezanne Rather, as Leslie testified, he simply acted in disregard of the terms of the Operating Agreement and instead rested on his right as the patriarch of the family to “fire” Dusty and Lezanne for, in his opinion, not working enough Hence, * * * Leslie did not have the authority under the Operating Agreement to terminate the management positions of Dusty and Lezanne in the manner in which he did * * * * By failing to instruct the jury that it also could consider Leslie’s “firing” of Dusty and Lezanne as evidence in support of their breach-of-fiduciary-duty claim, we conclude that the trial court probably injuriously affected substantial rights of Dusty and Lezanne * * * * Had the jury properly considered all the evidence supporting their breach-of-fiduciary-duty claim, it might have concluded that a higher amount of compensatory damages and possibly even punitive damages should have been awarded to Dusty and Lezanne DECISION AND REMEDY  A state intermediate appellate court reversed the lower court’s judgment on the claim for breach of fiduciary duty and remanded the case for a new trial The lower court committed reversible error by instructing the jury that Dusty and Lezanne’s employment as managers was at will and by failing to instruct the jury that it could consider their “firing” as evidence in support of their claim WHAT IF THE FACTS WERE DIFFERENT?  Suppose that Leslie owned a majority of Polk Plumbing Could his “firing” of Dusty and Lezanne still be considered as evidence of a breach of fiduciary duty? Explain THE LEGAL ENVIRONMENT DIMENSION  Under what circumstances might the ­employment-at-will doctrine apply to the members of an LLC? The LLC Operating Agreement The members of an LLC can decide how to operate the various aspects of the business by forming an ­operating agreement [ULLCA 103(a)] In many states, an operating agreement is not required for an LLC to exist, and if there is one, it need not be in writing Generally, though, LLC members should protect their interests by creating a written operating agreement Operating agreements typically contain provisions relating to the following areas: Management and how future managers will be chosen or removed (Although most LLC statutes are silent on this issue, the ULLCA provides that members may choose and remove managers by majority vote [ULLCA 404(b)(3)].) How profits will be divided How membership interests may be transferred Whether the dissociation of a member, such as by death or departure, will trigger dissolution of the LLC Whether formal members’ meetings will be held How voting rights will be apportioned (If the agreement does not cover voting, LLC statutes in most states provide that voting rights are apportioned according to each member’s capital contributions.5 Some states provide that, in the absence of an agreement to the contrary, each member has one vote.) In contrast, partners in a partnership generally have equal rights in management and equal voting rights unless they specify otherwise in their partnership agreement (see Chapter 17) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 422  Unit Four  The Business Environment State Statutes Fill in Gaps  If the agreement does not cover a topic, such as how profits will be divided, the state LLC statute will govern Most LLC statutes provide that if the members have not specified how profits will be divided, they will be divided equally among the members Partnership Law May Apply  If a dispute arises and the state’s LLC statute does not cover the issue, courts sometimes apply the principles of partnership law ▶  Case in Point 18.4  Clifford Kuhn, Jr., and Joseph Tumminelli formed Touch of Class Limousine Service as an LLC They did not create a written operating agreement but orally agreed that Kuhn would provide the financial backing and that Tumminelli would manage the day-to-day operations Tumminelli embezzled $283,000 from the company after cashing customers’ checks at Quick Cash, Inc., a local check-cashing service Kuhn sued Tumminelli and Quick Cash to recover the embezzled funds He argued that Quick Cash was liable because Tumminelli did not have the authority to cash the company’s checks The court, however, held that in the absence of a written operating agreement to the contrary, a member of an LLC, like a partner in a partnership, has the authority to cash a firm’s checks Therefore, Kuhn’s claim against Quick Cash was dismissed.6  ◀ S ECTION Dissociation and Dissolution of an LLC Recall from Chapter 17 that in a partnership, ­dissociation occurs when a partner ceases to be associated in the carrying on of the partnership business The same concept applies to LLCs A member of an LLC has the power to dissociate from the LLC at any time, but he or she may not have the right to dissociate Under the ULLCA, the events that trigger a member’s dissociation from an LLC are similar to the events causing a partner to be dissociated under the Uniform Partnership Act (UPA) These include voluntary withdrawal, expulsion by other members or by court order, incompetence, and death Generally, if a member dies or otherwise dissociates from an LLC, Kuhn v Tumminelli, 366 N.J.Super 431, 841 A.2d 496 (2004) the other members may continue to carry on the LLC business, unless the operating agreement provides otherwise Effect of Dissociation When a member dissociates from an LLC, he or she loses the right to participate in management and the right to act as an agent for the LLC The member’s duty of loyalty to the LLC also terminates, and the duty of care continues only with respect to events that occurred before dissociation Generally, the dissociated member also has a right to have his or her interest in the LLC bought out by the other members The LLC’s operating agreement may contain provisions establishing a buyout price, but if it does not, the member’s interest is usually purchased at a fair value In states that have adopted the ULLCA, the LLC must purchase the interest at fair value within 120 days after the dissociation If the member’s dissociation violates the LLC’s operating agreement, it is considered legally wrongful, and the dissociated member can be held liable for damages caused by the dissociation ▶  Example 18.5  Chadwick and Barrow are members in an LLC Chadwick manages the accounts, and Barrow, who has many connections in the community and is a skilled investor, brings in the business If Barrow wrongfully dissociates from the LLC, the LLC’s business will suffer, and Chadwick can hold Barrow liable for the loss of business resulting from her withdrawal.  ◀ Dissolution Regardless of whether a member’s dissociation was wrongful or rightful, normally the dissociated member has no right to force the LLC to dissolve The remaining members can opt either to continue or to dissolve the business Members can also stipulate in their operating agreement that certain events will cause dissolution, or they can agree that they have the power to dissolve the LLC by vote As with partnerships, a court can order an LLC to be dissolved in certain circumstances For instance, a court might order dissolution when the members have engaged in illegal or oppressive conduct, or when it is no longer feasible to carry on the business In the following case, the court had to decide whether an LLC could be dissolved because continuing the business was impracticable Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 18  Limited Liability Business Forms  423 Case 18.3 Venture Sales, LLC v Perkins Supreme Court of Mississippi, 86 So.3d 910 (2012) BACKGROUND AND FACTS  Walter Perkins, Gary Fordham, and David Thompson formed Venture Sales, LLC, to develop a subdivision in Petal, Mississippi All three members contributed land and funds to Venture Sales, resulting in total holdings of 466 acres of land and about $158,000 in cash Perkins was an assistant coach for the Cleveland Browns, so he trusted Fordham and Thompson to develop the property Over a decade later, however, Fordham and Thompson still had not done anything with the property, although they had developed at least two other subdivisions in the area Fordham and Thompson said that they did not know when they could develop the property and that they had been unable to get the additional $8 million they needed to proceed Fordham and Thompson suggested selling the property, but Perkins did not agree with the proposed listing price of $3.5 million Perkins then sought a judicial dissolution of Venture Sales in Mississippi state court The trial court ordered the company dissolved Fordham, Thompson, and Venture Sales appealed IN THE LANGUAGE OF THE COURT WALLER, Chief Justice, for the Court * * * * * * * [Under the Mississippi Code, an LLC may be dissolved if it] is not reasonably practicable to carry on the business in conformity with the certificate of formation or the limited liability company agreement * * * * * * * While no definitive, widely accepted test or standard exists for determining “reasonable practicability,” it is clear that when a limited liability company is not meeting the economic purpose for which it was established, dissolution is appropriate In making this determination, we must first look to the company’s operating agreement to determine the purpose for which the company was formed [Emphasis added.] Venture Sales’ operating agreement states that the company’s purpose is “to initially acquire, develop and sale [sic] commercial and residential properties near Petal, Forrest County, Mississippi.” At trial, Fordham admitted that the company was formed for the purpose of acquiring and developing property Yet, more than ten years after Venture Sales was formed with Perkins as a member, the property remains completely undeveloped Fordham and Thompson have offered a number of reasons why development has been delayed to this point [Emphasis in original.] * * * * Despite [the] alleged hindrances, Fordham and Thompson have, during this ten-year period, successfully formed two other LLCs and have developed at least two other subdivisions with around 200 houses, collectively, within twenty-five miles of the subject property More importantly, though, Fordham and Thompson presented no evidence that Venture Sales would be able to develop the land as intended within the foreseeable future When asked by the trial court when Venture Sales might be able to begin developing as it had planned, Fordham could not say Fordham and Thompson admitted that it would take around $8 million to “kick off” construction of the subdivision as planned, and the [trial court] found that Venture Sales was currently unable to get additional bank loans or other funding needed to begin development * * * * Fordham and Thompson claim that Perkins has blocked Venture Sales from taking advantage of certain “business opportunities,” such as selling the property at a reduced price of $3.5 million * * * However, these “business opportunities” were merely ideas from Fordham about how to make use of the property * * * As discussed above, they presented no evidence that Venture Sales could develop the property, which is the purpose for which the company was formed CASE 18.3 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 424  Unit Four  The Business Environment DECISION AND REMEDY  The Mississippi Supreme Court held that Venture Sales could be judicially CASE 18.3 CONTINUEd dissolved It therefore affirmed the decision of the trial court The Legal Environment Dimension  Would dissolution be appropriate if the parties had formed a partnership rather than an LLC? Explain your answer Managerial Implications  To avoid the type of dispute in which the members of Venture Sales became embroiled, the managers of an LLC or other business organization should take care to act on the firm’s “economic purpose” within a reasonable time To ensure that they will be able to so, the managers should draw up plans and determine the full cost of the project They should also ascertain how the needed funds will be obtained If bank loans or other funding will not be available, as occurred in this case, the LLC should require a higher level of contributions from its members to ensure that there will be sufficient funds to complete the project successfully Winding Up When an LLC is dissolved, any members who did not wrongfully dissociate may participate in the winding up process To wind up the business, members must collect, liquidate, and distribute the LLC’s assets Members may preserve the assets for a reasonable time to optimize their return, and they continue to have the authority to perform reasonable acts in conjunction with winding up In other words, the LLC will be bound by the reasonable acts of its members during the winding up process Once all of the LLC’s assets have been sold, the proceeds are distributed to pay off debts to creditors first (including debts owed to members who are creditors of the LLC) The members’ capital contributions are returned next, and any remaining amounts are then distributed to members in equal shares or according to their operating agreement Section Limited Liability Partnerships The limited liability partnership (LLP) is a hybrid form of business designed mostly for professionals who normally business as partners in a partnership Almost all of the states have enacted LLP statutes The major advantage of the LLP is that it allows a partnership to continue as a pass-through entity for tax purposes but limits the personal liability of the partners The LLP is especially attractive for professional service firms and family businesses All of the “Big Four” accounting firms—the four largest interna- tional accountancy and professional services firms— are organized as LLPs, including Ernst & Young, LLP, and PricewaterhouseCoopers, LLP Formation of an LLP LLPs must be formed in compliance with state statutes, which may include provisions of the Uniform Partnership Act (UPA) The appropriate form must be filed with a central state agency, usually the secretary of state’s office, and the business’s name must include either “Limited Liability Partnership” or “LLP” [UPA 1001, 1002] An LLP must file an annual report with the state to remain qualified as an LLP in that state [UPA 1003] In most states, it is relatively easy to convert a traditional partnership into an LLP because the firm’s basic organizational structure remains the same Additionally, all of the statutory and common law rules governing partnerships still apply (apart from those modified by the LLP statute) Normally, LLP statutes are simply amendments to a state’s already existing partnership law Liability in an LLP An LLP allows professionals, such as attorneys and accountants, to avoid personal liability for the malpractice of other partners A partner in an LLP is still liable for her or his own wrongful acts, such as negligence, however Also liable is the partner who supervised the individual who committed a wrongful act (This generally is true for all types of partners and partnerships, not just LLPs.) ▶  Example 18.6  Five lawyers operate a law firm as an LLP One of the attorneys, Dan Kolcher, is sued for malpractice and loses The firm’s m ­ alpractice ­insurance Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 18  Limited Liability Business Forms  is insufficient to pay the judgment If the firm had been organized as a traditional (general) partnership, the personal assets of the other attorneys could be used to satisfy the obligation Because the firm is organized as an LLP, however, no other partner at the law firm can be held personally liable for Kolcher’s malpractice, unless she or he acted as Kolcher’s supervisor In the absence of a supervisor, only Kolcher’s personal assets can be used to satisfy the judgment.  ◀ Although LLP statutes vary from state to state, generally each state statute limits the liability of partners in some way For instance, Delaware law protects each innocent partner from the “debts and obligations of the partnership arising from negligence, wrongful acts, or misconduct.” The UPA more broadly exempts partners from personal liability for any partnership obligation, “whether arising in contract, tort, or otherwise” [UPA 306(c)] Liability from State to State When an LLP formed in one state wants to business in another state, it may be required to register in the second state—for example, by filing a statement of foreign qualification [UPA 1102] Because state LLP statutes are not uniform, a question sometimes arises as to which law applies if the LLP statutes in the two states provide different liability protection Most states apply the law of the state in which the LLP was formed, even when the firm does business in another state, which is also the rule under UPA 1101 Sharing Liability among Partners  When more than one partner in an LLP is negligent, there is a question as to how liability should be shared Some states provide for proportionate liability—that is, for separate determinations of the negligence of the partners ▶  Example 18.7  Accountants Zach and Lyla are partners in an LLP, with Zach supervising Lyla Lyla negligently fails to file a tax return for a client, Centaur Tools Centaur files a suit against Zach and Lyla Under a proportionate liability statute, Zach will be liable for no more than his portion of the responsibility for the missed tax deadline In a state that does not allow for proportionate liability, Zach can be held liable for the entire loss.  ◀ Family Limited Liability Partnerships A family limited liability partnership (FLLP) is a limited liability partnership in which the partners are related to each other—for example, as spouses, 425 parents and children, siblings, or cousins A person acting in a fiduciary capacity for persons so related can also be a partner All of the partners must be natural persons or persons acting in a fiduciary capacity for the benefit of natural persons Probably the most significant use of the FLLP form of business organization is in agriculture Familyowned farms sometimes find this form to their benefit The FLLP offers the same advantages as other LLPs with certain additional advantages, such as, in Iowa, an exemption from real estate transfer taxes when partnership real estate is transferred among partners.7 Section Limited Partnerships We now look at a business organizational form that limits the liability of some of its owners—the limited partnership (LP) Limited partnerships originated in medieval Europe and have been in existence in the United States since the early 1800s Limited partnerships differ from traditional (general) partnerships in several ways A limited partnership consists of at least one ­general partner and one or more limited ­partners A general partner assumes management responsibility for the partnership and has full responsibility for the partnership and for all its debts A limited partner contributes cash or other property and owns an interest in the firm but is not involved in management responsibilities and is not personally liable for partnership debts beyond the amount of his or her investment A limited partner can forfeit limited liability by taking part in the management of the business A comparison of traditional partnerships (see Chapter 17) and limited partnerships appears in Exhibit 18–1 on the following page.8 Most states and the District of Columbia have adopted the Revised Uniform Limited Partnership Act (RULPA), which we refer to in the following discussion A minority of states have adopted some amendments that were proposed in 2001 to make the RULPA more flexible Iowa Statutes Section 428A.2 Under the UPA, a general partnership can be converted into a limited partnership and vice versa [UPA 902, 903] The UPA also provides for the merger of a general partnership with one or more general or limited partnerships [UPA 905] Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 426  Unit Four  The Business Environment EXHIBIT 18 –1  A Comparison of General Partnerships and Limited Partnerships Characteristic General Partnership (UPA) Limited Partnership (RULPA) Creation By agreement of two or more persons to carry on a business as co-owners for profit By agreement of two or more persons to carry on a business as co-owners for profit Must include one or more general partners and one or more limited partners Filing of a certificate with the secretary of state is required Sharing of Profits and Losses By agreement In the absence of agreement, profits are shared equally by the partners, and losses are shared in the same ratio as profits Profits are shared as required in the certificate agreement, and losses are shared likewise, up to the amount of the limited partners’ capital contributions In the absence of a provision in the certificate agreement, profits and losses are shared on the basis of percentages of capital contributions Liability Unlimited personal liability of all partners Unlimited personal liability of all general partners; limited partners liable only to the extent of their capital contributions Capital Contribution No minimum or mandatory amount; set by agreement Set by agreement Management By agreement In the absence of agreement, all partners have an equal voice Only the general partner (or the general partners) Limited partners have no voice or else are subject to liability as general partners (but only if a third party has reason to believe that the limited partner is a general partner) A limited partner may act as an agent or employee of the partnership and vote on amending the certificate or on the sale or dissolution of the partnership Duration Terminated by agreement of the partners, but can continue to business even when a partner dissociates from the partnership Terminated by agreement in the certificate or by retirement, death, or mental incompetence of a general partner in the absence of the right of the other general partners to continue the partnership Death of a limited partner does not terminate the partnership, unless he or she is the only remaining limited partner Distribution of Assets on Liquidation— Order of Priorities 1. Payment of debts, including those owed to part1.  Outside creditors and partner creditors ner and nonpartner creditors 2. Partners and former partners entitled to distribu2. Return of capital contributions and distribution of tions of partnership assets profit to partners 3. Unless otherwise agreed, return of capital contributions and distribution of profit to partners Formation of a Limited Partnership In contrast to the informal, private, and voluntary agreement that usually suffices for a traditional partnership, the formation of a limited partnership is a public and formal proceeding that must follow statutory requirements Not only must a limited partnership have at least one general partner and one limited partner, but the partners must also sign a certificate of limited partnership Like articles of incorporation (see Chapter 19), this certificate must include certain information such as the name, mailing address, and capital contribution of each general and limited partner The certificate must be filed with the designated state official—under the RULPA, the secretary of state The certificate is usually open to public inspection Liabilities of Partners in a Limited Partnership General partners, unlike limited partners, are personally liable to the partnership’s creditors Thus, at least one general partner is necessary in a limited Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 18  Limited Liability Business Forms  ­ artnership so that someone has personal liability p This policy can be circumvented in states that allow a corporation to be the general partner in a partnership Because the corporation has limited liability by virtue of corporation statutes, if a corporation is the general partner, no one in the limited partnership has personal liability The liability of a limited partner, as mentioned, is limited to the capital that she or he contributes or agrees to contribute to the partnership [RULPA 502] Limited partners enjoy this limited liability only so long as they not participate in management [RULPA 303] A limited partner who participates in management will be just as liable as a general partner to any creditor who transacts business with the limited partnership Liability arises when the creditor believes, based on the limited partner’s conduct, that the limited partner is a general partner [RULPA 303] The extent of review and advisement that a limited partner can engage in before being exposed to liability is not always clear, though Rights and Duties in a Limited Partnership With the exception of the right to participate in management, limited partners have essentially the same rights as general partners Limited partners have a right of access to the partnership’s books and to information regarding partnership business On dissolution of the partnership, limited partners are entitled to a return of their contributions in accordance with the partnership certificate [RULPA 201(a) (10)] They can also assign their interests subject to the certificate [RULPA 702, 704] In addition, limited partners can sue an outside party on behalf of the firm if the general partners with authority to so have refused to file suit [RULPA 1001] Dissociation and Dissolution A general partner has the power to voluntarily dissociate, or withdraw, from a limited partnership unless the partnership agreement specifies otherwise A limited partner theoretically can withdraw from the partnership by giving six months’ notice unless the partnership agreement specifies a term, as most Also, some states have passed laws prohibiting the withdrawal of limited partners Events That Cause Dissociation  In a limited partnership, a general partner’s voluntary dissociation from the firm normally will lead to dissolution unless 427 all partners agree to continue the business Similarly, the bankruptcy, retirement, death, or mental incompetence of a general partner will cause the dissociation of that partner and the dissolution of the limited partnership unless the other members agree to continue the firm [RULPA 801] Bankruptcy of a limited partner, however, does not dissolve the partnership unless it causes the bankruptcy of the firm Death or an assignment of the interest of a limited partner does not dissolve a limited partnership [RULPA 702, 704, 705] A limited partnership can be dissolved by court decree [RULPA 802] Distribution of Assets  On dissolution, creditors’ claims, including those of partners who are creditors, take first priority After that, partners and former partners receive unpaid distributions of partnership assets Unless otherwise agreed, they are also entitled to a return of their contributions in the proportions in which the partners share in distributions [RULPA 804] Valuation of Assets Disputes commonly arise about how the partnership’s assets should be valued and distributed and whether the business should be sold ▶  Case in Point 18.8  Actor Kevin Costner was a limited partner in Midnight Star Enterprises, LP, which runs a casino, bar, and restaurant in South Dakota There were two other limited partners, Carla and Francis Caneva, who owned a small percentage of the partnership (3.25 units each) and received salaries for managing its operations Another company owned by Costner, Midnight Star Enterprises, Limited (MSEL), was the general partner Costner thus controlled a majority of the partnership (93.5 units) When communications broke down between the partners, MSEL asked a court to dissolve the partnership MSEL’s accountant determined that the firm’s fair market value was $3.1 million The Canevas presented evidence that a competitor would buy the business for $6.2 million The Canevas wanted the court to force Costner to either buy the business for that price within ten days or sell it on the open market to the highest bidder Ultimately, the state’s highest court held in favor of Costner A partner cannot force the sale of a limited partnership when the other partners want to continue the business The court also accepted the $3.1 million buyout price of MSEL’s accountant and ordered Costner to pay the Canevas the value of their 6.5 partnership units.9  ◀ In re Dissolution of Midnight Star Enterprises, LP, 2006 SD 98, 724 N.W.2d 334 (S.D.Sup.Ct 2006) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 428  Unit Four  The Business Environment Limited Liability Limited Partnerships A limited liability limited partnership (LLLP) is a type of limited partnership An LLLP differs from a limited partnership in that a general partner in an LLLP has the same liability as a limited partner in a limited partnership In other words, the liability of all partners is limited to the amount of their investments in the firm A few states provide expressly for LLLPs.10 In states that not provide for LLLPs but allow for limited partnerships and limited liability partnerships, a limited partnership should probably still be able to register with the state as an LLLP 10 See, for example, Colorado Revised Statutes Annotated Section 7-62109 Other states that provide for LLLPs include Delaware, Florida, Georgia, Kentucky, Maryland, Nevada, Texas, and Virginia Reviewing: Limited Liability Business Forms The city of Papagos, Arizona, had a deteriorating bridge in need of repair on a prominent public roadway The city posted notices seeking proposals for an artistic bridge design and reconstruction Davidson Masonry, LLC, which was owned and managed by Carl Davidson and his wife, Marilyn Rowe, decided to submit a bid to create a decorative concrete structure that incorporated artistic metalwork They contacted Shana Lafayette, a local sculptor who specialized in large-scale metal creations, to help them design the bridge The city selected their bridge design and awarded them the contract for a commission of $184,000 Davidson Masonry and Lafayette then agreed to work together on the bridge project Davidson Masonry agreed to install and pay for concrete and structural work, and Lafayette agreed to install the metalwork at her expense in exchange for 25 percent of the profits Lafayette designed numerous metal sculptures of trout that were incorporated into colorful decorative concrete forms designed by Rowe, while Davidson performed the structural engineering Using the information presented in the chapter, answer the following questions Would Davidson Masonry automatically be taxed as a partnership or a corporation? Is Davidson Masonry member managed or manager managed? Suppose that during construction, Lafayette had entered into an agreement to rent space in a warehouse that was close to the bridge so that she could work on her sculptures near the site where they would eventually be installed She entered into the contract without the knowledge or consent of Davidson Masonry In this situation, would a court be likely to hold that Davidson Masonry was bound by the contract that Lafayette entered? Why or why not? Now suppose that Rowe has an argument with her husband and wants to withdraw from being a member of Davidson Masonry What is the term for such a withdrawal, and what effect would it have on the LLC? Debate This Because LLCs are essentially just partnerships with limited liability for members, all partnership laws should apply Terms and Concepts articles of organization 418 certificate of limited partnership 426 family limited liability partnership (FLLP) 425 general partner 425 limited liability company (LLC) 416 limited liability limited partnership (LLLP) 428 limited liability partnership (LLP) 424 limited partner 425 limited partnership (LP) 425 member 416 operating agreement 421 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 18  Limited Liability Business Forms  429 ExamPrep Issue Spotters Before the Test  Gabriel, Harris, and Ida are members of Jeweled Watches, LLC What are their options with respect to the management of their firm? (See page 420.) Go to www.cengagebrain.com, enter the ISBN 9781285428949, and click on “Find” to locate this textbook’s Web site Then, click on “Access Now” under “Study Tools,” and select Chapter 18 at the top There, you will find an Interactive Quiz that you can take to assess your mastery of the concepts in this chapter, as well as Flashcards and a Glossary of important terms Dorinda, Luis, and Elizabeth form a limited partnership Dorinda is a general partner, and Luis and Elizabeth are limited partners If Elizabeth is petitioned into involuntary bankruptcy, does that constitute a dissolution of the limited partnership (See page 427.) •  Check your answers to the Issue Spotters against the answers provided in Appendix E at the end of this text Business Scenarios 18–1.  Limited Liability Companies.  John, Lesa, and Tabir form a limited liability company John contributes 60 percent of the capital, and Lesa and Tabir each contribute 20 percent Nothing is decided about how profits will be divided John assumes that he will be entitled to 60 percent of the profits, in accordance with his contribution Lesa and Tabir, however, assume that the profits will be divided equally A dispute over the profits arises, and ultimately a court has to decide the issue What law will the court apply? In most states, what will result? How could this dispute have been avoided in the first place? Discuss fully (See page 418.) 18–2. Diversity Jurisdiction and Limited Liability Companies  Joe, a resident of New Jersey, wants to open a restaurant He asks Kay, his friend, an experienced attorney and a New Yorker, for her business and legal advice in exchange for a 20 percent ownership interest in the restaurant Kay helps Joe negotiate a lease for the restaurant premises and advises Joe to organize the business as a limited liability company (LLC) Joe forms Café Olé, LLC, and with Kay’s help, obtains financing Then, the night before the restaurant opens, Joe tells Kay that he is “cutting her out of the deal.” The restaurant proves to be a success Kay wants to file a suit in a federal district court against Joe and the LLC Can a federal court exercise jurisdiction over the parties based on diversity of citizenship? Explain (See page 419.) Business Case Problems 18–3.  Limited Partnership.  James Carpenter contracted with Austin Estates, LP, to buy property in Texas Carpenter asked Sandra McBeth to invest in the deal He admitted that a dispute had arisen with the city of Austin over water for the property, but he assured her that it would not be a significant obstacle McBeth agreed to invest $800,000 to hold open the option to buy the property She became a limited partner in StoneLake Ranch, LP Carpenter acted as the firm’s general partner Despite his assurances to McBeth, the purchase was delayed due to the water dispute Unable to complete the purchase in a timely manner, Carpenter paid the $800,000 to Austin Estates without notifying McBeth Later, Carpenter and others—excluding McBeth—bought the property and sold it at a profit McBeth filed a suit in a Texas state court against Carpenter What is the nature of the fiduciary duty that a general partner owes a limited partner? Did Carpenter breach that duty in this case? Explain [McBeth v Carpenter, 565 F.3d 171 (5th Cir 2009)] (See page 425.) 18–4. Limited Liability Companies. Coco Investments, LLC, and other investors participated in a condominium conver- sion project to be managed by Zamir Manager River Terrace, LLC The participants entered into a new LLC agreement for the project The investors subsequently complained that Zamir had failed to disclose its plans for dramatic changes involving higher-than-expected construction costs and delays, had failed to provide financial information, and had restructured loans in a manner that allowed Zamir representatives to avoid personal liability The investors sued Zamir on various grounds, including breach of contract and breach of fiduciary duty Zamir moved for summary judgment How should the court rule? Explain [Coco Investments, LLC v Zamir Manager River Terrace, LLC, 26 Misc.3d 1231 (N.Y.Sup 2010)] (See page 420.) 18–5.  Business Case Problem with Sample Answer:  LLC Operation After Hurricane Katrina, James Williford, Patricia Mosser, Marquetta Smith, and Michael Floyd formed Bluewater Logistics, LLC, to bid on construction contracts Under Mississippi law, every member of a member-managed LLC is entitled to participate in managing the business The operating agreement provided for a Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 430  Unit Four  The Business Environment “super majority” 75 percent vote to remove a member “under any other circumstances that would jeopardize the company status” as a contractor After Bluewater had completed more than $5 million in contracts, Smith told Williford that she, Mosser, and Floyd were exercising their “super majority” vote to fire him No reason was provided Williford sued Bluewater and the other members Did Smith, Mosser, and Floyd breach the state LLC statute, their fiduciary duties, or the Bluewater operating agreements? Discuss [Bluewater Logistics, LLC v Williford, 55 So.3d 148 (Miss 2011)] (See page 420.) •  For a sample answer to Problem 18–5, go to Appendix F at the end of this text 18–6.  Jurisdictional Requirements. Fadal Machining Centers, LLC, and MAG Industrial Automation Centers, LLC, sued a New Jersey–based corporation, Mid-Atlantic CNC, Inc., in federal district court Ten percent of MAG was owned by SP MAG Holdings, a Delaware LLC SP MAG had six members, including a Delaware limited partnership called Silver Point Capital Fund and a Delaware LLC called SPCP Group III In turn, Silver Point and SPCP Group had a common member, Robert O’Shea, who was a New Jersey citizen Assuming that the amount in controversy exceeds $75,000, does the district court have diversity jurisdiction? Why or why not? [Fadal Machining Centers, LLC v Mid-Atlantic CNC, Inc., 2012 WL 8669 (9th Cir 2012)] (See page 419.) 18–7.  A Question of Ethics:  Limited Liability Companies Blushing Brides, LLC, a publisher of wedding planning magazines in Columbus, Ohio, opened an account with Gray Printing Co in July 2000 On behalf of Blushing Brides, Louis Zacks, the firm’s member-manager, signed a credit agreement that identified the firm as the “purchaser” and required payment within thirty days Despite the agreement, Blushing Brides typically took up to six months to pay the full amount for its orders Gray printed and shipped 10,000 copies of a fall/winter 2001 issue for Blushing Brides but had not been paid when the firm ordered 15,000 copies of a spring/summer 2002 issue Gray refused to print the new order without an assurance of payment On May 22, Zacks signed a promissory note payable to Gray within thirty days for $14,778, plus interest at percent per year Gray printed the new order but by October had been paid only $7,500 Gray filed a suit in an Ohio state court against Blushing Brides and Zacks to collect the balance [Gray Printing Co v Blushing Brides, LLC, 2006 WL 832587 (Ohio App 2006)] (See page 416.) (a)  Under what circumstances is a member of an LLC liable for the firm’s debts? In this case, is Zacks personally liable under the credit agreement for the unpaid amount on Blushing Brides’ account? Did Zacks’s promissory note affect the parties’ liability on the account? Explain (b)  Should a member of an LLC assume an ethical responsibility to meet the obligations of the firm? Discuss (c)  Gray shipped only 10,000 copies of the spring/summer 2002 issue of Blushing Brides’ magazine, waiting for the publisher to identify a destination for the other 5,000 copies The magazine had a retail price of $4.50 per copy Did Gray have a legal or ethical duty to “mitigate the damages” by attempting to sell or otherwise distribute these copies itself? Why or why not? 18–8.  Special Case Analysis:  Limited Liability Companies Go to Case Analysis Case 18.1, ORX Resources, Inc v MBW Exploration, LLC, on pages 417 and 418 Read the excerpt and answer the following questions (a)  Issue: What was the main issue in this case? (b)  Rule of Law: What rule of law did the court apply? (c)  Applying the Rule of Law: How did the court apply the rule of law to the facts of this case? (d)  Conclusion: What was the court’s conclusion? Legal Reasoning Group Activity 18–9.  Fiduciary Duties in LLCs. Newbury Properties Group owns, manages, and develops real property Jerry Stoker and the Stoker Group, Inc (the Stokers), also develop real property Newbury entered into agreements with the Stokers concerning a large tract of property in Georgia The parties formed Bellemare, LLC, to develop various parcels of the tract for residential purposes The operating agreement of Bellemare indicated that “no Member shall be accountable to the LLC or to any other Member with respect to any other business or activity even if the business or activity competes with the LLC’s business.” Later, when the Newbury group contracted with other parties to develop parcels within the tract in competition with Bellemare, LLC, the Stokers sued, alleging breach of fiduciary duty (See page 420.) (a)  The first group will discuss and outline the fiduciary duties that the members of an LLC owe to each other (b)  The second group will determine whether the terms of an operating agreement can alter these fiduciary duties (c) The last group will decide in whose favor the court should rule in this situation Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19 Corporations T he corporation is a creature of statute A corporation is an artificial being, existing only in law and neither tangible nor visible Its existence generally depends on state law, although some corporations, especially public organizations, are created under federal law Each state has its own body of corporate law, and these laws are not entirely uniform The Model Business Corporation Act (MBCA) is a codification of modern corporation law that has been influential in shaping state corporation statutes Today, the majority of state statutes are guided by the most recent version of the MBCA, often referred to as the Revised Model Business Corporation Act (RMBCA) SECTION The Nature and Classification of Corporations A corporation is a legal entity created and recognized by state law This business entity can have one or more owners (called shareholders), and it operates under a name distinct from the names of its owners The owners may be individuals, or natural persons (as opposed to the artificial legal person of the corporation), or other businesses Although the corporation substitutes itself for its shareholders when conducting corporate business and incurring liability, its authority to act and the liability for its actions are separate and apart from the individuals who own it A corporation is recognized as a “person,” and it enjoys many of the same rights and privileges under state and federal law that U.S citizens enjoy For instance, corporations possess the same right of access to the courts as citizens and can sue or be sued The constitutional guarantees of due process, free speech, and freedom from unreasonable searches and seizures also apply to corporations Keep in mind, however, that there is considerable variation among the laws of states that have used the MBCA or the RMBCA as a basis for their statutes In addition, several states not follow either act Consequently, individual state corporation laws should be relied on to determine corporate law rather than the MBCA or RMBCA Corporate Personnel In a corporation, the responsibility for the overall management of the firm is entrusted to a board of directors, whose members are elected by the shareholders The board of directors makes the policy decisions and hires corporate officers and other employees to run the daily business operations When an individual purchases a share of stock in a corporation, that person becomes a shareholder and an owner of the corporation Unlike the partners in a partnership, the body of shareholders can change constantly without affecting the continued existence of the corporation A shareholder can sue the corporation, and the corporation can sue a shareholder Additionally, under certain circumstances, a shareholder can sue on behalf of a corporation The rights and duties of corporate directors, officers, and shareholders will be discussed later in this chapter The Limited Liability of Shareholders One of the key advantages of the corporate form is the limited liability of its owners Normally, corporate shareholders are not personally liable for the 431 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 432  Unit Four  The Business Environment ­ bligations of the corporation beyond the extent of o their investments In certain limited situations, however, a court can pierce the corporate veil (see page 441) and impose liability on shareholders for the corporation’s obligations Additionally, creditors often will not extend credit to small companies unless the shareholders assume personal liability, as guarantors, for corporate obligations Corporate Earnings and Taxation When a corporation earns profits, it can either pass them on to shareholders in the form of dividends (see page 454) or retain them as profits These retained earnings, if invested properly, will yield higher corporate profits in the future and thus cause the price of the company’s stock to rise Individual shareholders can then reap the benefits of these retained earnings in the capital gains that they receive when they sell their stock Corporate Taxation  Whether a corporation retains its profits or passes them on to the shareholders as dividends, those profits are subject to income tax by various levels of government Failure to pay taxes can lead to severe consequences The state can suspend the entity’s corporate status until the taxes are paid or even dissolve the corporation for failing to pay taxes (Businesses today, including corporations, may also be required to collect state sales taxes on goods or services sold via the Internet, as discussed in the Insight into E-Commerce feature in Chapter 11.) Another important aspect of corporate taxation is that corporate profits can be subject to double taxation The company pays tax on its profits Then, if the profits are passed on to the shareholders as dividends, the shareholders must also pay income tax on them (unless the dividends represent distributions of capital) The corporation normally does not receive a tax deduction for dividends it distributes This double-taxation feature is one of the major disadvantages of the corporate form Holding Companies  Some U.S corporations use holding companies to reduce or defer their U.S income taxes At its simplest, a holding company (sometimes referred to as a parent company) is a company whose business activity consists of holding shares in another company Typically, the holding company is established in a low-tax or no-tax offshore jurisdiction, such as the Cayman Islands, Dubai, Hong Kong, Luxembourg, Monaco, or Panama Sometimes, a U.S corporation sets up a holding company in a low-tax offshore environment and then transfers its cash, bonds, stocks, and other investments to the holding company In general, any profits received by the holding company on these investments are taxed at the rate of the offshore jurisdiction where the company is registered In other words, holding company profits are not taxed at the rates applicable to the parent company or its shareholders in their country of residence Thus, deposits of cash, for instance, may earn interest that is taxed at only a minimal rate Once the profits are brought “onshore,” though, they are taxed at the federal corporate income tax rate, and any payments received by the shareholders are also taxable at the full U.S rates Tort Liability A corporation is liable for the torts committed by its agents or officers within the course and scope of their employment This principle applies to a corporation exactly as it applies to the ordinary agency relationships that we will discuss in Chapter 20 It follows the doctrine of respondeat superior The following case arose from a fraudulent scheme perpetrated by the officer of an investment firm through a separate investment fund that the officer controlled and managed When investors in the fund filed a suit to recover the funds they had lost, the court had to determine whether the corporate employer of the officer could be liable for his actions C A S E ANALY S IS Case 19.1  Belmont v MB Investment Partners, Inc United States Court of Appeals, Third Circuit, 708 F.3d 470 (2013) In the language of the court jordan, Circuit Judge * * * * [Mark] Bloom formed North Hills [L.P.] in 1997, as an enhanced stock index fund based on various stock indices Bloom was the sole princi- pal and managing member of North Hills Management, LLC, the general partner of North Hills, and he had sole authority over the selection of the Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  433 CASE 19.1 CONTINUEd fund’s investments * * * Between 2001 and 2007, Bloom raised approximately $30 million from 40 to 50 investors for the North Hills fund He claimed that North Hills consistently generated investment returns of 10–15 percent per year without significant risk In fact, however, North Hills was a Ponzi scheme that Bloom used to finance his lavish personal lifestyle, and, over time, he diverted at least $20 million from North Hills for his own personal use Bloom used those funds to acquire multiple apartments and homes, furnishings, luxury cars and boats, and jewelry, and to fund parties and travel * * * * Bloom operated North Hills the entire time that he was an executive of [MB Investment Partners, Inc.] He made no attempt, while working at MB, to conceal his activities related to North Hills Investments in North Hills were administered by Bloom and other MB personnel, using MB’s offices, computers, filing facilities, and office equipment MB support staff sometimes carried out tasks related to North Hills MB officers and directors were aware that Bloom was operating North Hills while he was also working as an investment adviser at MB * * * During the period of the North Hills fraud, MB did not have in place basic compliance procedures employed throughout the investment advising industry to identify and prevent fraud and self-dealing by MB employees and affiliates Compliance weaknesses permitted Bloom to avoid required disclosures to MB about North Hills as a personal investment vehicle MB officers and directors failed to make basic inquiries about Bloom’s operation of North Hills, and did not collect any information on North Hills or monitor sales of investments in North Hills to MB’s own customers [Emphasis added.] * * * * * * * In 2008, * * * two large investors in North Hills requested a full redemption of their investments By that time, most of the money that had been invested in North Hills was gone * * *  [Bloom] was arrested on February 25, 2009, and he was terminated by MB that same day * * * * The Investors filed their * * * Complaint in this action on October 28, 2009 * * * , alleging * * * fraud * * * on the part of Bloom * * * and MB * * * * * * * On January 5, 2012, the District Court granted summary judgment to [MB] * * * On February 17, 2012, the Court entered a default judgment against Bloom and in favor of the Investors in the amount of approximately $5.7 million * * * This timely appeal followed * * * * * * * Bloom’s violations * * * are beyond dispute, and the Investors argue that those violations may be imputed to MB as his employer * * * The fraud of an officer of a cor­ poration is imputed to the corporation when the officer’s fraudulent contact was (1) in the course of his employment, and (2) for the benefit of the corporation This is true even if the officer’s conduct was unauthorized, effected for his own benefit but clothed with apparent authority of the corporation, or contrary to instructions The underlying reason is that a corporation can speak and act only through its agents and so must be accountable for any acts committed by one of its agents within his actual or apparent scope of authority and while transacting corporate business [Emphasis added.] * * * * * * * We therefore conclude that imputation may be appropriate in this case, if the Investors can prove that the manner in which Bloom marketed North Hills to them while he was working for MB, and the apparent benefit to MB, made it appear that he marketed North Hills within the scope of his authority as a senior executive of MB * * * * For the foregoing reasons, we * * * will vacate the grant of summary judgment to MB * * * , and we will remand this case for a trial with respect to those claims against MB Legal Reasoning Questions What is the imputation doctrine? What public-policy reasons support imputing the fraud of a corporate officer to the corporation? What circumstances in this case suggest that MB should be held liable for Bloom’s fraud? What conditions did the court place on the application of the imputation doctrine in this case? MB, which was already in financial distress, had to cease operations as a result of Bloom’s fraud How might MB have discovered the fraud before it grew so large as to have such dire effects? Criminal Acts Under modern criminal law (see Chapter 7), a corporation may also be held liable for the criminal acts of its agents and employees, provided the punishment is one that can be applied to the corporation Although corporations cannot be imprisoned, they can be fined (Of course, corporate directors and officers can be imprisoned, and some have been in recent years.) In addition, under sentencing guidelines for crimes Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 434  Unit Four  The Business Environment committed by corporate employees (white-collar crimes), corporate lawbreakers can face fines amounting to hundreds of millions of dollars.1 ▶  Case in Point 19.1  Brian Gauthier drove a dump truck for Angelo Todesca Corporation The truck was missing its back-up alarm, but Angelo allowed Gauthier to continue driving it At a worksite, Gauthier backed up to dump a load and struck and killed a police officer who was directing traffic The state charged Angelo and Gauthier with the crime of vehicular homicide Angelo argued that a corporation could not be guilty of vehicular homicide because it cannot operate a vehicle The court ruled that if an employee commits a crime “while engaged in corporate business that the employee has been authorized to conduct,” the corporation can be held liable for the crime Hence, the court held that Angelo Todesca Corporation was liable for Gauthier’s negligent operation of its truck, which resulted in a person’s death.2  ◀ Classification of Corporations Corporations can be classified in several ways The classification of a corporation normally depends on its location, purpose, and ownership characteristics, as described in the following subsections Domestic, Foreign, and Alien Corporations  A corporation is referred to as a domestic corporation by its home state (the state in which it incorporates) A corporation formed in one state but doing business in another is referred to in the second state as a foreign corporation A corporation formed in another country (say, Mexico) but doing business in the United States is referred to in the United States as an alien corporation A corporation does not have an automatic right to business in a state other than its state of incorporation In some instances, it must obtain a certificate of authority in any state in which it plans to business Once the certificate has been issued, the corporation generally can exercise in that state all of the powers conferred on it by its home state If a foreign corporation does business in a state without obtaining a certificate of authority, the state can impose substantial fines and sanctions on that corporation Note that the Sarbanes-Oxley Act of 2002 (see Chapter 4) stiffened the penalties for certain types of corporate crime and ordered the U.S Sentencing Commission to revise the sentencing guidelines accordingly Commonwealth v Angelo Todesca Corp., 446 Mass 128, 842 N.E.2d 930 (2006) Note that most state statutes specify certain activities, such as soliciting orders via the Internet, that are not considered “doing business” within the state Thus, a foreign corporation normally does not need a certificate of authority to sell goods or services via the Internet or by mail Public and Private Corporations  A public ­ orporation is a corporation formed by the governc ment to meet some political or governmental purpose Cities and towns that incorporate are common examples In addition, many federal government organizations, such as the U.S Postal Service, the Tennessee Valley Authority, and AMTRAK, are public corporations Note that a public corporation is not the same as a ­ publicly held corporation A publicly held ­corporation (often called a public company) is any corporation whose shares are publicly traded in a securities market, such as the New York Stock Exchange or the NASDAQ (an electronic stock exchange founded by the National Association of Securities Dealers) In contrast to public corporations (not public companies), private corporations are created either wholly or in part for private benefit—that is, for profit Most corporations are private Although they may serve a public purpose, as a public electric or gas utility does, they are owned by private persons rather than by a government.3 Nonprofit Corporations  Corporations formed for purposes other than making a profit are called nonprofit or not-for-profit corporations Private hospitals, educational institutions, charities, and religious organizations, for example, are frequently organized as nonprofit corporations The nonprofit corporation is a convenient form of organization that allows various groups to own property and to form contracts without exposing the individual members to personal liability Close Corporations  Most corporate enterprises in the United States fall into the category of close corporations A close corporation is one whose shares are held by members of a family or by relatively few persons Close corporations are also referred to as closely held, family, or privately held corporations Usually, the members of the small group constituting the shareholders of a close corporation are personally known to each other Because the number of shareholders is so small, there is no trading market for the shares The United States Supreme Court first recognized the property rights of private corporations and clarified the distinction between public and private corporations in the landmark case Trustees of Dartmouth College v Woodward, 17 U.S (4 Wheaton) 518, L.Ed 629 (1819) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  In practice, a close corporation is often operated like a partnership Some states have enacted special statutory provisions that apply to these corporations and allow them to depart significantly from certain formalities required by traditional corporation law.4 Additionally, the RMBCA gives a close corporation considerable flexibility in determining its rules of operation [RMBCA 7.32] If all of a corporation’s shareholders agree in writing, the corporation can operate without directors and bylaws In addition, the corporation can operate without annual or special shareholders’ or directors’ meetings, stock certificates, or formal records of shareholders’ or directors’ decisions.5 Management of Close Corporations.  Management of a close corporation resembles that of a sole proprietorship or a partnership, in that a single shareholder or a tightly knit group of shareholders usually hold the positions of directors and officers As a corporation, however, the firm must meet all specific legal requirements set forth in state statutes To prevent a majority shareholder from dominating the company, a close corporation may require that more than a simple majority of the directors approve any action taken by the board Typically, this would apply only to extraordinary actions, such as changing the amount of dividends or dismissing an employee-shareholder, and not to ordinary business decisions Transfer of Shares in Close Corporations.  By definition, a close corporation has a small number of shareholders Thus, the transfer of one shareholder’s shares to someone else can cause serious management problems The other shareholders may find themselves required to share control with someone they not know or like ▶  Example 19.2  Three brothers, Terry, Damon, and Henry Johnson, are the only shareholders of Johnson’s Car Wash, Inc Terry and Damon not want Henry to sell his shares to an unknown third person To avoid this situation, the corporation could restrict the transferability of shares to outside persons Shareholders could be required to offer their shares to the corporation or the other shareholders before selling them to an outside purchaser For example, in some states (such as Maryland), a close corporation need not have a board of directors Shareholders cannot agree, however, to eliminate certain rights of shareholders, such as the right to inspect corporate books and records or the right to bring derivative actions (lawsuits on behalf of the corporation—see page 455) 435 In fact, a few states have statutes that prohibit the transfer of close corporation shares unless certain persons—including shareholders, family members, and the corporation—are first given the opportunity to purchase the shares for the same price.  ◀ Shareholder Agreement to Restrict Stock Transfers.  Control of a close corporation can also be stabilized through the use of a shareholder agreement A shareholder agreement can provide for proportional control when one of the original shareholders dies The decedent’s shares of stock in the corporation would be divided in such a way that the proportionate holdings of the survivors, and thus their proportionate control, would be maintained Agreements between shareholders can also restrict the transfer of a close corporation’s stock in other ways For instance, shareholders might agree that existing shareholders will have an option to purchase stock before it is sold or transferred to an outside party Misappropriation of Close Corporation Funds.  Sometimes, a majority shareholder in a close corporation takes advantage of his or her position and misappropriates company funds In such situations, the normal remedy for the injured minority shareholders is to have their shares appraised and to be paid the fair market value for them ▶  Case in Point 19.3  John Murray, Stephen Hopkins, and Paul Ryan were the controlling shareholders of Olympic Adhesives, Inc., as well as its officers, directors, and employees Merek Rubin was a minority shareholder Murray, Hopkins, and Ryan were paid salaries Under Olympic’s profit-sharing plan, onethird of its net operating income was paid into a fund that was distributed to employees, including Murray, Hopkins, and Ryan Twice a year, Murray, Hopkins, and Ryan also paid themselves additional compensation—a percentage of the net profits after profit sharing, allocated according to their stock ownership Over a fifteenyear period, the percentage grew from 75 percent to between 92 and 98 percent During this time, the additional compensation totaled nearly $15 million Rubin filed a suit in a Massachusetts state court against Murray, Hopkins, and Ryan, alleging that they had paid themselves excessive compensation and deprived him of his share of Olympic’s profits in violation of their fiduciary duty to him as a minority shareholder The court ordered the defendants to repay Olympic Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 436  Unit Four  The Business Environment nearly $6 million to be distributed among its shareholders The decision was affirmed on appeal.6  ◀ greater flexibility, the S corporation has lost much of its appeal S Corporations  A close corporation that meets the qualifying requirements specified in Subchapter S of the Internal Revenue Code can choose to operate as an S corporation (A corporation will automatically be taxed under Subchapter C unless it elects S corporation status.) If a corporation has S corporation status, it can avoid the imposition of income taxes at the corporate level while retaining many of the advantages of a corporation, particularly limited liability Professional Corporations Professionals such as physicians, lawyers, dentists, and accountants can incorporate Professional corporations are typically identified by the letters P.C (professional corporation), S.C (service corporation), or P.A (professional association) In general, the laws governing the formation and operation of professional corporations are similar to those governing ordinary business corporations There are some differences in terms of liability, however, because the shareholder-owners are professionals who are held to a higher standard of conduct For liability purposes, some courts treat a professional corporation somewhat like a partnership and hold each professional liable for any malpractice committed within the scope of the business by the others in the firm With the exception of malpractice or a breach of duty to clients or patients, a shareholder in a professional corporation generally cannot be held liable for the torts committed by other professionals at the firm Important Requirements. Among the numerous requirements for S corporation status, the following are the most important: The corporation must be a domestic corporation The corporation must not be a member of an affiliated group of corporations The shareholders of the corporation must be individuals, estates, or certain trusts and tax-exempt organizations The corporation must have no more than one hundred shareholders The corporation must have only one class of stock, although all shareholders not need to have the same voting rights No shareholder of the corporation may be a nonresident alien Effect of S Election.  An S corporation is treated differently than a regular corporation for tax purposes An S corporation is taxed like a partnership, so the corporate income passes through to the shareholders, who pay personal income tax on it This treatment enables the S corporation to avoid the double taxation imposed on regular corporations In addition, the shareholders’ tax brackets may be lower than the tax bracket that the corporation would have been in if the tax had been imposed at the corporate level The resulting tax saving is particularly attractive when the corporation wants to accumulate earnings for some future business purpose If the corporation has losses, the S election allows the shareholders to use the losses to offset other income Nevertheless, because the limited liability company (see Chapter 18) and the limited liability partnership (see Chapter 17) offer similar tax advantages and Rubin v Murray, 79 Mass.App.Ct 64, 943 N.E.2d 949 (2011) Benefit Corporations A growing number of states have enacted legislation that creates a new corporate form called a benefit corporation A benefit ­corporation is a for-profit corporation that seeks to have a material positive impact on society and the environment Benefit corporations differ from traditional corporations in the following three ways: Purpose Although the corporation is designed to make a profit, its purpose is to benefit the public as a whole (rather than just to provide long-term shareholder value, as in ordinary corporations) The directors of a benefit corporation must, during the decision-making process, consider the impact of their decisions on society and the environment Accountability Shareholders of a benefit corporation determine whether the company has achieved a material positive impact Shareholders also have a right of private action, called a benefit enforcement proceeding, enabling them to sue the corporation if it fails to pursue or create public benefit Transparency A benefit corporation must issue an annual benefit report on its overall social and environmental performance that uses a recognized third party standard to assess its performance The report must be delivered to the shareholders and posted on a public Web site Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  SECTION Corporate Formation Many Fortune 500 companies started as sole proprietorships or partnerships and then converted to corporate entities as the businesses grew and needed to obtain additional capital by issuing shares of stock Incorporating a business is much simpler today than it was twenty years ago, and many states allow businesses to incorporate via the Internet Here, we examine the process by which a corporation comes into existence Promotional Activities In the past, preliminary steps were taken to organize and promote the business prior to incorporating Contracts were made with investors and others on behalf of the future corporation Today, due to the relative ease of forming a corporation in most states, persons incorporating their business rarely, if ever, engage in preliminary promotional activities Nevertheless, it is important for businesspersons to understand that they are personally liable for all preincorporation contracts made with investors, accountants, or others on behalf of the future corporation Personal liability continues until the newly formed corporation assumes liability for the preincorporation contracts through a novation (see Chapter 10) ▶  Example 19.4  Jade Sorrel contracts with an accountant, Ray Cooper, to provide tax advice for a proposed corporation, Blackstone, Inc Cooper provides the services to Sorrel, knowing that the corporation has not yet been formed Once Blackstone, Inc., is formed, Cooper sends an invoice to the corporation and to Sorrel personally, but the bill is not paid Because Sorrel is personally liable for the preincorporation contract, Cooper can sue Sorrel for breach of the contract Cooper cannot seek to hold Blackstone, Inc., liable unless he has entered into a contract with the corporation through a novation.  ◀ Incorporation Procedures Exact procedures for incorporation differ among states, but the basic steps are as follows: (1) select a state of incorporation, (2) secure the corporate name, 437 (3) prepare the articles of incorporation, and (4) file the articles of incorporation with the secretary of state These steps are discussed in more detail in the following subsections Select the State of Incorporation  The first step in the incorporation process is to select a state in which to incorporate Because state laws differ, individuals may look for the states that offer the most advantageous tax or incorporation provisions Another consideration is the fee that a particular state charges to incorporate, as well as the annual fees and the fees for specific transactions (such as stock transfers) Delaware has historically had the least restrictive laws and provisions that favor corporate management Consequently, many corporations, including a number of the largest, have incorporated there Delaware’s statutes permit firms to incorporate in that state and conduct business and locate their operating headquarters elsewhere Most other states now permit this as well Note, though, that close corporations, particularly those of a professional nature, generally incorporate in the state where their principal shareholders live and work For reasons of convenience and cost, businesses often choose to incorporate in the state in which most of the corporation’s business will be conducted Secure the Corporate Name  The choice of a corporate name is subject to state approval to ensure against duplication or deception State statutes usually require that the secretary of state run a check on the proposed name in the state of incorporation Some states require that the persons incorporating a firm run a check on the proposed name at their own expense A check can often be made via the Internet If a firm is likely to business in other states—or over the Internet—the incorporators should check existing corporate names in those states as well Once cleared, a name can be reserved for a short time, for a fee, pending the completion of the articles of incorporation All states require the corporation’s name to include the word Corporation (Corp.), Incorporated (Inc.), Company (Co.), or Limited (Ltd.).7 First Check Available Domain Names.  All corporations need to have an online presence to compete effectively Failure to use one of these abbreviations to disclose corporate status may be grounds for holding an individual incorporator liable for corporate contracts under agency law (see Chapter 20) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 438  Unit Four  The Business Environment in today’s business climate The corporate name should be one that can be used as the business’s Internet domain name Therefore, it is advisable to check what domain names are available before securing a corporate name with the state Incorporators can this by going to one of the many companies that issue domain names, such as Network Solutions (www.whois.com/whois), and finding out if the preferred name is available If another business is using that name, the incorporators can select an alternative name that can be used as the business’s URL, and then seek approval from the state for the name Trade Name Disputes. A new corporation’s name cannot be the same as (or deceptively similar to) the name of an existing corporation doing business within the same state If a firm does business under a name that is the same as or deceptively similar to an existing company’s name, it may be liable for trade name infringement (see Chapter 14) ▶  Example 19.5  An existing corporation is named Digital Synergy, Inc The state is not likely to allow a new corporation to use the name Digital Synergy Company That name is deceptively similar to the first and could cause confusion The use of too similar a name could also transfer part of the goodwill established by the first corporate user to the second, thus infringing on the first company’s trademark rights.  ◀ Prepare the Articles of Incorporation  The primary document needed to incorporate a business is the articles of incorporation The articles include basic information about the corporation and serve as a primary source of authority for its future organization and business functions The person or persons who execute (sign) the articles are the incorporators Generally, the articles of incorporation must include the following information [RMBCA 2.02] The name of the corporation The number of shares the corporation is authorized to issue The name and street address of the corporation’s initial registered agent and registered office The name and address of each incorporator In addition, the articles may set forth other information, such as the names and addresses of the initial members of the board of directors, and the duration and purpose of the corporation Articles of incorporation vary widely depending on the jurisdiction and the size and type of the corporation Frequently, the articles not provide much detail about the firm’s operations, which are spelled out in the company’s bylaws (internal rules of management adopted by the corporation at its first organizational meeting) Shares of the Corporation.  The articles must specify the number of shares of stock the corporation is authorized to issue [RMBCA 2.02(a)] For instance, a company might state that the aggregate number of shares that the corporation has the authority to issue is five thousand Large corporations often state a par value for each share, such as $.20 per share, and specify the various types or classes of stock authorized for issuance Registered Office and Agent.  The corporation must indicate the location and street address of its registered office within the state Usually, the registered office is also the principal office of the corporation The corporation must also give the name and address of a specific person who has been designated as an agent The registered agent is the person who can receive legal documents (such as orders to appear in court) on behalf of the corporation Incorporators.  Each incorporator must be listed by name and address The incorporators need not have any interest at all in the corporation, and sometimes signing the articles is their only duty Many states not have residency or age requirements for incorporators It can be as few as one or as many as three Incorporators frequently participate in the first organizational meeting of the corporation Duration and Purpose.  A corporation has perpetual existence unless the articles state otherwise The RMBCA does not require a specific statement of purpose to be included in the articles A corporation can be formed for any lawful purpose The articles may indicate that the corporation is organized for “any legal business.” By not mentioning specifics, the corporation avoids the need for future amendments to the corporate articles [RMBCA 2.02(b)(2)(i), 3.01] Internal Management.  The articles can describe the corporation’s internal management structure, although this usually is included in the bylaws adopted after the corporation is formed The bylaws typically describe Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  such matters as voting requirements for shareholders, the election of the board of directors, and the methods of replacing directors Bylaws cannot conflict with the incorporation statute or the articles of incorporation [RMBCA 2.06] Under the RMBCA, shareholders may amend or repeal the bylaws The board of directors may also amend or repeal the bylaws unless the articles of incorporation or state statutory provisions reserve this power to the shareholders exclusively [RMBCA 10.20] File the Articles with the State  Once the articles of incorporation have been prepared and signed, they are sent to the appropriate state official, usually the secretary of state, along with the required filing fee In most states, the secretary of state then stamps the articles “Filed” and returns a copy of the articles to the incorporators Once this occurs, the corporation officially exists First Organizational Meeting to Adopt Bylaws After incorporation, the first organizational meeting must be held Usually, the most important function of this meeting is the adoption of bylaws, which, as mentioned, are the internal rules of management for the corporation If the articles of incorporation named the initial board of directors, then the directors, by majority vote, call the meeting to adopt the bylaws and complete the company’s organization If the articles did not name the directors (as is typical), then the incorporators hold the meeting to elect the directors and adopt bylaws The incorporators may also complete the routine business of incorporation (such as authorizing the issuance of shares and hiring employees) at this meeting The business transacted depends on the requirements of the state’s corporation statute, the nature of the corporation, the provisions made in the articles, and the desires of the incorporators 439 De Jure Corporations  If a corporation has substantially complied with all conditions precedent to incorporation, the corporation is said to have de jure (rightful and lawful) existence In most states and under RMBCA 2.03(b), the secretary of state’s filing of the articles of incorporation is conclusive proof that all mandatory statutory provisions have been met [RMBCA 2.03(b)] Sometimes, the incorporators fail to comply with all statutory mandates If the defect is minor, such as an incorrect address listed on the articles of incorporation, most courts will overlook the defect and find that a corporation (de jure) exists De Facto Corporations  If the defect in formation is substantial, however, such as a corporation’s failure to hold an organizational meeting to adopt bylaws, the outcome will vary depending on the jurisdiction Some states, including Mississippi, New York, Ohio, and Oklahoma, still recognize the common law doctrine of de facto corporation.8 In those states, the courts will treat a corporation as a legal corporation despite the defect in its formation if the following three requirements are met: A state statute exists under which the corporation can be validly incorporated The parties have made a good faith attempt to comply with the statute The parties have already undertaken to business as a corporation Many state courts, however, have interpreted their states’ version of the RMBCA as abolishing the common law doctrine of de facto corporations These states include Alaska, Arizona, Minnesota, New Mexico, Oregon, South Dakota, Tennessee, Utah, and Washington, as well as the District of Columbia In those jurisdictions, if there is a substantial defect in complying with the incorporation statute, the corporation does not legally exist, and the incorporators are personally liable Corporation by Estoppel Improper Incorporation The procedures for incorporation are very specific If they are not followed precisely, others may be able to challenge the existence of the corporation Errors in incorporation procedures can become important when, for instance, a third party who is attempting to enforce a contract or bring a suit for a tort injury learns of them Sometimes, a business association holds itself out to others as being a corporation when it has made no attempt to incorporate In those situations, the firm normally will be estopped (prevented) from denying corporate status in a lawsuit by a third party The estoppel doctrine most commonly applies when a See, for example, In re Hausman, 13 N.Y.3d 408, 921 N.E.2d 191, 893 N.Y.S.2d 499 (2009) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 440  Unit Four  The Business Environment third party contracts with an entity that claims to be a corporation but has not filed articles of incorporation It may also apply when a third party contracts with a person claiming to be an agent of a corporation that does not in fact exist When justice requires, courts in some states will treat an alleged corporation as if it were an actual corporation for the purpose of determining the rights and liabilities in particular circumstances.9 Recognition of corporate status does not extend beyond the resolution of the problem at hand ▶  Case in Point 19.6  W.P Media, Inc., entered an agreement with Alabama MBA, Inc., to form a wireless Internet services company W.P Media was to create a wireless network, and Alabama MBA was to contribute the capital Hugh Brown signed the parties’ contract on behalf of Alabama MBA as the chair of its board At the time, however, Alabama MBA’s articles of incorporation had not yet been filed Brown filed the articles of incorporation the following year Later, Brown and Alabama MBA filed a suit alleging that W.P Media had breached their contract by not building the wireless network The Supreme Court of Alabama held that because W.P Media had treated Alabama MBA as a corporation, W.P Media was estopped from denying Alabama MBA’s corporate existence.10  ◀ SECTION Corporate Powers When a corporation is created, the express and implied powers necessary to achieve its purpose also come into existence The express powers of a corporation are found in its articles of incorporation, in the law of the state of incorporation, and in the state and federal constitutions Corporate bylaws and the resolutions of the corporation’s board of directors also establish the express powers of the corporation Because state corporation statutes frequently provide default rules that apply if the company’s bylaws are silent on an issue, it is important that the bylaws set forth the specific operating rules of the corporation In addition, after the bylaws are adopted, the corporation’s board of direc 9 Some states have expressly rejected the common law theory of corporation by estoppel, finding that it is inconsistent with their statutory law Other states have abolished only the doctrines of de facto and de jure corporations See, for example, Stone v Jetmar Properties, LLC, 733 N.W.2d 480 (Minn.App 2007) 10 Brown v W.P Media, Inc., 17 So.3d 1167 (2009) tors will pass resolutions that also grant or restrict corporate powers The following order of priority is used if a conflict arises among the various documents involving a corporation: The U.S Constitution State constitutions State statutes The articles of incorporation Bylaws Resolutions of the board of directors Implied Powers When a corporation is created, certain implied powers arise In the absence of express constitutional, statutory, or other prohibitions, the corporation has the implied power to perform all acts reasonably necessary to accomplish its corporate purposes For this reason, a corporation has the implied power to borrow funds within certain limits, lend funds, and extend credit to those with whom it has a legal or contractual relationship To borrow funds, the corporation acts through its board of directors to authorize the loan Most often, the president or chief executive officer of the corporation (see page 446) will execute the necessary documents on behalf of the corporation Corporate officers such as these have the implied power to bind the corporation in matters directly connected with the ordinary business affairs of the enterprise There is a limit to what a corporate officer can do, though A corporate officer does not have the authority to bind the corporation to an action that will greatly affect the corporate purpose or undertaking, such as the sale of substantial corporate assets Ultra Vires Doctrine The term ultra vires means “beyond the power.” In corporate law, acts of a corporation that are beyond its express or implied powers are ultra vires acts When a Corporation’s Actions Exceed Its Stated Purpose  In the past, most cases dealing with ultra vires acts involved contracts made for unauthorized purposes Now, however, most private corporations are organized for “any legal business” and not state a specific purpose, so the ultra vires doctrine has declined in importance Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  Today, cases that allege ultra vires acts usually involve nonprofit corporations or municipal (public) corporations ▶  Case in Point 19.7  Four men formed a nonprofit corporation to create the Armenian Genocide Museum & Memorial (AGM&M) The bylaws appointed them as trustees (similar to corporate directors) for life One of the trustees, Gerard L Cafesjian, became the chair and president of AGM&M Eventually, the relationship among the trustees deteriorated, and Cafesjian resigned The corporation then brought a suit claiming that Cafesjian had engaged in numerous ultra vires acts, self-dealing, and mismanagement Although the bylaws required an 80 percent affirmative vote of the trustees to take action, Cafesjian had taken many actions without the board’s approval He had also entered into contracts for real estate transactions in which he had a personal interest Because Cafesjian had taken actions that exceeded his authority and had failed to follow the rules set forth in the bylaws for board meetings, the court ruled that the corporation could go forward with its suit.11  ◀ Remedies for Ultra Vires Acts  Under Section 3.04 of the RMBCA, the shareholders can seek an injunction from a court to prevent (or stop) the corporation from engaging in ultra vires acts The attorney general in the state of incorporation can also bring an action to obtain an injunction against the ultra vires transactions or to seek dissolution of the corporation The corporation or its shareholders (on behalf of the corporation) can seek damages from the officers and directors who were responsible for the ultra vires acts SECTION Piercing the Corporate Veil Occasionally, the owners use a corporate entity to perpetrate a fraud, circumvent the law, or in some other way accomplish an illegitimate objective In these situations, the courts will ignore the corporate structure and pierce the corporate veil, exposing the shareholders to personal liability [RMBCA 2.04] Generally, courts pierce the veil when the corporate privilege is abused for personal benefit or 11 Armenian Assembly of America, Inc v Cafesjian, 692 F.Supp.2d 20 (D.C 2010) 441 when the corporate business is treated so carelessly that it is indistinguishable from that of a controlling shareholder When the facts show that great injustice would result from the use of a corporation to avoid individual responsibility, a court will look behind the corporate structure to the individual shareholders Factors That Lead Courts to Pierce the Corporate Veil The following are some of the factors that frequently cause the courts to pierce the corporate veil: A party is tricked or misled into dealing with the corporation rather than the individual The corporation is set up never to make a profit or always to be insolvent, or it is too “thinly” capitalized That is, it has insufficient capital at the time it is formed to meet its prospective debts or potential liabilities The corporation is formed to evade an existing legal obligation Statutory corporate formalities, such as holding required corporation meetings, are not followed Personal and corporate interests are mixed together, or commingled, to such an extent that the corporation has no separate identity Although state corporation codes usually not prohibit a shareholder from lending funds to her or his corporation, courts will scrutinize the transaction closely if the loan comes from an officer, director, or majority shareholder Loans from persons who control the corporation must be made in good faith and for fair value A Potential Problem for Close Corporations The potential for corporate assets to be used for personal benefit is especially great in a close corporation, in which the shares are held by a single person or by only a few individuals, usually family members In such a situation, the separate status of the corporate entity and the sole shareholder (or family-member shareholders) must be carefully preserved Certain practices invite trouble for the one-person or family-owned (close) corporation, including any of the following: The commingling of corporate and personal funds Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 442  Unit Four  The Business Environment The failure to hold board of directors’ meetings and record the minutes The shareholders’ continuous personal use of corporate property (for instance, company-owned vehicles) In the following case, when a close corporation failed to pay its legal fees, its attorneys sought to hold the shareholders personally liable The court had to decide whether to pierce the corporate veil Case 19.2 Brennan’s, Inc v Colbert Court of Appeal of Louisiana, 85 So.3d 787 (2012) BACKGROUND AND FACTS  Pip, Jimmy, and Theodore Brennan are brothers and shareholders of Brennan’s, Inc., which owns and operates New Orleans’s famous Brennan’s Restaurant In 1998, the Brennan brothers retained attorney Edward Colbert and his firm, Kenyon & Kenyon, L.L.P., to represent Brennan’s, Inc., in a dispute with another family member All bills were sent to Brennan’s, Inc., and the payments came from the company’s checking accounts As a close corporation, Brennan’s, Inc., did not hold formal corporate meetings with agendas and minutes, but it did maintain corporate books, hold corporate bank accounts, and file corporate tax returns In 2005, Brennan’s, Inc., sued Colbert and his law firm for legal malpractice In its answer, Kenyon & Kenyon demanded unpaid legal fees both from Brennan’s, Inc., and from the Brennan brothers personally The trial court found that the Brennan brothers could not be held personally liable Kenyon & Kenyon appealed The law firm argued that the court should pierce the corporate veil because Brennan’s, Inc., did not observe corporate formalities and because the Brennan brothers did not honor their promises to pay their legal bills IN THE LANGUAGE OF THE COURT Daniel L DYSART, Judge * * * * As a general rule, a corporation is a distinct legal entity, separate from the individuals who compose it, thus insulating the shareholders from personal liability There are limited exceptions where the court may ignore the corporate fiction and find the shareholders personally liable for the debts of a corporation One of those exceptions is where the corporation is found to be the “alter ego” of the shareholder It usually involves situations where fraud or deceit has been practiced by the shareholder through the corporation Another basis is where the shareholders disregard the corporate formalities to the extent that the corporation and the shareholders are no longer distinct entities * * * * Absent fraud, malfeasance or criminal wrongdoing, courts have been reluctant to hold a shareholder personally liable for corporate obligations When a party seeks to pierce the corporate veil, the totality of the circumstances is determinative [Emphasis added.] * * * * The Kenyon firm was aware of the nature of the operation of Brennan’s, Inc., * * * prior to being retained The client was Brennan’s, Inc., bills were sent to Brennan’s, Inc., and payments were paid with checks from the Brennan’s, Inc., bank accounts * * * Brennan’s, Inc., maintained its own accounting records and filed its own tax returns * * * The Kenyon firm acknowledged that Brennan’s, Inc., acting through its shareholders, promised to make good on the debt [Emphasis in original.] There is no evidence that the Brennan brothers ever agreed to bind themselves personally for any debt incurred in connection with the legal services provided by the Kenyon firm There is no written retention agreement between the corporation and the Kenyon firm, nor is there a written guaranty from any of the brothers The Kenyon firm admits that there is no requirement for small, [close] corporations to operate with the formality usually expected of larger corporations The Kenyon firm has failed Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  CASE 19.2 CONTINUEd 443 to establish that the lack of corporate formalities, particularly meetings, agendas and minutes, is sufficient to pierce the corporation veil Brennan’s, Inc., at all times since its inception has maintained corporate books, corporate bank accounts, and has filed corporate tax returns * * * * The Kenyon firm has not proven that any of the Brennan brothers made promises to pay the firm’s bills without the intent to pay them * * * If a broken promise to pay was sufficient to establish fraud, then every lawsuit against a corporation for a debt would automatically allow for the piercing of the corporate veil Clearly, a juridical entity such as a corporation can only speak through its shareholders [Emphasis added.] DECISION AND REMEDY  The Louisiana appellate court held that Kenyon & Kenyon could not hold the Brennan brothers personally liable by piercing the corporate veil The court therefore affirmed the trial court’s judgment for the Brennan brothers The Ethical Dimension  Should the Brennan brothers be held personally liable because they misled their attorneys? Why or why not? The Economic Dimension  Do corporations benefit from shareholders’ limited liability? If so, how? The Alter-Ego Theory Sometimes, courts pierce the corporate veil under the theory that the corporation was not operated as a separate entity, but was just another side (or alter ego) of the individual or group that actually controlled the corporation This is called the alter-ego theory, which was discussed in the context of limited liability companies in Chapter 18 The alter-ego theory is applied when a corporation is so dominated and controlled by an individual or group that the separate identities of the person (or group) and the corporation are no longer distinct Courts use the alter-ego theory to avoid injustice or fraud that would result if wrongdoers were allowed to hide behind the protection of limited liability ▶  Case in Point 19.8  Harvey and Barbara Jacobson owned Aqua Clear Technologies, Inc., which installed and serviced home water-softening systems The Jacobsons consistently took funds out of the business for their personal expenses, including payments for their home, cars, health-insurance premiums, and credit cards Three weeks after Aqua filed a bankruptcy petition, Harvey formed another corporation called Discount Water Services, Inc Discount appropriated Aqua’s equipment and inventory (without buying it) and continued to service water-softening systems for Aqua’s customers, even using the same phone number The trustee appointed to Aqua’s bankruptcy case sought to recover Aqua’s assets on the ground that Discount was Aqua’s alter ego The court ruled that Discount was simply a continuation of Aqua’s business (its alter ego) under a new name, and therefore held Discount liable for the claims asserted against Aqua in bankruptcy (totaling $108,732.64).12  ◀ S ection Directors and Officers Corporate directors, officers, and shareholders all play different roles within the corporate entity Sometimes, actions that may benefit the corporation as a whole not coincide with the separate interests of the individuals making up the corporation In such situations, it is important to know the rights and duties of all participants in the corporate enterprise The Roles of Directors and Officers The board of directors is the ultimate authority in every corporation Directors have responsibility for all policymaking decisions necessary to the management of all corporate affairs Additionally, the directors must act as a body in carrying out routine corporate 12 In re Aqua Clear Technologies, Inc., 361 Bankr 567 (S.D.Fla 2007) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 444  Unit Four  The Business Environment business The board selects and removes the corporate officers, determines the capital structure of the corporation, and declares dividends Each director has one vote, and customarily the majority rules The general areas of responsibility of the board of directors are shown in Exhibit 19–1 below Directors are sometimes inappropriately characterized as agents because they act on behalf of the corporation No individual director, however, can act as an agent to bind the corporation As a group, directors collectively control the corporation in a way that no agent is able to control a principal In addition, although directors occupy positions of trust and control over the corporation, they are not trustees because they not hold title to property for the use and benefit of others Few qualifications are required for directors Only a handful of states impose minimum age and residency requirements A director may be a shareholder, but that is not necessary (unless the articles of incorporation or bylaws require ownership interest) Election of Directors  Subject to statutory limitations, the number of directors is set forth in the corporation’s articles or bylaws Historically, the minimum number of directors has been three, but today many states permit fewer Normally, the incorporators appoint the first board of directors at the time the corporation is created, or the directors are named in the articles of incorporation The initial board serves until the first annual shareholders’ meeting Subsequent directors are elected by a majority vote of the shareholders A director usually serves for a term of one year— from annual meeting to annual meeting Most state statutes permit longer and staggered terms A common practice is to elect one-third of the board mem- bers each year for a three-year term In this way, there is greater management continuity Removal of Directors.  A director can be removed for cause—that is, for failing to perform a required duty— either as specified in the articles or bylaws or by shareholder action The board of directors may also have the power to remove a director for cause, subject to shareholder review In most states, a director cannot be removed without cause unless the shareholders have reserved the right to so at the time of election Vacancies on the Board.  Vacancies occur on the board if a director dies or resigns or when a new position is created through amendment of the articles or bylaws In these situations, either the shareholders or the board itself can fill the vacant position, depending on state law or on the provisions of the bylaws Note, however, that even when an election appears to be authorized by the bylaws, a court can invalidate the results if the directors were attempting to manipulate the election in order to reduce the shareholders’ influence ▶  Case in Point 19.9  The bylaws of Liquid Audio, Inc., authorized a board of five directors Two directors were elected each year Another company offered to buy all of Liquid Audio’s stock, but the board rejected this offer To prevent the shareholders from electing new directors who would allow the sale, the directors amended the bylaws The amendment increased the number of directors to seven, thereby diminishing the shareholders’ influence in the upcoming election The shareholders filed an action challenging the election The court ruled that the directors’ action was illegal because they had attempted to diminish the EX H IBIT 19 –1  Directors’ Management Responsibilities Authorize Major Corporate Policy Decisions Select and Remove Corporate Officers and Other Managerial Employees, and Determine Their Compensation Make Financial Decisions Examples: Examples: Examples: •  O  versee major contract negotiations and management-labor negotiations •  Initiate negotiations on the sale or lease of corporate assets outside the regular course of business •  Decide whether to pursue new product lines or business opportunities •  S earch for and hire corporate executives and determine the elements of their compensation packages, including stock options •  Supervise managerial employees and make decisions regarding their termination •  M  ake decisions regarding the issuance of authorized shares and bonds •  Decide when to declare dividends to be paid to shareholders Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  shareholders’ right to vote effectively in an election of directors.13  ◀ Compensation of Directors  In the past, corporate directors were rarely compensated Today, directors are often paid at least nominal sums and may receive more substantial compensation in large corporations because of the time, work, effort, and especially risk involved Most states permit the corporate articles or bylaws to authorize compensation for directors In fact, the RMBCA states that unless the articles or bylaws provide otherwise, the board itself may set the directors’ compensation [RMBCA 8.11] Directors also receive indirect benefits, such as business contacts and prestige, and other rewards, such as stock options In many corporations, directors are also chief corporate officers (president or chief executive officer, for example) and receive compensation in their managerial positions A director who is also an officer of the corporation is referred to as an inside director, whereas a director who does not hold a management position is an outside director Typically, a corporation’s board of directors includes both inside and outside directors Board of Directors’ Meetings  The board of directors conducts business by holding formal meetings with recorded minutes The dates of regular meetings are usually established in the articles or bylaws or by board resolution, and ordinarily no further notice is required Special meetings can be called, with notice sent to all directors Most states today allow directors to participate in board of directors’ meetings from remote locations via telephone, Web conferencing, or Skype, provided that all the directors can simultaneously hear each other during the meeting [RMBCA 8.20] Quorum of Directors.  Unless the articles of incorporation or bylaws specify a greater number, a majority of the board of directors normally constitutes a quorum [RMBCA 8.24] (A quorum is the minimum number of members of a body of officials or other group that must be present for business to be validly transacted.) Some state statutes specifically allow c­ orporations to set a quorum at less than a majority but not less than one-third of the directors.14 13 MM Companies, Inc v Liquid Audio, Inc., 813 A.2d 1118 (Del.Sup.Ct 2003) 14 See, for example, Delaware Code Annotated Title 8, Section 141(b); and New York Business Corporation Law Section 707 445 Voting.  Once a quorum is present, the directors transact business and vote on issues affecting the corporation Each director present at the meeting has one vote.15 Ordinary matters generally require a simple majority vote, but certain extraordinary issues may require a greater-than-majority vote Committees of the Board of Directors  When a board of directors has a large number of members and must deal with myriad complex business issues, meetings can become unwieldy Therefore, the boards of large, publicly held corporations typically create committees of directors and delegate certain tasks to these committees By focusing on specific subjects, committees can increase the efficiency of the board Two common types of committees are the ­executive committee and the audit committee An executive committee handles interim management decisions between board meetings It is limited to dealing with ordinary business matters, though, and does not have the power to declare dividends, amend the bylaws, or authorize the issuance of stock The Sarbanes-Oxley Act requires all publicly held corporations to have an audit committee The audit committee is responsible for the selection, compensation, and oversight of the independent public accountants that audit the firm’s financial records Rights of Directors  A corporate director must have certain rights to function properly in that position Right to Participation.  The right to participation means that directors are entitled to participate in all board of directors’ meetings and have a right to be notified of these meetings Because the dates of regular board meetings are usually specified in the bylaws, no notice of these meetings is required If special meetings are called, however, notice is required unless waived by the director [RMBCA 8.23] Right of Inspection.  A director also has a right of inspection, which means that each director can access the corporation’s books and records, facilities, and premises Inspection rights are essential for directors to make informed decisions and to exercise the necessary supervision over corporate officers and employees This right of inspection is almost absolute and cannot be restricted (by the articles, bylaws, or any act of the board of directors) 15 Except in Louisiana, which allows a director to vote by proxy under certain circumstances Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 446  Unit Four  The Business Environment Right to Indemnification.  When a director becomes involved in litigation by virtue of her or his position or actions, the director may also have a right to indemnification (reimbursement) for the legal costs, fees, and damages incurred Most states allow corporations to indemnify and purchase liability insurance for corporate directors [RMBCA 8.51] Corporate Officers and Executives Corporate officers and other executive employees are hired by the board of directors At a minimum, most corporations have a president, one or more vice presidents, a secretary, and a treasurer In most states, an individual can hold more than one office, such as president and secretary, and can be both an officer and a director of the corporation In addition to carrying out the duties articulated in the bylaws, corporate and managerial officers act as agents of the corporation Therefore, the ordinary rules of agency (to be discussed in Chapter 20) normally apply to their employment Corporate officers and other high-level managers are employees of the company, so their rights are defined by employment contracts Nevertheless, the board of directors normally can remove a corporate officer at any time with or without cause If the directors remove an officer in violation of the terms of an employment contract, however, the corporation may be liable for breach of contract For a synopsis of the roles of directors and officers, see Concept Summary 19.1 below Duties and Liabilities of Directors and Officers The duties of corporate directors and officers are similar because both groups are involved in decision making and are in positions of control Directors and officers are considered to be fiduciaries of the corporation because their relationship with the corporation and its shareholders is one of trust and confidence As fiduciaries, directors and officers owe ethical—and legal—duties to the corporation and the shareholders as a whole These fiduciary duties include the duty of care and the duty of loyalty Duty of Care  Directors and officers must exercise due care in performing their duties The standard of due care has been variously described in judicial deci- Concept Summary Summary19.1 8.1 Concept Roles of Directors and Officers Aspect Description Election of Directors The incorporators usually appoint the first board of directors Thereafter, shareholders elect the directors Directors usually serve a one-year term, although the term can be longer Few qualifications are required A director can be a shareholder but is not required to be Compensation usually is specified in the corporate articles or bylaws Board of Directors’ Meetings The board of directors conducts business by holding formal meetings with recorded minutes The dates of regular meetings are usually established in the corporate articles or bylaws Special meetings can be called, with notice sent to all directors Usually, a quorum is a majority of the corporate directors Once a quorum is present, each director has one vote, and the majority normally rules in ordinary matters Rights of Directors Directors’ rights include the rights of participation, inspection, compensation, and indemnification Board of Directors’ Committees Directors may appoint committees and delegate some of their responsibilities to the committees and to corporate officers and executives For instance, directors commonly appoint an executive committee, which handles ordinary, interim management decisions between board of directors’ meetings Directors may also appoint an audit committee to hire and supervise the independent public accountants who audit the corporation’s financial records Role of Corporate Officers and Executives The board of directors normally hires the corporate officers and other executive employees In most states, a person can hold more than one office and can be both an officer and a director of a corporation The rights of corporate officers and executives are defined by employment contracts Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  sions and codified in many state corporation codes Generally, it requires a director or officer to: Act in good faith (honestly) Exercise the care that an ordinarily prudent (careful) person would exercise in similar circumstances Do what she or he believes is in the best interests of the corporation [RMBCA 8.30(a), 8.42(a)] If directors or officers fail to exercise due care and the corporation or its shareholders suffer harm as a result, the directors or officers can be held liable for negligence (unless the business judgment rule applies, as will be discussed shortly) Duty to Make Informed Decisions.  Directors and officers are expected to be informed on corporate matters and to conduct a reasonable investigation of the relevant situation before making a decision This means that they must what is necessary to be adequately informed—that is, attend meetings and presentations, ask for information from those who have it, read reports, and review other written materials In other words, directors and officers must investigate, study, and discuss matters and evaluate alternatives before making a decision They cannot decide on the spur of the moment without adequate research Although directors and officers are expected to act in accordance with their own knowledge and training, they are also normally entitled to rely on information given to them by certain other persons Under the laws of most states and Section 8.30(b) of the RMBCA, such persons include competent officers or employees, professionals such as attorneys and accountants, and committees of the board of directors (on which the director does not serve) The r­ eliance must be in good faith to insulate a director from liability if the information later proves to be inaccurate or unreliable Duty to Exercise Reasonable Supervision.  Directors are also expected to exercise a reasonable amount of supervision when they delegate work to corporate officers and employees ▶  Example 19.10  Dale, a corporate bank director, fails to attend any board of directors’ meetings for five years In addition, Dale never inspects any of the corporate books or records and generally fails to supervise the activities of the bank president and the loan committee Meanwhile, Brennan, the bank president, who is a corporate officer, makes various improper loans and permits large overdrafts In this situation, Dale (the corporate director) can be held liable to the corporation for losses resulting from the 447 unsupervised actions of the bank president and the loan committee.  ◀ Dissenting Directors.  Directors are expected to attend board of directors’ meetings, and their votes should be entered into the minutes Sometimes, an individual director disagrees with the majority’s vote (which becomes an act of the board of directors) Unless a dissent is entered in the minutes, the director is presumed to have assented If the directors are later held liable for mismanagement as a result of a decision, dissenting directors are rarely held individually liable to the corporation For this reason, a director who is absent from a given meeting sometimes registers a dissent with the secretary of the board regarding actions taken at the meeting The Business Judgment Rule  Directors and officers are expected to exercise due care and to use their best judgment in guiding corporate management, but they are not insurers of business success Under the business judgment rule, a corporate director or officer will not be liable to the corporation or to its shareholders for honest mistakes of judgment and bad business decisions Courts give significant deference to the decisions of corporate directors and officers, and consider the reasonableness of a decision at the time it was made, without the benefit of hindsight Thus, corporate decision makers are not subjected to second-guessing by shareholders or others in the corporation When the Rule Applies.  The business judgment rule will apply as long as the director or officer: Took reasonable steps to become informed about the matter Had a rational basis for her or his decision Did not have a conflict of interest between her or his personal interest and that of the corporation Provides Broad Protections.  The business judgment rule provides broad protections to corporate decision makers In fact, unless there is evidence of bad faith, fraud, or a clear breach of fiduciary duties, most courts will apply the rule and protect directors and officers who make bad business decisions from liability for those choices ▶  Case in Point 19.11  After a foreign firm announced its intention to acquire Lyondell Chemical Company, Lyondell’s directors did nothing to prepare for a possible merger They failed to research Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 448  Unit Four  The Business Environment Lyondell’s market value and made no attempt to seek out other potential buyers The $13 billion cash merger was negotiated and finalized in less than a week—and the directors met for only seven hours to discuss it Shareholders sued, claiming that the directors had breached their fiduciary duties by failing to maximize the sale price of the corporation The Delaware Supreme Court ruled that the directors were protected by the business judgment rule.16  ◀ Duty of Loyalty  Loyalty can be defined as faithfulness to one’s obligations and duties In the corporate context, the duty of loyalty requires directors and officers to subordinate their personal interests to the welfare of the corporation For instance, a director should not oppose a transaction that is in the corporation’s best interest simply because pursuing it may cost the director his or her position 16 Lyondell Chemical Co v Ryan, 970 A.2d 235 (Del.Sup 2009) Directors cannot use corporate funds or confidential corporate information for personal advantage and must refrain from self-dealing Cases dealing with the duty of loyalty typically involve one or more of the following: Competing with the corporation Usurping (taking personal advantage of) a corporate opportunity Pursuing an interest that conflicts with that of the corporation Using information that is not available to the public to make a profit trading securities (see the discussion of insider trading in Chapter 28) Authorizing a corporate transaction that is detrimental to minority shareholders Selling control over the corporation The following classic case illustrates the conflict that can arise between a corporate official’s personal interest and his or her duty of loyalty Classic Case 19.3 Guth v Loft, Inc Supreme Court of Delaware, 23 Del.Ch 255, A.2d 503 (1939) background and facts  In 1930, Charles Guth became the president of Loft, Inc., a candyand-restaurant chain Guth and his family also owned Grace Company, which made syrups for soft drinks Coca-Cola Company supplied Loft with cola syrup Unhappy with what he felt was Coca-Cola’s high price, Guth entered into an agreement with Roy Megargel to acquire the trademark and formula for Pepsi-Cola and form Pepsi-Cola Corporation Neither Guth nor Megargel could finance the new venture, however, and Grace Company was insolvent Without the knowledge of Loft’s board, Guth used Loft’s capital, credit, facilities, and employees to further the Pepsi enterprise At Guth’s direction, a Loft employee made the concentrate for the syrup, which was sent to Grace to add sugar and water Loft charged Grace for the concentrate but allowed forty months’ credit Grace charged Pepsi for the syrup but also granted substantial credit Grace sold the syrup to Pepsi’s customers, including Loft, which paid on delivery or within thirty days Loft also paid for Pepsi’s advertising Finally, with profits declining as a result of switching from Coca-Cola, Loft filed a suit in a Delaware state court against Guth, Grace, and Pepsi, seeking their Pepsi stock and an accounting The court entered a judgment in the plaintiff’s favor The defendants appealed to the Delaware Supreme Court in the language of the court LAYTON, Chief Justice, delivering the opinion of the court: * * * * Corporate officers and directors are not permitted to use their position of trust and confidence to further their private interests * * * They stand in a fiduciary relation to the corporation and its stockholders A public policy, existing through the years, and derived from a profound knowledge of human characteristics and motives, has established a rule that demands of a corporate officer or director, peremptorily [not open for debate] and inexorably [unavoidably], the most scrupulous observance of his duty, not only affirmatively to protect the interests of the corporation committed to his charge, but also to refrain from doing anything that would work injury to the corporation * * *  The rule that requires an undivided and unselfish loyalty to the corporation demands that there shall be no conflict between duty and self-interest [Emphasis added.] Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  CASE 19.3 CONTINUEd 449 * * * * * * * If there is presented to a corporate officer or director a business opportunity which the corporation is financially able to undertake [that] is * * * in the line of the corporation’s business and is of practical advantage to it * * * and, by embracing the opportunity, the self-interest of the officer or director will be brought into conflict with that of his corporation, the law will not permit him to seize the opportunity for himself * * * In such circumstances, * * * the corporation may elect to claim all of the benefits of the transaction for itself, and the law will impress a trust in favor of the corporation upon the property, interests and profits so acquired [Emphasis added.] * * * * * * * The appellants contend that no conflict of interest between Guth and Loft resulted from his acquirement and exploitation of the Pepsi-Cola opportunity [and] that the acquisition did not place Guth in competition with Loft * * * [In this case, however,] Guth was Loft, and Guth was Pepsi He absolutely controlled Loft His authority over Pepsi was supreme As Pepsi, he created and controlled the supply of Pepsi-Cola syrup, and he determined the price and the terms What he offered, as Pepsi, he had the power, as Loft, to accept Upon any consideration of human characteristics and motives, he created a conflict between self-interest and duty He made himself the judge in his own cause * * * Moreover, a reasonable probability of injury to Loft resulted from the situation forced upon it Guth was in the same position to impose his terms upon Loft as had been the Coca-Cola Company * * * The facts and circumstances demonstrate that Guth’s appropriation of the Pepsi-Cola opportunity to himself placed him in a competitive position with Loft with respect to a commodity essential to it, thereby rendering his personal interests incompatible with the superior interests of his corporation; and this situation was accomplished, not openly and with his own resources, but secretly and with the money and facilities of the corporation which was committed to his protection decision and remedy  The Delaware Supreme Court upheld the judgment of the lower court The state supreme court was “convinced that the opportunity to acquire the Pepsi-Cola trademark and formula, goodwill and business belonged to [Loft], and that Guth, as its President, had no right to appropriate the opportunity to himself.” what if the facts were different?  Suppose that Loft’s board of directors had approved Pepsi-Cola’s use of its personnel and equipment Would the court’s decision have been different? Discuss IMPACT OF THIS CASE ON TODAY’S LAW  This early Delaware decision was one of the first to set forth a test for determining when a corporate officer or director has breached the duty of loyalty The test has two basic parts: Was the opportunity reasonably related to the corporation’s line of business, and was the corporation financially able to undertake the opportunity? The court also considered whether the corporation had an interest or expectancy in the opportunity and recognized that when the corporation had “no interest or expectancy, the officer or director is entitled to treat the opportunity as his own.” Conflicts of Interest  Corporate directors often have many business affiliations, and a director may sit on the board of more than one corporation Of course, directors are precluded from entering into or supporting businesses that operate in direct competition with corporations on whose boards they serve Their fiduciary duty requires them to make a full disclosure of any potential conflicts of interest that might arise in any corporate transaction [RMBCA 8.60] Sometimes, a corporation enters into a contract or engages in a transaction in which an officer or direc- tor has a personal interest The director or officer must make a full disclosure of the nature of the conflicting interest and all facts pertinent to the transaction, and must abstain from voting on the proposed transaction Otherwise, directors would be prevented from ever having financial dealings with the corporations they serve ▶  Example 19.12  Ballo Corporation needs office space Stephanie Colson, one of its five directors, owns the building adjoining the corporation’s headquarters Colson can negotiate a lease for the space to Ballo if she fully discloses her conflicting interest and Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 450  Unit Four  The Business Environment any facts known to her about the proposed transaction to Ballo and the other four directors If the lease arrangement is fair and reasonable, Colson abstains from voting on it, and the other members of the corporation’s board of directors unanimously approve it, the contract is valid.  ◀ Liability of Directors and Officers  Directors and officers are exposed to liability on many fronts They can be held liable for negligence in certain circumstances, as previously discussed They may also be held liable for the crimes and torts committed by themselves or by corporate employees under their supervision (See this chapter’s Insight into Ethics below for a discussion of how one federal statute makes lying a crime.) Additionally, if shareholders perceive that the corporate directors are not acting in the best interests of the corporation, they may sue the directors, in what is called Insight into Ethics When Is Lying a Federal Crime? The federal government defines and prosecutes almost 4,500 crimes In addition to prosecuting defendants for allegedly committing these crimes, the government can also charge them with lying about their actions Under Section 1001 of Title 18 of the United States Code, any person convicted of knowingly and willfully making “any material false, fictitious or fraudulent statements or misrepresentations” can be fined or imprisoned or both When prosecutors not have enough evidence to charge someone with the underlying crime, they may still bring charges under Section 1001 if the person made any false statements in interviews A Costly Phone Interview In 2004, attorney Melissa Ann Mahler was interviewed by phone by an official at the Securities and Exchange Commission She made a false statement about a securities transaction in her personal brokerage account Ultimately, a court determined that she had violated Section 1001 The court suspended Mahler’s attorney’s license, sentenced her to two years on probation, fined her $2,500, and ordered her to perform a hundred hours of community service.a Whistling at a Whale Can Be Dangerous Nancy Black, a marine biologist who operates a whalewatching boat company in California, also ran afoul of Section 1001 When a humpback whale appeared near one of her boats, the captain of the boat whistled at the whale, hoping that the sound would intrigue the whale and cause it to come closer Regulators investigated whether the whistling constituted harassment of a whale, which is a federal crime Prosecutors have not charged Black with whale harassment Instead, she has been charged with lying about the a Matter of Mahler, 94 A.D.3d 114, 939 N.Y.S.2d 900 (2012) See also In re Simels, 94 A.D.3d 108, 940 N.Y.S 2d 577 (2012) incident by supplying the regulators with a video that had been edited to delete material that Black thought was not relevant In an interview, she commented, “I wasn’t charged with anything about the dealings with the humpback So why would they charge me with lying about it? It makes no sense.” b What Constitutes a Lie under Section 1001? The courts have interpreted Section 1001 as encompassing almost any statement made to a federal official The statement may be oral or in writing The person making it need not be under oath, and the government does not have to have warned the person that any falsehood could have very serious consequences Although the lie has to be “material,” any statement that has a “natural tendency to influence, or [is] capable of influencing, the decision of the decision-making body to which it is addressed” is considered material.c In other words, the federal government does not have to show that the falsehood actually influenced or misled anyone Consider a not too far-fetched example Suppose that you fill out your time sheets at work inaccurately by listing more hours than you actually worked and occasionally complete a time sheet for a day that you did not work If your employer has to submit employees’ time sheets to a federal regulatory agency, you could ultimately be held criminally liable for lying Legal Critical Thinking Insight into the Social Environment Many businesspersons believe that the federal government’s power under Section 1001 is almost without limits What ethical issues are at stake here? b “ ‘Lying’ Is a Handy Charge for the U.S Government,” Wall Street Journal, April 11, 2012 c United States v Gaudin, 515 U.S 506, 115 S.Ct 2310, 132 L.Ed.2d 444 (1995) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  a shareholder’s derivative suit, on behalf of the corporation (This type of action will be discussed later in this chapter, in the context of shareholders’ rights.) Directors and officers can also be held personally liable under a number of statutes, such as statutes enacted to protect consumers or the environment (see Chapters 24 and 25) SECTION Shareholders The acquisition of a share of stock makes a person an owner and a shareholder in a corporation Shareholders thus own the corporation Although they have no legal title to corporate property, such as buildings and equipment, they have an equitable (ownership) interest in the firm As a general rule, shareholders have no responsibility for the daily management of the corporation, although they are ultimately responsible for choosing the board of directors, which does have such control Ordinarily, corporate officers and other employees owe no direct duty to individual shareholders (unless some contract or special relationship exists between them in addition to the corporate relationship).  The duty of officers and directors is to act in the best interests of the corporation and its shareholderowners as a whole.  In turn, as you will read later in this chapter, controlling shareholders owe a fiduciary duty to minority shareholders Shareholders’ Powers Shareholders must approve fundamental changes affecting the corporation before the changes can be implemented Hence, shareholder approval normally is required to amend the articles of incorporation or bylaws, to conduct a merger or dissolve the corporation, and to sell all or substantially all of the cor­ poration’s assets Some of these powers are subject to prior board approval Shareholder approval may also be requested (though it is not required) for certain other actions, such as to approve an independent auditor Shareholders have the power to vote to elect or remove members of the board of directors As described earlier, the first board of directors is either named in the articles of incorporation or chosen by the incorporators to serve until the first shareholders’ meeting From that time on, selection and retention of directors are exclusively shareholder functions Directors usually serve their full terms If the shareholders judge them unsatisfactory, they are simply 451 not reelected Shareholders have the inherent power, however, to remove a director from office for cause (breach of duty or misconduct) by a majority vote.17 As noted earlier in this chapter, some state statutes (and some articles of incorporation) permit removal of directors without cause by the vote of a majority of the shareholders entitled to vote.18 Shareholders’ Meetings Shareholders’ meetings must occur at least annually In addition, special meetings can be called to deal with urgent matters Notice of meetings  A corporation must notify its shareholders of the date, time, and place of an annual or special shareholders’ meeting at least ten days, but not more than sixty days, before the meeting date [RMBCA 7.05].19 (The date and time of the annual meeting can be specified in the bylaws.) Notice of a special meeting must include a statement of the purpose of the meeting, and business transacted at the meeting is limited to that purpose The RMBCA does not specify how the notice must be given (such as by mail, e-mail, or social media), but most corporations specify in their bylaws the acceptable methods of notifying shareholders about meetings Also, some states’ incorporation statutes outline the means of notice that a corporation can use in that jurisdiction For instance, in Alaska, notice may be given in person, by mail, or by fax, e-mail, blog, or Web post—as long as the shareholder has agreed to that electronic method.20 Proxies  It usually is not practical for owners of only a few shares of stock of publicly traded corporations to attend a shareholders’ meeting Therefore, the law allows stockholders to appoint another person as their agent to vote their shares at the meeting The signed appointment form or electronic transmission authorizing an agent to vote the shares is called a proxy (from the Latin procurare, meaning “to manage or take care of”) 17 A director can often demand court review of removal for cause, however 18 Most states allow cumulative voting for directors (described later in the chapter) If cumulative voting is authorized, a director may not be removed if the number of votes against removal would be sufficient to elect a director under cumulative voting See, for example, California Corporations Code Section 303A See also Section 8.08(c) of the RMBCA 19 The shareholder can waive the requirement of notice by signing a waiver form [RMBCA 7.06] A shareholder who does not receive notice but who learns of the meeting and attends without protesting the lack of notice is said to have waived notice by such conduct 20 Alaska Statutes Section 10.06.410 Notice of Shareholders’ Meetings Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 452  Unit Four  The Business Environment Management often solicits proxies, but any person can so to concentrate voting power Groups of shareholders have used proxies as a device for taking over a corporation Proxies normally are revocable (can be withdrawn), unless they are specifically designated as irrevocable and coupled with an interest A proxy is coupled with an interest when, for instance, the person receiving the proxies from shareholders has agreed to buy their shares Under RMBCA 7.22(c), proxies are valid for eleven months, unless the proxy agreement mandates a longer period shareholder proposals  When shareholders want to change a company policy, they can put their ideas up for a shareholder vote They this by submitting a shareholder proposal to the board of directors and asking the board to include the proposal in the proxy materials that are sent to all shareholders before meetings As you will read in Chapter 28, the Securities and Exchange Commission (SEC) regulates the purchase and sale of securities The SEC has special provisions relating to proxies and shareholder proposals SEC Rule 14a-8 provides that all shareholders who own stock worth at least $1,000 are eligible to submit proposals for inclusion in corporate proxy materials The corporation is required to include information on whatever proposals will be considered at the shareholders’ meeting along with proxy materials Only those proposals that relate to significant policy considerations, not ordinary business operations, must be included Electronic Proxy Materials  In the past, corporations had to send large packets of paper documents to shareholders, but today, the SEC requires all publicly held companies to distribute electronic proxy (e-proxy) materials.21 Although the law requires proxy materials to be posted online, public companies may still choose among several options—including paper documents or a DVD sent by mail—for actually delivering the materials to shareholders If a company wishes to distribute proxy materials only via the Internet, it can choose the notice-andaccess delivery option Under this model, the corporation posts the proxy materials on a Web site and notifies the shareholders that the proxy materials are available online If a shareholder requests paper proxy materials, the company must send them within three business days Shareholders can permanently elect 21 17 C.F.R Parts 240, 249, and 274 to receive all future proxy materials on paper or by e-mail with electronic links Shareholder Voting Shareholders exercise ownership control through the power of their votes Corporate business matters are presented in the form of resolutions, which shareholders vote to approve or disapprove Unless there is a provision to the contrary, each shareholder is entitled to one vote per share, although the voting techniques discussed next enhance the power of the shareholder’s vote The articles of incorporation can exclude or limit voting rights, particularly for certain classes of shares [RMBCA 7.21] If a state statute requires specific voting procedures, the corporation’s articles or bylaws must be consistent with the statute Quorum Requirements For shareholders to act ­ uring a meeting, a quorum must be present Generally, d a quorum exists when shareholders holding more than 50 percent of the outstanding shares are present, but state laws often permit the articles of incorporation to set higher or lower quorum requirements In some states, obtaining the unanimous written consent of shareholders is a permissible alternative to holding a shareholders’ meeting [RMBCA 7.25] Once a quorum is present, voting can proceed A straight majority vote of the shares represented at the meeting is usually required to pass resolutions ▶  Example 19.13  Novo Pictures, Inc., has 10,000 outstanding shares of voting stock Its articles of incorporation set the quorum at 50 percent of outstanding shares and provide that a majority vote of the shares present is necessary to pass ordinary matters Therefore, for this firm, a quorum of stockholders representing 5,000 outstanding shares must be present to conduct business at the shareholders’ meeting If exactly 5,000 shares are represented at the meeting, a vote of at least 2,501 of those shares is needed to pass a resolution If 6,000 shares are represented, a vote of 3,001 will be necessary.  ◀ At times, more than a simple majority vote will be required either by statute or by the articles of incorporation Extraordinary corporate matters, such as a merger, a consolidation, or dissolution of the corporation, require a higher percentage (more than a majority) of all corporate shares entitled to vote [RMBCA 7.27] Voting Lists  The corporation prepares the voting list before each shareholders’ meeting Ordinarily, only Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  persons whose names appear on the corporation’s stockholder records as owners are entitled to vote.22 The voting list contains the name and address of each shareholder as shown on the corporate records on a given cutoff date, or record date (Under RMBCA 7.07, the bylaws or board of directors may fix a record date that is as much as seventy days before the meeting.) The voting list also includes the number of voting shares held by each owner The list is usually kept at the corporate headquarters and must be made available for shareholder inspection [RMBCA 7.20] Cumulative Voting  Most states permit, and many require, shareholders to elect directors by cumulative voting, a voting method designed to allow minority shareholders to be represented on the board of directors Formula.  With cumulative voting, each shareholder is entitled to a total number of votes equal to the number of board members to be elected multiplied by the number of voting shares that the shareholder owns The shareholder can cast all of these votes for one candidate or split them among several nominees for director All nominees stand for election at the same time When cumulative voting is not required by statute or under the articles, the entire board can be elected by a majority of shares at a shareholders’ meeting How Cumulative Voting Works.  Cumulative voting can best be understood by example ▶  Example 19.14  A corporation has 10,000 shares issued and outstanding The minority shareholders hold 3,000 shares, and the majority shareholders hold the other 7,000 shares Three members of the board are to be elected The majority shareholders’ nominees are Alvarez, Beasley, and Caravel The minority shareholders’ nominee is Dovrik Can Dovrik be elected to the board by the minority shareholders? 22 When the legal owner is deceased, bankrupt, mentally incompetent, or in some other way under a legal disability, his or her vote can be cast by a person designated by law to control and manage that owner’s property 453 If cumulative voting is allowed, the answer is yes The minority shareholders have 9,000 votes among them (the number of directors to be elected times the number of shares, or 3 3,000 9,000 votes) All of these votes can be cast to elect Dovrik The majority shareholders have 21,000 votes (3 7,000 21,000 votes), but these votes must be distributed among their three nominees The principle of cumulative voting is that no matter how the majority shareholders cast their 21,000 votes, they will not be able to elect all three directors if the minority shareholders cast all of their 9,000 votes for Dovrik, as illustrated in Exhibit 19–2 below.  ◀ Shareholder Voting Agreements  Before a shareholders’ meeting, a group of shareholders can create a shareholder voting agreement by agreeing in writing to vote their shares together in a specified manner Such agreements usually are held to be valid and enforceable Nevertheless, corporate managers must be careful that such agreements not constitute a breach of their fiduciary duties ▶  Case in Point 19.15  Several shareholders of CryoCell International, Inc., mounted a proxy contest in an effort to replace the board of directors Another stockholder, Andrew Filipowski, agreed to support management in exchange for being included in management’s slate of directors The company’s chief executive officer, Mercedes Walton, secretly promised Filipowski that if management’s slate won, the board of directors would add another board seat to be filled by a Filipowski designee After management won the election, Walton prepared to add Filipowski’s designee to the board When the dissident shareholders challenged the election results, the court held that the board’s actions and Walton’s secret agreement constituted serious breaches of fiduciary duty that tainted the election The court therefore ordered a new election to be held.23  ◀ 23 Portnoy v Cryo-Cell International, Inc., 940 A.2d 43 (Del.Ch 2008) EX H IBIT 19 –2  Results of Cumulative Voting Majority Shareholder Votes Ballot Minority Shareholder Votes Alvarez Beasley Caravel Dovrik 10,000   9,001  6,000 10,000   9,000  7,000 1,000 2,999 8,000 9,000 9,000 9,000 Directors Elected Alvarez, Beasley, Dovrik Alvarez, Beasley, Dovrik Beasley, Caravel, Dovrik Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 454  Unit Four  The Business Environment Voting Trust Another voting technique is for shareholders to enter into a voting trust (A shareholder can also appoint a voting agent and vote by proxy, as mentioned previously.) A voting trust is an agreement (a trust contract) under which a shareholder assigns the right to vote his or her shares to a trustee, usually for a specified period of time The trustee is then responsible for voting the shares on behalf of all the shareholders in the trust The shareholder retains all rights of ownership (for example, the right to receive dividend payments) except the power to vote the shares [RMBCA 7.30] Rights of Shareholders Shareholders possess numerous rights A significant right—the right to vote their shares—has already been discussed We look at some additional rights of shareholders in the following subsections Stock Certificates  In the past, corporations commonly issued stock certificates that evidenced ownership of a specified number of shares in the corporation Only a few jurisdictions still require physical stock certificates, and shareholders there have the right to demand that the corporation issue certificates (or replace those that were lost or destroyed) Stock is intangible personal property, however, and the ownership right exists independently of the certificate itself In most states and under RMBCA 6.26, a board of directors may provide that shares of stock will be uncertificated, or “paperless”—that is, no actual, physical stock certificates will be issued When shares are uncertificated, the corporation may be required to send each shareholder a letter or some other form of notice that contains the same information that traditionally appeared on the face of stock certificates Notice of shareholders’ meetings, dividends, and operational and financial reports are all distributed according to the recorded ownership listed in the corporation’s books Preemptive Rights Sometimes, the articles of incorporation grant preemptive rights to shareholders With preemptive rights, a shareholder receives a preference over all other purchasers to subscribe to or purchase a prorated share of a new issue of stock In other words, the shareholder can purchase a percentage of the new shares that is equal to his or her current percentage of ownership in the corporation Under RMBCA 6.30, preemptive rights not exist unless provided for in the articles of incorporation Generally, preemptive rights apply only to additional, newly issued stock sold for cash, and the preemptive rights must be exercised within a specific time period, which is usually thirty days Allow a Shareholder to Maintain Proportionate Interest.  Preemptive rights allow each shareholder to maintain her or his proportionate control, voting power, or financial interest in the corporation ▶  Example 19.16  Tron Corporation authorizes and issues 1,000 shares of stock, and Omar Loren purchases 100 shares, making him the owner of 10 percent of the company’s stock Subsequently, Tron, by vote of its shareholders, authorizes the issuance of another 1,000 shares (by amending the articles of incorporation) This increases its capital stock to a total of 2,000 shares If preemptive rights have been provided, Loren can purchase one additional share of the new stock being issued for each share he already owns—or 100 additional shares Thus, he will own 200 of the 2,000 shares outstanding, and his relative position as a shareholder will be maintained If preemptive rights are not provided, his proportionate control and voting power will be diluted from that of a 10 percent shareholder to that of a percent shareholder because the additional 1,000 shares were issued.  ◀ Important in Close Corporations.  Preemptive rights are most important in close corporations because each shareholder owns a relatively small number of shares but controls a substantial interest in the corporation Without preemptive rights, it would be possible for a shareholder to lose his or her proportionate control over the firm Nevertheless, preemptive rights can hinder a corporation from raising capital from new, outside investors who can provide needed expertise as well as capital Stock Warrants  Stock warrants are rights to buy stock at a stated price by a specified date that are given by the company Usually, when preemptive rights exist and a corporation is issuing additional shares, it gives its shareholders stock warrants Warrants are often publicly traded on securities exchanges Dividends  As mentioned, a dividend is a distribution of corporate profits or income ordered by the directors and paid to the shareholders in proportion to their respective shares in the corporation Dividends can be paid in cash, property, stock of the corporation that is paying the dividends, or stock of other corporations.24 24 On one occasion, a distillery declared and paid a dividend in bonded whiskey Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  State laws vary, but each state determines the general circumstances and legal requirements under which dividends are paid State laws also control the sources of revenue to be used Only certain funds are legally available for paying dividends Depending on state law, dividends may be paid from the following sources: Retained earnings All states allow dividends to be paid from the undistributed net profits earned by the corporation, including capital gains from the sale of fixed assets As mentioned earlier, the undistributed net profits are called retained earnings Net profits A few states allow dividends to be issued from current net profits without regard to deficits in prior years Surplus A number of states allow dividends to be paid out of any kind of surplus For instance, earned surplus is the sum of a company’s net profits over a period of time It increases by the amount of each year’s net income after dividend payments Earned surplus is not extra cash, but shareholder equity A company’s board of directors may choose to pay dividends from the surplus or to use it for some other corporate purpose (such as for acquisitions) Illegal Dividends.  Sometimes, dividends are improperly paid from an unauthorized account, or their payment causes the corporation to become insolvent Generally, shareholders must return illegal dividends only if they knew that the dividends were illegal when the payment was received (or if the dividends were paid when the corporation was insolvent) Whenever dividends are illegal or improper, the board of directors can be held personally liable for the amount of the payment The Directors’ Failure to Declare a Dividend. When directors fail to declare a dividend, shareholders can ask a court to compel the directors to meet and declare a dividend To succeed, the shareholders must show that the directors have acted so unreasonably in withholding the dividend that their conduct is an abuse of their discretion A corporation might accumulate large cash reserves for a legitimate corporate purpose, such as expansion or research The mere fact that the firm has sufficient earnings or surplus available to pay a dividend normally is not enough to compel the directors to distribute funds that, in the board’s opinion, should not be distributed The courts are reluctant to interfere with corporate operations and will not compel directors to declare dividends unless abuse of discretion is clearly shown Inspection Rights  Shareholders in a corporation enjoy both common law and statutory inspection 455 rights The RMBCA provides that every shareholder is entitled to examine specified corporate records, including voting lists [RMBCA 7.20, 16.02] The shareholder may inspect in person, or an attorney, accountant, or other authorized assistant can so as the shareholder’s agent A shareholder only has a right to inspect and copy corporate books and records for a proper purpose, however, and the request to inspect must be made in advance A shareholder who is denied the right of inspection can seek a court order to compel the inspection The power of inspection is fraught with potential abuses, and the corporation is allowed to protect itself from them For instance, a shareholder can properly be denied access to corporate records to prevent harassment or to protect trade secrets or other confidential corporate information In some states, a shareholder must have held her or his shares for a minimum period of time immediately preceding the demand to inspect or must hold a certain percentage of outstanding shares Transfer of Shares  Corporate stock represents an ownership right in intangible personal property The law generally recognizes the right of an owner to transfer property to another person unless there are valid restrictions on its transferability Restrictions on the transfer of shares in a close corporation usually are valid When shares are transferred, a new entry is made in the corporate stock book to indicate the new owner Until the corporation is notified and the entry is complete, all rights—including voting rights, notice of shareholders’ meetings, and the right to dividend distributions—remain with the current record owner Rights on Dissolution  When a corporation is dissolved and its outstanding debts and the claims of its creditors have been satisfied, there may be assets remaining The remaining assets are distributed to the shareholders in proportion to the percentage of shares owned by each shareholder The articles of incorporation may provide that certain classes of stock will be given priority If no class of stock has been given preference in the distribution of assets, all of the stockholders share the remaining assets The Shareholder’s Derivative Suit When the corporation is harmed by the actions of a third party, the directors can bring a lawsuit in the name of the corporation against that party If the corporate directors fail to bring a lawsuit, shareholders can so “derivatively” in what is known as a s­ hareholder’s derivative suit Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 456  Unit Four  The Business Environment Before shareholders can bring a derivative suit, they must submit a written demand to the corporation, asking the board of directors to take appropriate action [RMBCA 7.40] The directors then have ninety days in which to act Only if they refuse to so can the derivative suit go forward When Acts of Directors and Officers Cause Harm to the Corporation.  The right of shareholders to bring a derivative action is especially important when the wrong suffered by the corporation results from the actions of the corporate directors and officers For obvious reasons, the directors and officers would probably be unwilling to take any action against themselves Nevertheless, a court will dismiss a derivative suit if a majority of the directors or an independent panel determines in good faith that the lawsuit is not in the best interests of the corporation [RMBCA 7.44] Any Damages Awarded Go to the Corporation.  When shareholders bring a derivative suit, they are not pursuing rights or benefits for themselves personally but are acting as guardians of the corporate entity Therefore, if the suit is successful, any damages recovered normally go into the corporation’s treasury, not to the shareholders personally.25 Duties and Liabilities of Shareholders One of the hallmarks of the corporate form of organization is that shareholders are not personally liable for the debts of the corporation If the corporation fails, the shareholders can lose their investments, but that generally is the limit of their liability As previously discussed, in certain instances of fraud, undercapitalization, or careless observance of corporate formalities, a court will pierce the corporate veil (disregard the corporate entity) and hold the shareholders individually liable But these situations are the exception, not the rule A shareholder can also be personally liable in certain other rare instances One relates to illegal dividends, which were discussed previously Another relates to watered stock Still another concerns the duties majority shareholders owe to minority shareholders Watered Stock  When a corporation issues shares for less than their fair market value, the shares are referred to as watered stock.26 Usually, the share25 The shareholders may be entitled to reimbursement for reasonable expenses of the derivative lawsuit, including attorneys’ fees 26 The phrase watered stock was originally used to describe cattle that were kept thirsty during a long drive and then were allowed to drink large quantities of water just before their sale The increased weight of the watered stock allowed the seller to reap a higher profit holder who receives watered stock must pay the difference to the corporation (the shareholder is personally liable) In some states, the shareholder who receives watered stock may be liable to creditors of the corporation for unpaid corporate debts ▶  Example 19.17  During the formation of a corporation, Gomez, one of the incorporators, transfers his property, Sunset Beach, to the corporation for 10,000 shares of stock at a par value of $100 per share for a total price of $1 million After the property is transferred and the shares are issued, Sunset Beach is carried on the corporate books at a value of $1 million On appraisal, it is discovered that the market value of the property at the time of transfer was only $500,000 The shares issued to Gomez are therefore watered stock, and he is liable to the corporation for the difference between the value of the shares and the value of the property.  ◀ Duties of Majority Shareholders In some instances, a majority shareholder is regarded as having a fiduciary duty to the corporation and to the minority shareholders This duty occurs when a single shareholder (or a few shareholders acting in concert) owns a sufficient number of shares to exercise de facto (actual) control over the corporation In these situations, the majority shareholder owes a fiduciary duty to the minority shareholders When a majority shareholder breaches her or his fiduciary duty to a minority shareholder, the minority shareholder can sue for damages A breach of ­fiduciary duties by those who control a close corporation normally constitutes what is known as oppressive conduct A common example of a breach of fiduciary duty occurs when the majority shareholders “freeze out” the minority shareholders and exclude them from certain benefits of participating in the firm ▶  Case in Point 19.18  Brodie, Jordan, and Barbuto formed a close corporation to operate a machine shop Each owned one-third of the shares in the company, and all three were directors Brodie served as the corporate president for twelve years but thereafter met with the other shareholders only a few times a year After disagreements arose, Brodie asked the company to purchase his shares, but his requests were refused A few years later, Brodie died, and his wife inherited his shares in the company Jordan and Barbuto refused to perform a valuation of the company, denied her access to the corporate information she requested, did not declare any dividends, and refused to elect her as a director In this situation, a court found that the majority shareholders had violated their fiduciary duty to Brodie’s wife.27  ◀ 27 Brodie v Jordan, 447 Mass 866, 857 N.E.2d 1076 (2006) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  S ection Major Business Forms Compared As mentioned in Chapter 17, when deciding which form of business organization to choose, businesspersons normally consider several factors, including ease 457 of creation, the liability of the owners, tax considerations, and the ability to raise capital Each major form of business organization offers distinct advantages and disadvantages with respect to these and other factors Exhibit 19–3 below and on the next page summarizes the essential advantages and disadvantages of each of the forms of business organization discussed in Chapters 17 through 19 EX H IBIT 19 – 3  Major Forms of Business Compared Characteristic Sole Proprietorship Partnership Corporation Method of Creation Created at will by owner Created by agreement of the parties Authorized by the state under the state’s corporation law Legal Position Not a separate entity; owner is the business A general partnership is a separate legal entity in most states Always a legal entity separate and distinct from its owners—a legal fiction for the purposes of owning property and being a party to litigation Liability Unlimited liability Unlimited liability Limited liability of shareholders— shareholders are not liable for the debts of the corporation Duration Determined by owner; automatically dissolved on owner’s death Terminated by agreement of the partners, but can continue to business even when a partner dissociates from the partnership Can have perpetual existence Transferability of Interest Interest can be transferred, but individual’s proprietorship then ends Although partnership interest can be assigned, assignee does not have full rights of a partner Shares of stock can be transferred Management Completely at owner’s discretion Each partner has a direct and equal voice in management unless expressly agreed otherwise in the partnership agreement Shareholders elect directors, who set policy and appoint officers Taxation Owner pays personal taxes on business income Each partner pays pro rata share of income taxes on net profits, whether or not they are distributed Double taxation—corporation pays income tax on net profits, with no deduction for dividends, and shareholders pay income tax on disbursed dividends they receive Organizational Fees, Annual License Fees, and Annual Reports None or minimal None or minimal All required Transaction of Business in Other States Generally no limitation Generally no limitation a Normally must qualify to business and obtain certificate of authority a.  A few states have enacted statutes requiring that foreign partnerships qualify to business there Continued Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 458  Unit Four  The Business Environment E x h i b i t 19 – 3  Major Forms of Business Compared—Continued Charactistic Limited Partnership Limited Liability Company Limited Liability Partnership Method of Creation Created by agreement to carry on a business for profit At least one party must be a general partner and the other(s) limited partner(s) Certificate of limited partnership is filed Charter must be issued by the state Created by an agreement of the member-owners of the company Articles of organization are filed Charter must be issued by the state Created by agreement of the partners A statement of qualification for the limited liability partnership is filed Legal Position Treated as a legal entity Treated as a legal entity Generally, treated same as a general partnership Liability Unlimited liability of all general partners Limited partners are liable only to the extent of capital contributions Member-owners’ liability is limited to the amount of capital contributions or investments Varies, but under the Uniform Partnership Act, liability of a partner for acts committed by other partners is limited Duration By agreement in certificate, or by termination of the last general partner (retirement, death, and the like) or last limited partner Unless a single-member LLC, can Remains in existence until cancelhave perpetual existence (same as a lation or revocation corporation) Transferability of Interest Interest can be assigned (same as a general partnership), but if assignee becomes a member with consent of other partners, certificate must be amended Member interests are freely transferable Interest can be assigned same as in a general partnership Management General partners have equal voice or by agreement Limited partners may not retain limited liability if they actively participate in management Member-owners can fully participate in management or can designate a group of persons to manage on behalf of the members Same as a general partnership Taxation Generally taxed as a partnership LLC is not taxed, and members are taxed personally on profits “passed through” the LLC Same as a general partnership Organizational Fees, Annual License Fees, and Annual Reports Organizational fee required; usually not others Organizational fee required Others vary with states Fees are set by each state for filing statements of qualification, statements of foreign qualification, and annual reports Transaction of Business in Other States Generally no limitations Generally no limitations, but may vary depending on state Must file a statement of foreign qualification before doing business in another state Reviewing: Corporations William Sharp was the sole shareholder and manager of Chickasaw Club, Inc., an S corporation that operated a popular nightclub of the same name in Columbus, Georgia Sharp maintained a corporate checking account but paid the club’s employees, suppliers, and entertainers in cash out of the club’s proceeds Sharp owned the property on which the club was located He rented it to the club but made Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  459 mortgage payments out of the club’s proceeds and often paid other personal expenses with Chickasaw corporate funds At 12:45 a.m on July 31, eighteen-year-old Aubrey Lynn Pursley, who was already intoxicated, entered the Chickasaw Club A city ordinance prohibited individuals under the age of twenty-one from entering nightclubs, but Chickasaw employees did not check Pursley’s identification to verify her age Pursley drank more alcohol at Chickasaw and was visibly intoxicated when she left the club at 3:00 a.m with a beer in her hand Shortly afterward, Pursley lost control of her car, struck a tree, and was killed Joseph Dancause, Pursley’s stepfather, filed a tort lawsuit in a Georgia state court against Chickasaw Club, Inc., and William Sharp, seeking damages Using the information presented in the chapter, answer the following questions Under what theory might the court in this case make an exception to the limited liability of shareholders and hold Sharp personally liable for the damages? What factors would be relevant to the court’s decision? Suppose that Chickasaw’s articles of incorporation failed to describe the corporation’s purpose or management structure as required by state law Would the court be likely to rule that Sharp is personally liable to Dancause on that basis? Why or why not? Suppose that the club extended credit to its regular patrons in an effort to maintain a loyal clientele, although neither the articles of incorporation nor the corporate bylaws authorized this practice Would the corporation likely have the power to engage in this activity? Explain How would the court classify the Chickasaw Club corporation—domestic or foreign, public or private? Why? Debate This The sole shareholder of an S corporation should not be able to avoid liability for the torts of her or his employees Terms and Concepts alien corporation 434 articles of incorporation 438 benefit corporation 436 business judgment rule 447 bylaws 438 close corporation 434 commingle 441 dividend 454 domestic corporation 434 foreign corporation 434 holding company 432 inside director 445 outside director 445 pierce the corporate veil 441 preemptive rights 454 proxy 451 public corporation 434 publicly held corporation 434 quorum 445 retained earnings 432 S corporation 436 shareholder’s derivative suit 455 stock certificate 454 stock warrant 454 ultra vires 440 voting trust 454 watered stock 456 ExamPrep Issue Spotters Northwest Brands, Inc., is a small business incorporated in Minnesota Its one class of stock is owned by twelve members of a single family Ordinarily, corporate income is taxed at the corporate and shareholder levels Is there a way for Northwest Brands to avoid this double taxation? Explain your answer (See page 436.) Wonder Corporation has an opportunity to buy stock in XL, Inc The directors decide that instead of Wonder buying the stock, the directors will buy it Yvon, a Wonder shareholder, learns of the purchase and wants to sue the directors on Wonder’s behalf Can she it? Explain (See page 455.) • Check your answers to the Issue Spotters against the answers provided in Appendix E at the end of this text Before the Test  Go to www.cengagebrain.com, enter the ISBN 9781285428949, and click on “Find” to locate this textbook’s Web site Then, click on “Access Now” under Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 460  Unit Four  The Business Environment “Study Tools,” and select Chapter 19 at the top There, you will find an Interactive Quiz that you can take to assess your mastery of the concepts in this chapter, as well as Flashcards and a Glossary of important terms Business Scenarios 19–1. Preincorporation. Cummings, Okawa, and Taft are recent college graduates who want to form a corporation to manufacture and sell digital tablets Peterson tells them he will set in motion the formation of their corporation First, Peterson makes a contract with Owens for the purchase of a piece of land for $20,000 Owens does not know of the prospective corporate formation at the time the contract is signed Second, Peterson makes a contract with Babcock to build a small plant on the property being purchased Babcock’s contract is conditional on the corporation’s formation Peterson secures all necessary subscription agreements and capitalization, and he files the articles of incorporation (See page 437.) (a) Discuss whether the newly formed corporation, Peterson, or both are liable on the contracts with Owens and Babcock (b) Discuss whether the corporation is automatically liable to Babcock on formation 19–2. Conflicts of Interest.  Oxy Corp is negotiating with Wick Construction Co for the renovation of Oxy’s corporate headquarters Wick, the owner of Wick Construction Co., is also one of the five members of Oxy’s board of directors The contract terms are standard for this type of contract Wick has previously informed two of the other directors of his interest in the construction company Oxy’s board approves the contract by a three-to-two vote, with Wick voting with the majority Discuss whether this contract is binding on the corporation (See page 449.) 19–3. Liability of Directors. AstroStar, Inc., has approximately five hundred shareholders Its board of directors consists of three members—Eckhart, Dolan, and Macero At a regular board meeting, the board selects Galiard as president of the corporation by a two-to-one vote, with Eckhart dissenting The minutes of the meeting not register Eckhart’s dissenting vote Later, an audit reveals that Galiard is a former convict and has embezzled $500,000 from the corporation that is not covered by insurance Can the corporation hold directors Eckhart, Dolan, and Macero personally liable? Discuss (See page 450.) Business Case Problems 19–4. Spotlight on Smart Inventions—Piercing the Corporate Veil.  Thomas Persson and Jon Nokes founded Smart Inventions, Inc., to market household consumer products The success of their first product, the Smart Mop, continued with later products, which were sold through infomercials and other means Persson and Nokes were the firm’s officers and equal shareholders Persson was responsible for product development, and Nokes was in charge of day-to-day operations By 1998, they had become dissatisfied with each other’s efforts Nokes represented the firm as financially “dying,” “in a grim state, worse than ever,” and offered to buy all of Persson’s shares for $1.6 million Persson accepted On the day that they signed the agreement to transfer the shares, Smart Inventions began marketing a new product—the Tap Light It was an instant success, generating millions of dollars in revenues In negotiating with Persson, Nokes had intentionally kept the Tap Light a secret Persson sued Smart Inventions, asserting fraud and other claims Under what principle might Smart Inventions be liable for Nokes’s fraud? Is Smart Inventions liable in this case? Explain [Persson v Smart Inventions, Inc., 125 Cal.App.4th 1141, 23 Cal Rptr.3d 335 (2 Dist 2005)] (See page 441.) 19–5. Close Corporations.  Mark Burnett and Kamran Pourgol were the only shareholders in a corporation that built and sold a house When the buyers discovered that the house exceeded the amount of square footage allowed by the building permit, Pourgol agreed to renovate the house to conform to the permit No work was done, however, and Burnett filed a suit against Pourgol Burnett claimed that, without his knowledge, Pourgol had submitted incorrect plans to obtain the building permit, misrepresented the extent of the renovation, and failed to fix the house Was Pourgol guilty of misconduct? If so, how might it have been avoided? Discuss [Burnett v Pourgol, 83 A.D.3d 756, 921 N.Y.S.2d 280 (2 Dept 2011)] (See page 441.) 19–6.  Business Case Problem with Sample Answer:  Rights of Shareholders Stanka Woods is the sole member of Hair Ventures, LLC Hair Ventures owns million shares of stock in Biolustré Inc For several years, Woods and other Biolustré shareholders did not receive notice of shareholders’ meetings or financial reports On learning that Biolustré planned to issue more stock, Woods, through Hair Ventures, demanded to see Biolustré’s books and records Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 19  Corporations  Biolustré asserted that the request was not for a proper purpose Does Woods have a right to inspect Biolustré’s books and records? If so, what are the limits? Do any of those limits apply in this case? Explain [Biolustré Inc v Hair Ventures, LLC, 2011 WL 540054 (Tex.App.—San Antonio 2011)] (See page 454.) •  For a sample answer to Problem 19–6, go to Appendix F at the end of this text 19–7. Piercing the Corporate Veil.  In 1997, Leon Greenblatt, Andrew Jahelka, and Richard Nichols incorporated Loop Corp with only $1,000 of capital Three years later, Banco Panamericano, Inc., which was run entirely by Greenblatt and owned by a Greenblatt family trust, extended a large line of credit to Loop Loop’s subsidiaries then participated in the credit, giving $3 million to Loop while acquiring a security interest in Loop itself Loop then opened an account with Wachovia Securities, LLC, to buy stock shares using credit provided by Wachovia When the stock values plummeted, Loop owed Wachovia $1.89 million Loop also defaulted on its loan from Banco, but Banco agreed to lend Loop millions of dollars more Rather than repay Wachovia with the influx of funds, Loop gave the funds to closely related entities and “compensated” Nichols and Jahelka without issuing any W-2 forms (forms reporting compensation to the Internal Revenue Service) The evidence also showed that Loop made loans to other related entities and shared office space, equipment, and telephone and fax numbers with related entities Loop also moved employees among related entities, failed to file its tax returns on time (or sometimes at all), and failed to follow its own bylaws In a lawsuit brought by Wachovia, can the court hold Greenblatt, Jahelka, and Nichols personally liable by piercing the corporate veil? Why or why not? [Wachovia Securities, LLC v Banco Panamericano, Inc., 674 F.3d 743 (9th Cir 2012)] (See page 441.) 19–8.  Duty of Loyalty.  Kids International Corp produced children’s wear for Wal-mart and other retailers Gila Dweck was a Kids director and its chief executive officer Because she felt that she was not paid enough for the company’s success, she started Success Apparel to compete with Kids Success operated out of Kids’ premises, used its employees, borrowed on its credit, took advantage of its business opportunities, and capitalized on its customer relationships As an “administrative fee,” Dweck paid Kids percent of Success’s total 461 sales Did Dweck breach any fiduciary duties? Explain [Dweck v Nasser, 2012 WL 3194069 (Del.Ch 2012)] (See page 448.) 19–9.  A Question of Ethics:  Improper Incorporation Mike Lyons incorporated Lyons Concrete, Inc., in Montana, but did not file its first annual report, so the state involuntarily dissolved the firm in 1996 Unaware of the dissolution, Lyons continued to business as Lyons Concrete In 2003, he signed a written contract with William Weimar to form and pour a certain amount of concrete on Weimar’s property in Lake County for $19,810 Weimar was in a rush to complete the entire project, and he and Lyons orally agreed to additional work on a time-andmaterials basis When scheduling conflicts arose, Weimar had his own employees set some of the forms, which proved deficient Weimar also directed Lyons to pour concrete in the rain, which undercut its quality In mid-project, Lyons submitted an invoice for $14,389, which Weimar paid After the work was complete, Lyons sent Weimar an invoice for $25,731, but he refused to pay, claiming that the $14,389 covered everything To recover the unpaid amount, Lyons filed a mechanic’s lien as “Mike Lyons d/b/a Lyons Concrete, Inc.” against Weimar’s property Weimar filed a suit in a Montana state court to strike the lien, and Lyons filed a counterclaim to reassert it [Weimar v Lyons, 338 Mont 242, 164 P.3d 922 (2007)] (See page 439.) (a) Before the trial, Weimar asked for a change of venue on the ground that a sign on the courthouse lawn advertised “Lyons Concrete.” How might the sign affect a trial on the parties’ dispute? Should the court grant this request? Why or why not? (b) Weimar asked the court to dismiss the counterclaim on the ground that the state had dissolved Lyons Concrete in 1996 Lyons immediately filed new articles of incorporation for “Lyons Concrete, Inc.” Under what doctrine might the court rule that Weimar could not deny the existence of Lyons Concrete? What ethical values underlie this doctrine? Should the court make this ruling? Explain (c) At the trial, Weimar argued, in part, that there was no “fixed price” contract between the parties and that even if there were, the poor quality of the work, which required repairs, amounted to a breach, excusing Weimar’s further performance Should the court rule in Weimar’s favor on this basis? Why or why not? Legal Reasoning Group Activity 19–10.  Shareholders’ Duties.  Milena Weintraub and Larry Griffith were shareholders in Grand Casino, Inc., which operated a casino in South Dakota Griffith owned 51 percent of the stock and Weintraub 49 percent Weintraub managed the casino, which Griffith typically visited once a week At the end of 2012, an accounting audit showed that the cash on hand was less than the amount posted in the casino’s books Later, more Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 462  Unit Four  The Business Environment shortfalls were discovered In October 2014, Griffith did a complete audit Weintraub was unable to account for $200,500 in missing cash Griffith then kept all of the casino’s most recent profits, including Weintraub’s $90,447.20 share, and, without telling Weintraub, sold the casino for $400,000 and kept all of the proceeds Weintraub filed a suit against Griffith, asserting a breach of fiduciary duty Griffith countered with evidence of Weintraub’s misappropriation of corporate cash (See page 456.) (a) The first group will discuss the duties that these parties owed to each other, and determine whether Weintraub or Griffith, or both, breached those duties (b) The second group will decide how this dispute should be resolved and who should pay what to whom to reconcile the finances (c) A third group will discuss whether Weintraub or Griffin violated any ethical duties to each other or to the corporation Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 42  Securities Law and Corporate Governance  Unit Four  Focus on Ethics 463 Ethics and the Business Environment Every now and then, scandals in the business world rock the nation Certainly, this was true in the first decade of the 2000s when the activities of Enron Corporation, WorldCom, and a number of other companies came to light Congress responded to public outcry by passing the Sarbanes-Oxley Act, which was mentioned in Chapter 19 That act imposed stricter requirements on corporations with respect to accounting practices and statements made in documents filed with the Securities and Exchange Commission (SEC) The lesson for the business world is, of course, that if business leaders not behave ethically (and legally), the government will create new laws and regulations that force them to so We offered suggestions on how business decision makers can create an ethical workplace in Chapter Here, we look at selected areas in which the relationships within specific business organizational forms may raise ethical issues The Emergence of Corporate Governance The well-publicized corporate abuses of the last decade provided the impetus for businesspersons to create their own internal rules for corporate governance (which will be discussed in Chapter 28) Examples of these abuses make it clear why such rules are needed In a few situations, officers have blatantly stolen from the corporation and its shareholders More frequently, though, officers have received excessive benefits, or “perks,” because of their position To illustrate: Tyco International bought a $6,000 shower curtain and a $15,000 umbrella stand for its chief executive officer’s apartment Corporate officers may be given numerous benefits, which they may or may not deserve On several occasions, a leading corporate officer has received compensation of $50 million or more in a year when the company’s share price actually declined Even if corporate officers are scrupulously honest and have modest personal tastes, their behavior may still raise concerns: they may not be good managers, and they may make incompetent corporate decisions They may be a little lazy and fail to the hard work necessary to investigate the corporation’s alternatives Sometimes, officers may simply fail to appreciate the concerns of shareholders on certain matters, such as maximizing short-term versus long-term results Corporate governance controls are meant to ensure that officers receive only the benefits they earn Governance monitors the actions taken by officers to make sure they are wise and in the best interests of the company In this way, the corporation can be confident that it is acting ethically toward its shareholders Fiduciary Duties Revisited The law of agency, which will be outlined in Chapter 20, permeates nearly all relationships within any partnership or corporation An important duty that arises in the law of agency, and applies to all partners and corporate directors, officers, and management personnel, is the duty of loyalty As caretakers of the shareholders’ wealth, corporate directors and officers also have a fiduciary duty to exercise care when making decisions affecting the corporate enterprise The Duty of Loyalty  Every individual has personal interests, which may at times conflict with the interests of the partnership or corporation with which he or she is affiliated In particular, partners or corporate officers and directors may face a conflict between personal interests and the interests of the business entity Acquiring Assets.  Corporate officers and directors may find themselves in a position to acquire assets that would also benefit the corporation if acquired in the corporation’s name If an officer does purchase the asset without offering the opportunity to the corporation, however, she or he may be liable for usurping a corporate opportunity.1 Disclosure.  Most courts also hold that a corporate officer or director has a fiduciary duty to disclose improper conduct to the corporation For example, a leading case on the issue involved Thomas Coughlin, a top executive in theft prevention at Wal-Mart He had held several other high-level positions prior to becoming a member of the board of directors When he retired, Coughlin signed an agreement and release of claims with Wal-Mart under which he was to receive millions of dollars in benefits over the years Then Wal-Mart discovered that Coughlin, before his retirement, had abused his position of authority He had conspired with subordinates to misappropriate hundreds of thousands of dollars in property and cash through various fraudulent schemes Wal-Mart sued Coughlin alleging that he had breached his fiduciary duty of loyalty by failing to disclose his misconduct before entering a self-dealing contract Ultimately, the Supreme Court of Arkansas agreed and held that the director’s fiduciary duty obligated him to divulge material facts of past fraud to the corporation before entering the contract The court stated, “We are persuaded, in addition, that the majority view is correct, which is that the failure of a fiduciary to disclose material facts of his fraudulent conduct to his corporation prior to entering into a self-dealing contract with that corporation will void that contract.”2 The Duty of Care  In addition to the duty of loyalty, every corporate director or officer owes a duty of care Due care means For a landmark case on this issue, see Guth v Loft, Inc., A.2d 503 (Del 1939), presented as Case 19.3 in Chapter 19 Wal-Mart Stores, Inc v Coughlin, 369 Ark 365, 255 S.W.3d 424 (2007) See also Blankenship v USA Truck, Inc., 601 F.3d 852 (8th Cir 2010), interpreting Arkansas law by applying the Wal-Mart case; and Mazak Corp v King, 2012 WL 3590817 (6th Cir 2012), in which a federal court recognized that the Wal-Mart case stated the rule in the majority of states Focus on Ethics CONTINUES  • 463 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Unit Four  Focus on Ethics Ethics and the Business Environment, Continued that officers and directors must keep themselves informed and make businesslike judgments Officers have a duty to disclose material information that shareholders need for competent decision making Some courts have even suggested that corporate directors have a duty to detect and “ferret out” wrongdoing within the corporation.3 In fact, a number of courts applying Delaware law have recognized that directors may be held liable for failing to exercise proper oversight.4 For example, one Delaware court held that shareholders of Citigroup, Inc., could sue the directors and officers for failure to exercise due care to adequately protect the corporation from exposure to the subprime lending market.5 Corporate law also creates other structures to protect shareholder interests, such as the right to inspect books and records Although traditionally the duty of care did not require directors to monitor the behavior of corporate employees to detect and prevent wrongdoing, the tide may be changing The corporate sentencing guidelines give courts the power to impose substantial penalties on corporations and corporate directors for criminal wrongdoing Moreover, since the Sarbanes-Oxley Act required the sentencing commission to revise these guidelines, the penalties for white-collar crimes, such as federal mail and wire fraud, have increased dramatically The guidelines allow these penalties to be mitigated, though, if a company can show that it has an effective compliance program in place to detect and prevent wrongdoing by corporate personnel Legal Reasoning Three decades ago, corporations and corporate directors were rarely prosecuted for crimes, and penalties for corporate crimes were relatively light Today, this is no longer true Under the corporate sentencing guidelines, corporate wrongdoers can receive substantial penalties Do these developments mean that corporations are committing more crimes today than in the past? Will stricter laws be effective in curbing corporate criminal activity? How can a company avoid liability for crimes committed by its employees? Fiduciary Duties to Creditors  It is a long-standing principle that corporate directors ordinarily owe fiduciary duties only to a corporation’s shareholders Directors who have favored the interests of other corporate “stakeholders,” such as creditors, over those of the shareholders have been held liable for breaching these duties In re China Agritech, Inc Shareholder Derivative Litigation, 2013 WL 2181514 (Del.Ch 2013); and In re Caremark International, Inc Derivative Litigation, 698 A.2d 959 (Del.Ch 1996) See, for example, McCall v Scott, 239 F.3d 808 (6th Cir 2001); Guttman v Huang, 823 A.2d 492 (Del.Ch 2003); Landy v D’Alessandro, 316 F.Supp.2d 49 (D.Mass 2004); and Miller v U.S Foodservice, Inc., 361 F.Supp.2d 470 (D.Md 2005) In re Citigroup, Inc Shareholder Derivative Litigation, 964 A.2d 106 (Del.Ch 2009) The picture changes, however, when a corporation approaches insolvency At this point, the shareholders’ equity interests in the corporation may be worthless, while the interests of creditors become paramount In this situation, the fiduciary duties of loyalty and care extend to the corporation’s creditors as well as to the shareholders? The answer to this question, according to some courts, is yes In one case, a Delaware court held that when a corporation is on the brink of insolvency, the directors assume a fiduciary duty to other stakeholders that sustain the corporate entity, including creditors.6 When a corporation is insolvent, courts may require directors to consider the best interests of the whole corporate enterprise, including all its constituent groups, and not to give preference to the interests of any one group.7 Legal Reasoning Do you agree that when a corporation is approaching insolvency, the directors’ fiduciary obligations should extend to the corporation’s creditors as well as to the shareholders? Why or why not? Franchise Relationships Franchise relationships can create significant ethical issues One issue has to with the franchisor’s quality control over the franchisee’s activities On the one hand, if the franchisor ignores the problem of quality control, the reputation of the franchisor’s business may suffer On the other hand, if a franchisor’s control over the operations of the franchisee is too extensive, the franchisor may be liable for the torts of the franchisee’s employees under agency theory (see Chapter 20) Even when an independent business entity purchases a franchise and the franchise agreement specifies that no agency relationship exists, the courts may find otherwise Legal Reasoning As explained, if a franchisor exercises “too much control” over a franchisee’s business operations, a court may deem the franchisor to be liable as an employer for the torts committed by the franchisee’s employees How can holding franchisors liable in such circumstances be squared with the doctrine of freedom of contract (see page 388)? Credit Lyonnais Bank Nederland N.V v Pathe Communications Corp., 1991 WL 277613 (Del.Ch 1991) See also Production Resources Group, LLC v NCT Group, Inc., 863 A.2d 772 (Del.Ch 2004); and In re USDigital, Inc., 443 Bankr 22 (D.Del 2011) See Berg & Berg Enterprises, LLC v Boyle, 178 Cal.App.4th 1020, 100 Cal.Rptr.3d 875 (2009); In re Moeller, 466 Bankr 525 (S.D.Cal 2012); and Scouler & Co., LLC v Schwartz, 2012 WL 1502762 (N.D.Cal 2012) 464 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Unit Five The Employment Environment Contents 20 Agency 21  Employment Relationships 22  Employment Discrimination 23  Immigration and Labor Law Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 20 Agency O ne of the most common, important, and pervasive legal relationships is that of agency In an agency relationship involving two parties, one of the parties, called the agent, agrees to represent or act for the other, called the principal The principal has the right to control the agent’s conduct in matters entrusted to the agent By using agents, a principal can conduct multiple business operations simultaneously in various locations Thus, for example, contracts that bind the principal can be made at different places with different persons at the same time A familiar example of an agent is a corporate officer who serves in a representative capacity for the owners of the corporation In this capacity, the officer has the authority to bind the principal (the corporation) to a contract In fact, agency law is essential to the existence and operation of a corporate entity because only through its agents SECTION Agency Relationships Section 1(1) of the Restatement (Third) of Agency1 defines agency as “the fiduciary relation [that] results from the manifestation of consent by one person to another that the other shall act in his [or her] behalf and subject to his [or her] control, and consent by the other so to act.” In other words, in a principal-agent relationship, the parties have agreed that the agent will act on behalf and instead of the principal in negotiating and transacting business with third parties The term fiduciary is at the heart of agency law This term can be used both as a noun and as an adjective When used as a noun, it refers to a person having a duty created by his or her undertaking to act primarily for another’s benefit in matters connected with the undertaking When used as an adjective, as in the phrase fiduciary relationship, it means that the relationship involves trust and confidence Agency relationships commonly exist between employers and employees Agency relationships may The Restatement (Third) of Agency is an authoritative summary of the law of agency and is often referred to by judges in their decisions and opinions can a corporation function and enter into contracts Most employees are also considered to be agents of their employers Thus, some of the concepts of employment law that you will learn about in Chapters 21 and 22 are based on agency law Indeed, agency relationships permeate the business world For that reason, an understanding of the law of agency is crucial to understanding business law sometimes also exist between employers and independent contractors who are hired to perform special tasks or services Employer-Employee Relationships Normally, all employees who deal with third parties are deemed to be agents A salesperson in a department store, for instance, is an agent of the store’s owner (the principal) and acts on the owner’s behalf Any sale of goods made by the salesperson to a customer is binding on the principal Similarly, most representations of fact made by the salesperson with respect to the goods sold are binding on the principal Because employees who deal with third parties generally are deemed to be agents of their employers, agency law and employment law overlap considerably Agency relationships, though, as will become apparent, can exist outside an employer-employee relationship, and thus agency law has a broader reach than employment law does Employment laws (state and federal) apply only to the employer-employee relationship Thus, statutes that govern Social Security, withholding taxes, workers’ compensation, unemployment compensation, and workplace safety apply only when an employer- 466 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 20  Agency  employee relationship exists (see Chapter 21) Similarly, laws that prohibit employment discrimination (see Chapter 22) apply only to employers and employees These laws not apply to an ­independent contractor Employer–Independent Contractor Relationships Independent contractors are not employees because, by definition, those who hire them have no control over the details of their work performance Section of the Restatement (Third) of Agency defines an independent contractor as follows: [An independent contractor is] a person who contracts with another to something for him [or her] but who is not controlled by the other nor subject to the other’s right to control with respect to his [or her] physical conduct in the performance of the undertaking He [or she] may or may not be an agent Building contractors and subcontractors are independent contractors A property owner who hires a contractor and subcontractors to complete a project does not control the details of the way they perform their work Truck drivers who own their vehicles and hire out on a per-job basis are independent contractors, but truck drivers who drive company trucks on a regular basis usually are employees The relationship between a principal and an independent contractor may or may not involve an agency relationship To illustrate: A homeowner who hires a real estate broker to sell her house has not only contracted with an independent contractor (the broker) but also established an agency relationship for the specific purpose of selling the property Another example is an insurance agent, who is both an independent contractor and an agent of the insurance company for which he sells policies (Note that an insurance broker, in contrast, normally is an agent of the person obtaining insurance and not of the insurance company.) Determination of Employee Status The courts are frequently asked to determine whether a particular worker is an employee or an independent contractor How a court decides this issue can have a significant effect on the rights and liabilities of the parties For instance, employers are required to pay certain taxes, such as Social Security and unemployment taxes, for employees but not for independent contractors 467 Criteria Used by the Courts  In deciding whether a worker is categorized as an employee or an independent contractor, courts often consider the following questions: How much control does the employer exercise over the details of the work? If the employer exercises considerable control over the details of the work and the day-to-day activities of the worker, this indicates employee status This is perhaps the most important factor weighed by the courts in determining employee status Is the worker engaged in an occupation or business distinct from that of the employer? If so, this points to independent-contractor, not employee, status Is the work usually done under the employer’s direction or by a specialist without supervision? If the work is usually done under the employer’s direction, this indicates employee status Does the employer supply the tools at the place of work? If so, this indicates employee status For how long is the person employed? If the person is employed for a long period of time, this indicates employee status What is the method of payment—by time period or at the completion of the job? Payment by time period, such as once every two weeks or once a month, indicates employee status What degree of skill is required of the worker? If a great degree of skill is required, this may indicate that the person is an independent contractor hired for a specialized job and not an employee Disputes Involving Employment Law.  Sometimes, workers may benefit from having employee status—for tax purposes and to be protected under certain employment laws, for example As mentioned earlier, federal statutes governing employment discrimination apply only when an employer-employee relationship exists Protection under employment-discrimination statutes provides a significant incentive for workers to claim that they are employees rather than independent contractors ▶  Case in Point 20.1  A Puerto Rican television station, WIPR, contracted with Victoria Alberty-Vélez to cohost a television show Alberty signed a new contract for each episode and was committed to work for WIPR only during the filming of the episodes WIPR paid her a lump sum for each contract and did not withhold any taxes When Alberty became pregnant, WIPR stopped contracting with her She filed a lawsuit claiming Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 468  Unit Five  The Employment Environment that WIPR was discriminating against her in violation of federal antidiscrimination laws, but the court found in favor of WIPR Because the parties had used repeated fixed-length contracts and had described Alberty as an independent contractor on tax documents, she could not maintain an employment-­ discrimination suit.2  ◀ Disputes Involving Tort Liability.  Whether a worker is an employee or an independent contractor can also affect the employer’s liability for the worker’s actions ▶  Case in Point 20.2  El Palmar Taxi, Inc., requires its drivers to supply their own cabs, which must display El Palmar’s logo The drivers pay gas, maintenance, and insurance costs, and a fee to El Palmar They are expected to comply with the law, including licensing regulations, but they can work when they want for as long as they want Mario Julaju drove a taxi under a contract with El Palmar that described him as an independent contractor El Palmar sent Julaju to pick up Maria Lopez and her children During the ride, Julaju’s cab collided with a truck To recover for their injuries, the Lopezes sued El Palmar The employer argued that it was not liable because Julaju was an independent contractor The court held in favor of El Palmar An employer normally is not responsible for the actions of an independent contractor with whom the employer contracts Here, the employment contract had clearly specified that Julaju was an independent contractor, and there were no facts indicating that he was an employee (or that the employer controlled his activities).3  ◀ In the following case, the court had to determine the status of an auto service company and its tow truck driver who assaulted the passenger of a vehicle the company had been hired to tow Alberty-Vélez v Corporación de Puerto Rico para la Difusión Pública, 361 F.3d (1st Cir 2004) Lopez v El Palmar Taxi, Inc., 297 Ga.App 121, 676 S.E.2d 460 (2009) Case 20.1 Coker v Pershad Superior Court of New Jersey, Appellate Division, 2013 WL 1296271 (2013) background and facts  AAA North Jersey, Inc., contracted with Five Star Auto Service to perform towing and auto repair services for AAA Terence Pershad, the driver of a tow truck for Five Star, responded to a call to AAA for assistance by the driver of a car involved in an accident in Hoboken, New Jersey Pershad got into a fight with Nicholas Coker, a passenger in the car, and assaulted Coker with a knife Coker filed a suit in a New Jersey state court against Pershad, Five Star, and AAA The court determined that Pershad was Five Star’s employee and that Five Star was an independent contractor, not AAA’s employee Thus, AAA was “not responsible for the alleged negligence of its independent contractor, defendant Five Star, in hiring Mr Pershad.” Five Star entered into a settlement with Coker Coker appealed the ruling in AAA’s favor In the language of the court PER CURIAM * * * * The important difference between an employee and an independent contractor is that one who hires an independent contractor has no right of control over the manner in which the work is to be done [Emphasis added.] * * * * * * * Plaintiff [Coker] argues AAA controlled the means and method of the work performed by Five Star * * * Factors * * * [that] determine whether a principal maintains the right of control over an individual or a corporation claimed to be an independent contractor [include]: (a) the extent of control which, by the agreement, the master may exercise over the details of the work; (b) whether or not the one employed is engaged in a distinct occupation or business; (c) the kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the employer or by a specialist without supervision; Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 20  Agency  CASE 20.1 CONTINUEd 469 (d) the skill required in the particular occupation; (e) whether the employer or the workman supplies the * * * tools * * * ; (f) the length of time for which the person is employed * * *  Applying these factors to the facts of this case, it is clear AAA did not control the manner and means of Five Star’s work The Agreement specifically stated Five Star was an independent contractor Five Star purchased its own trucks and any other necessary equipment AAA assigned jobs to Five Star and Five Star completed the work without any further supervision by AAA Five Star chose the employees to send on towing calls and the trucks and equipment the employees would use Five Star was also in business for itself and performed auto repair services for principals and customers other than AAA Five Star hired and fired its own employees * * *  * * * * Plaintiff also argues Five Star should be considered to be controlled by AAA because “providing towing and other roadside assistance is arguably the focus of the regular business of AAA.” * * * [But] AAA is an automobile club that provides a wide variety of services to its members It contracts with numerous service providers, such as gas stations, motels and other businesses, to provide these services Thus, AAA is not solely in the towing business * * * AAA had used Five Star to provide towing services for approximately eight years and there is nothing in the record to demonstrate it lacked the skill needed to provide these services decision and remedy  A state intermediate appellate court affirmed the lower court’s ruling AAA could not be held liable for the actions of Five Star, its independent contractor, because “AAA did not control the manner and means of Five Star’s work.” THE legal environment DIMENSION  Five Star’s contract with AAA required Five Star to be available to provide service for AAA members Does this support Coker’s argument that Five Star was AAA’s employee? Why or why not? Managerial implications  When an employment contract clearly designates one party as an independent contractor, the relationship between the parties is presumed to be that of employer and independent contractor But this is only a presumption Evidence can be introduced to show that the employer exercised sufficient control to establish the other party as an employee The Internal Revenue Service is increasingly pursuing employers that it claims have wrongly classified employees as independent contractors Thus, from a tax perspective, business managers need to ensure that all independent contractors fully control their own work Criteria Used by the IRS  The Internal Revenue Service (IRS) has established its own criteria for determining whether a worker is an independent contractor or an employee The most important factor is the degree of control the business exercises over the worker The IRS tends to closely scrutinize a firm’s classification of its workers because, as mentioned, employers can avoid certain tax liabilities by hiring independent contractors instead of employees Even when a firm has classified a worker as an independent contractor, the IRS may decide that the worker is actually an employee If the IRS decides that an employee is misclassified, the employer will be responsible for paying any applicable Social Security, withholding, and unemployment taxes Microsoft Corporation, for instance, was once ordered to pay back payroll taxes for hundreds of temporary workers who had contractually agreed to work for Microsoft as independent contractors.4 Employee Status and “Works for Hire”  Under the Copyright Act, any copyrighted work created by an employee within the scope of her or his employment at the request of the employer is a “work for hire.” The employer owns the copyright to the work In contrast, when an employer hires an independent contractor—a freelance artist, writer, or computer programmer, for example—the independent contractor normally owns the copyright An exception is made if the parties agree in writing that the work is a “work Vizcaino v U.S District Court for the Western District of Washington,173 F.3d 713 (9th Cir 1999) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 470  Unit Five  The Employment Environment for hire” and the work falls into one of nine specific categories, including audiovisual and other works ▶  Case in Point 20.3  Artisan House, Inc., hired a professional photographer, Steven H Lindner, owner of SHL Imaging, Inc., to take pictures of its products for the creation of color slides to be used by Artisan’s sales force Lindner controlled his own work and carefully chose the lighting and angles used in the photographs When Artisan published the photographs in a catalogue and brochures without Lindner’s permission, SHL filed a lawsuit for copyright infringement Artisan claimed that its publication of the photographs was authorized because they were works for hire The court, however, decided that SHL was an independent contractor and owned the copyright to the photographs Because SHL had not given Artisan permission (a license) to reproduce the photographs in other publications, Artisan was liable for copyright infringement.5  ◀ SECTION Formation of the Agency Relationship Agency relationships normally are consensual—that is, they come about by voluntary consent and agreement between the parties Generally, the agreement need not be in writing,6 and consideration is not required A person must have contractual capacity to be a principal.7 Those who cannot legally enter into contracts directly should not be allowed to so indirectly through an agent Any person can be an agent, however, regardless of whether he or she has the capacity to contract (including minors) An agency relationship can be created for any legal purpose An agency relationship created for a purpose that is illegal or contrary to public policy is unenforceable ▶  Example 20.4  Archer (as principal) contracts with Burke (as agent) to sell illegal narcotics The agency relationship is unenforceable because selling illegal narcotics is a felony and is contrary to public SHL Imaging, Inc v Artisan House, Inc., 117 F.Supp.2d 301 (S.D.N.Y 2000) There are two main exceptions to the statement that agency agreements need not be in writing: (1) Under the equal dignity rule (discussed later in this chapter), an agreement must be in writing if it empowers the agent to enter into a contract that the Statute of Frauds requires to be in writing (2) An agreement that gives an agent power of attorney must also be in writing Note that some states allow a minor to be a principal When a minor is permitted to be a principal, any resulting contracts will be voidable by the minor principal but not by the adult third party policy If Burke sells the narcotics and keeps the profits, Archer cannot sue to enforce the agency agreement.  ◀ An agency relationship can arise in four ways: by agreement of the parties, by ratification, by estoppel, and by operation of law Agency by Agreement Most agency relationships are based on an express or implied agreement that the agent will act for the principal and that the principal agrees to have the agent so act An agency agreement can take the form of an express written contract or be created by an oral agreement ▶  Example 20.5  Rees asks Grace, a gardener, to contract with others for the care of his lawn on a regular basis If Grace agrees, an agency relationship exists between Reese and Grace for the lawn care.  ◀ An agency agreement can also be implied by conduct ▶  Case in Point 20.6  Gilbert Bishop was admitted to Laurel Creek Health Care Center suffering from various physical ailments During an examination, Bishop told Laurel Creek staff that he could not use his hands well enough to write or hold a pencil, but he was otherwise found to be mentally competent Bishop’s sister, Rachel Combs, offered to sign the admissions forms, but it was Laurel Creek’s policy to have the patient’s spouse sign the admissions papers if the patient was unable to so Therefore, Gilbert asked Combs to get his wife, Anna, so that she could sign his admissions papers Combs then brought Anna to the hospital, and Anna signed the admissions paperwork, which contained a provision for mandatory arbitration Later, the Bishops sued the hospital for negligence, and Laurel Creek sought to compel arbitration The Bishops argued that Anna was not Bishop’s agent and had no legal authority to make decisions for him, but the court concluded that an agency relationship between Bishop and his wife, Anna, had been formed by conduct.8 ◀ Agency by Ratification On occasion, a person who is in fact not an agent (or who is an agent acting outside the scope of her or his authority) may make a contract on behalf of another (a principal) If the principal approves or affirms that contract by word or by action, an agency relationship Laurel Creek Health Care Center v Bishop, 2010 WL 985299 (Ky.App 2010) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 20  Agency  is created by ratification Ratification involves a question of intent, and intent can be expressed by either words or conduct The basic requirements for ratification will be discussed later in this chapter Agency by Estoppel Sometimes, a principal causes a third person to believe that another person is the principal’s agent, and the third person acts to his or her detriment in reasonable reliance on that belief When this occurs, the principal is “estopped to deny” (prevented from denying) the agency relationship An agency by estoppel arises when the principal’s actions have created the appearance of an agency that does not in fact exist The third person must prove that he or she reasonably believed that an agency relationship existed, however Facts and circumstances must show that an ordinary, prudent person familiar with business practice and custom would have been justified in concluding that the agent had authority ▶  Case in Point 20.7  Francis Azur was president and chief executive officer of ATM Corporation of America Michelle Vanek, Azur’s personal assistant at ATM, reviewed his credit-card statements, among other duties For seven years, Vanek took unauthorized cash advances from Azur’s credit-card account with Chase Bank The charges appeared on at least sixty-five monthly statements When Azur discovered Vanek’s fraud, he fired her and closed the account He filed a suit against Chase, arguing that the bank should not have allowed Vanek to take cash advances 471 The court concluded that Azur (the principal) had given the bank reason to believe that Vanek (the agent) had authority Therefore, Azur was estopped (prevented) from denying Vanek’s authority.9  ◀ Note that the acts or declarations of a purported agent in and of themselves not create an agency by estoppel Rather, it is the deeds or statements of the principal that create an agency by estoppel Agency by Operation of Law The courts may find an agency relationship in the absence of a formal agreement in other situations as well This may occur in family relationships, such as when one spouse purchases certain basic necessaries and charges them to the other spouse’s account The courts often rule that a spouse is liable for payment for the necessaries because of either a social policy or a legal duty to supply necessaries to family members Agency by operation of law may also occur in emergency situations If an agent cannot contact the principal and failure to act would cause the principal substantial loss, the agent may take steps beyond the scope of her or his authority For example, a railroad engineer may contract on behalf of his or her employer for medical care for an injured motorist hit by the train Concept Summary 20.1 below reviews the various ways that agencies are formed Azur v Chase Bank, USA, N.A., 601 F.3d 212 (3d Cir 2010) Concept Summary Summary20.1 8.1 Concept Formation of the Agency Relationship Method of Formation Description By Agreement The agency relationship is formed through express consent (oral or written) or implied by conduct By Ratification The principal either by act or by agreement ratifies the conduct of a person who is not in fact an agent By Estoppel The principal causes a third person to believe that another person is the principal’s agent, and the third person acts to his or her detriment in reasonable reliance on that belief By Operation of Law The agency relationship is based on a social or legal duty (such as the need to support family members) or formed in emergency situations when the agent is unable to contact the principal and failure to act outside the scope of the agent’s authority would cause the principal substantial loss Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 472  Unit Five  The Employment Environment SECTION Duties of Agents and Principals Once the principal-agent relationship has been created, both parties have duties that govern their conduct As discussed previously, the principal-agent relationship is fiduciary—based on trust In a fiduciary relationship, each party owes the other the duty to act with the utmost good faith In this section, we examine the various duties of agents and principals Agent’s Duties to the Principal Generally, the agent owes the principal five duties— performance, notification, loyalty, obedience, and accounting Performance  An implied condition in every agency contract is the agent’s agreement to use reasonable diligence and skill in performing the work When an agent fails to perform his or her duties, liability for breach of contract may result Standard of Care.  The degree of skill or care required of an agent is usually that expected of a reasonable person under similar circumstances Generally, this is interpreted to mean ordinary care If an agent has represented herself or himself as possessing special skills, however, the agent is expected to exercise the degree of skill claimed Failure to so constitutes a breach of the agent’s duty Gratuitous Agents.  Not all agency relationships are based on contract In some situations, an agent acts gratuitously—that is, without payment A gratuitous agent cannot be liable for breach of contract because there is no contract He or she is subject only to tort liability Once a gratuitous agent has begun to act in an agency capacity, he or she has the duty to continue to perform in that capacity A gratuitous agent must perform in an acceptable manner and is subject to the same standards of care and duty to perform as other agents ▶  Example 20.8  Bower’s friend Alcott is a real estate broker Alcott offers to sell Bower’s vacation home at no charge If Alcott never attempts to sell the home, Bower has no legal cause of action to force her to so If Alcott does attempt to sell the home to Friedman, but then performs so negligently that the sale falls through, Bower can sue Alcott for negligence.  ◀ Notification  An agent is required to notify the principal of all matters that come to her or his attention concerning the subject matter of the agency This is the duty of notification, or the duty to inform ▶  Example 20.9  Perez, an artist, is about to negotiate a contract to sell a series of paintings to Barber’s Art Gallery for $25,000 Perez’s agent learns that Barber is insolvent and will be unable to pay for the paintings The agent has a duty to inform Perez of Barber’s insolvency because it is relevant to the subject matter of the agency, which is the sale of Perez’s paintings.  ◀ Generally, the law assumes that the principal is aware of any information acquired by the agent that is relevant to the agency—regardless of whether the agent actually passes on this information to the principal It is a basic tenet of agency law that notice to the agent is notice to the principal Loyalty  Loyalty is one of the most fundamental duties in a fiduciary relationship Basically, the agent has the duty to act solely for the benefit of his or her principal and not in the interest of the agent or a third party For instance, an agent cannot represent two principals in the same transaction unless both know of the dual capacity and consent to it The duty of loyalty also means that any information or knowledge acquired through the agency relationship is confidential It is a breach of loyalty to disclose such information either during the agency relationship or after its termination Typical examples of confidential information are trade secrets and customer lists compiled by the principal The agent’s loyalty must be undivided The agent’s actions must be strictly for the benefit of the principal and must not result in any secret profit for the agent Obedience  When acting on behalf of the principal, an agent has a duty to follow all lawful and clearly stated instructions of the principal Any deviation from such instructions is a violation of this duty During emergency situations, however, when the principal cannot be consulted, the agent may deviate from the instructions without violating this duty Whenever instructions are not clearly stated, the agent can fulfill the duty of obedience by acting in good faith and in a manner reasonable under the circumstances Accounting  Unless the agent and principal agree otherwise, the agent must keep and make available to the principal an account of all property and funds received and paid out on the principal’s behalf This includes gifts from third parties in connection with Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 20  Agency  the agency For instance, a gift from a customer to a salesperson for prompt deliveries made by the salesperson’s firm, in the absence of a company policy to the contrary, belongs to the firm The agent has a duty to maintain a separate account for the principal’s funds and must not intermingle these funds with the agent’s personal funds If a licensed professional (such as an attorney) violates this duty, he or she may be subject to disciplinary proceedings carried out by the appropriate regulatory institution (such as the state bar association) Of course, the professional will also be liable to the principal (the professional’s client) for failure to account Principal’s Duties to the Agent The principal also has certain duties to the agent These duties relate to compensation, reimbursement and indemnification, cooperation, and safe working conditions Compensation  In general, when a principal requests certain services from an agent, the agent reasonably expects payment The principal therefore has a duty to pay the agent for services rendered For instance, when an accountant or an attorney is asked to act as an agent, an agreement to compensate the agent for this service is implied The principal also has a duty to pay that compensation in a timely manner Unless the agency relationship is gratuitous and the agent does not act in exchange for payment, the principal must pay the agreed-on value for the agent’s services If no amount has been expressly agreed on, then the principal owes the agent the customary compensation for such services Reimbursement and Indemnification  The principal has a duty to reimburse the agent for any funds disbursed at the principal’s request The principal must also reimburse the agent for any necessary expenses incurred in the course of the reasonable performance of her or his agency duties.10 Agents cannot recover for expenses incurred as a result of their own misconduct or negligence, though Subject to the terms of the agency agreement, the principal has the duty to indemnify (compensate) an agent for liabilities incurred because of authorized and 10 This principle applies to acts by gratuitous agents as well If a finder of a dog that becomes sick takes the dog to a veterinarian and pays the veterinarian’s fees, the gratuitous agent is entitled to be reimbursed by the dog’s owner 473 lawful acts and transactions For instance, if the agent, on the principal’s behalf, forms a contract with a third party, and the principal fails to perform the contract, the third party may sue the agent for damages In this situation, the principal is obligated to compensate the agent for any costs incurred by the agent as a result of the principal’s failure to perform the contract Additionally, the principal must indemnify the agent for the value of benefits that the agent confers on the principal The amount of indemnification usually is specified in the agency contract If it is not, the courts will look to the nature of the business and the type of loss to determine the amount Note that this rule applies to acts by gratuitous agents as well Cooperation  A principal has a duty to cooperate with the agent and to assist the agent in performing his or her duties The principal must nothing to prevent that performance For instance, when a principal grants an agent an exclusive territory, the principal creates an exclusive agency, in which the principal cannot compete with the agent or appoint or allow another agent to compete If the principal does so, he or she violates the exclusive agency and is exposed to liability for the agent’s lost profits ▶  Example 20.10  River City Times Company (the principal) grants Emir (the agent) the right to sell its newspapers at a busy downtown intersection to the exclusion of all other vendors This creates an exclusive territory within which only Emir has the right to sell those newspapers If River City Times allows another vendor to sell its papers on another corner of the same intersection, Emir can sue for lost profits.  ◀ Safe Working Conditions The common law requires the principal to provide safe working premises, equipment, and conditions for all agents and employees The principal has a duty to inspect working areas and to warn agents and employees about any unsafe situations When the agent is an employee, the employer’s liability is frequently covered by state workers’ compensation insurance In addition, federal and state statutes often require the employer to meet certain safety standards (see Chapter 21) Rights and Remedies of Agents and Principals In general, for every duty of the principal, the agent has a corresponding right, and vice versa When one party Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 474  Unit Five  The Employment Environment to the agency relationship violates his or her duty to the other party, the remedies available to the nonbreaching party arise out of contract and tort law These remedies include monetary damages, termination of the agency relationship, an injunction, and required accountings The agent has the right to be compensated, to be reimbursed and indemnified, and to have a safe working environment An agent also has the right to perform agency duties without interference by the principal An agent can also withhold further performance and demand that the principal give an accounting A principal has contract remedies for an agent’s breach of fiduciary duties The principal also has tort remedies if the agent engages in misrepresentation, negligence, deceit, libel, slander, or trespass In addition, any breach of a fiduciary duty by an agent may justify the principal’s termination of the agency SECTION Scope of Agent’s Authority The liability of a principal to third parties with whom an agent contracts depends on whether the agent had the authority to enter into legally binding contracts on the principal’s behalf An agent’s authority can be either actual (express or implied) or apparent If an agent contracts outside the scope of his or her authority, the principal may still become liable by ratifying the contract Express Authority Express authority is authority declared in clear, direct, and definite terms Express authority can be given orally or in writing The Equal Dignity Rule  In most states, the equal dignity rule requires that if the contract being executed is or must be in writing, then the agent’s authority must also be in writing Failure to comply with the equal dignity rule can make a contract voidable at the option of the principal The law regards the contract at that point as a mere offer If the principal decides to accept the offer, the acceptance must be ratified, or affirmed, in writing (or in an electronic record) ▶  Example 20.11  Paloma (the principal) orally asks Austin (the agent) to sell a ranch that Paloma owns Austin finds a buyer and signs a sales contract (a contract for an interest in realty must be in writing) on behalf of Paloma to sell the ranch The buyer can- not enforce the contract unless Paloma subsequently ratifies Austin’s agency status in writing Once the sales contract is ratified, either party can enforce rights under the contract.  ◀ Modern business practice allows several exceptions to the equal dignity rule: An executive officer of a corporation normally can conduct ordinary business transactions without obtaining written authority from the corporation (see Chapter 19) When the agent acts in the presence of the principal, the rule does not apply When the agent’s act of signing is merely a formality, then the agent does not need written authority to sign ▶  Example 20.12  Sandra Healy (the principal) negotiates a contract but is called out of town the day it is to be signed If Healy orally authorizes Santini to sign, the oral authorization is sufficient.  ◀ Power of Attorney  Giving an agent a power of attorney confers express authority.11 A power of attorney is a written document and is usually notarized (A document is notarized when a notary public—a public official authorized to attest to the authenticity of signatures—signs and dates the document and imprints it with her or his seal of authority.) Most states have statutory provisions for creating a power of attorney A power of attorney can be special (permitting the agent to perform specified acts only), or it can be general (permitting the agent to transact all business for the principal) Because of the extensive authority granted to an agent by a general power of attorney, it should be used with great caution and usually only in exceptional circumstances Ordinarily, a power of attorney terminates on the incapacity or death of the person giving the power.12 Implied Authority An agent has the implied authority to what is reasonably necessary to carry out express authority and accomplish the objectives of the agency 11 An agent who holds a power of attorney is called an attorney-in-fact for the principal The holder does not have to be an attorney-at-law (and often is not) 12 A durable power of attorney, however, continues to be effective despite the principal’s incapacity An elderly person, for example, might grant a durable power of attorney to provide for the handling of property and investments or specific health-care needs should he or she become incompetent Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 20  Agency  Authority can also be implied by custom or inferred from the position the agent occupies (For a discussion of what happens when an employee-agent makes unauthorized use of the employer’s computer data, see this chapter’s Insight into Ethics feature below.) ▶  Example 20.13  Archer is employed by Packard Grocery to manage one of its stores Packard has not expressly stated that Archer has authority to contract with third persons Nevertheless, authority to manage a business implies authority to what is reasonably required (as is customary or can be inferred from a manager’s position) to operate the business It is reasonable to imply the authority to form contracts to 475 hire employees, to buy merchandise and equipment, and to advertise the products sold in the store.  ◀ Note, however, that an agent’s implied authority cannot contradict his or her express authority Thus, if a principal has limited an agent’s express authority, then the fact that the agent customarily would have such authority is irrelevant ▶  Example 20.14  Juanita Alvarez is the owner of six Baja Tacos restaurants Alvarez (the principal) strictly forbids the managers (agents) of her taco shops from entering into contracts to hire additional workers Therefore, the fact that managers customarily would have authority to hire employees is immaterial.  ◀ Insight into Ethics The Ethical and Legal Implications of Breaching Company Policy on the Use of Electronic Data Suppose that an employee-agent who is authorized to access company trade secrets contained in computer files takes those secrets to a competitor for whom the employee is about to begin working Clearly, the agent has violated the ethical—and legal—duty of loyalty to the principal Does this breach of loyalty mean that the employee’s act of accessing the trade secrets was unauthorized? The question has significant implications for both parties If the action was unauthorized, the employee will be subject to state and federal laws prohibiting unauthorized access to computer information and data, including the Computer Fraud and Abuse Act (CFAA, discussed in Chapter 7) If the action was authorized, these laws will not apply Does Exceeding Authorized Access to a Company’s Database Violate the Law? David Nosal once worked for Korn/Ferry and had access to the company’s confidential database When he left, he encouraged several former colleagues who still worked there to join him in starting a competing firm He asked them to access Korn/Ferry’s database and download source lists, names, and client contact information before they quit The employees had authority to access the database, but Korn/Ferry’s policy forbade disclosure of confidential information The government filed charges against Nosal and his colleagues for violating the CFAA, among other things A Court Rules That Violating an Employer’s Use Restrictions Is Not a Crime The U.S Court of Appeals for the Ninth Circuit refused to find that the defendants had violated the CFAA The court ruled that the phrase “exceed authorized access” in the CFAA refers to restrictions on access, not restrictions on use The court reasoned that Congress’s intent in enacting the CFAA was to prohibit people from hacking into computers without authorization The court also stated that the CFAA should not be used to criminally prosecute persons who use data in an unauthorized or unethical way The court pointed out that “adopting the government’s interpretation would turn vast numbers of teens and pre-teens into juvenile delinquents—and their parents and teachers into delinquency contributors.” Furthermore, “the effect this broad construction of the CFAA has on workplace conduct pales by comparison with its effect on everyone else who uses a computer, smart-phone, iPad, Kindle, Nook, X-box, Blu-Ray player or any other Internet-enabled device.”a Legal Critical Thinking Insight into the Legal Environment If an employee accesses Facebook at work even though personal use of a workplace computer is against the employer’s stated policies, can the employee be criminally prosecuted? Why or why not? a United States v Nosal, 675 F.3d 854 (9th Cir 2012) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 476  Unit Five  The Employment Environment Apparent Authority Actual authority (express or implied) arises from what the principal makes clear to the agent Apparent authority, in contrast, arises from what the principal causes a third party to believe An agent has ­apparent authority when the principal, by either word or action, causes a third party reasonably to believe that the agent has authority to act, even though the agent has no express or implied authority Apparent authority usually comes into existence through a principal’s pattern of conduct over time ▶  Example 20.15  Bailey is a traveling salesperson with the authority to solicit orders for the goods of Carlon Industries (the principal) Because she does SP TLIGHT not carry any goods with her, she normally would not have the implied authority to collect payments from customers on Carlon’s behalf Suppose that Bailey does accept payments from Jayco Enterprises, however, and submits them to Carlon’s accounting department for processing If Carlon does nothing to stop Bailey from continuing this practice, a pattern develops over time Thus, the principal confers apparent authority on Bailey to accept payments from Jayco.  ◀ At issue in the following Spotlight Case was whether the manager of a horse breeding operation had the authority to bind the farm’s owner in a contract guaranteeing breeding rights on Apparent Authority Case 20.2 Lundberg v Church Farm, Inc Court of Appeals of Illinois, 151 Ill.App.3d 452, 502 N.E.2d 806, (1986) BACKGROUND AND FACTS  Gilbert Church owned a horse breeding farm managed by Herb Bagley Advertisements for the breeding rights to one of Church Farm’s stallions, Imperial Guard, directed all inquiries to “Herb Bagley, Manager.” Vern and Gail Lundberg bred Thoroughbred horses The Lundbergs contacted Bagley and executed a preprinted contract giving them breeding rights to Imperial Guard “at Imperial Guard’s location,” subject to approval of the mares by Church Bagley handwrote a statement on the contract that guaranteed the Lundbergs “six live foals in the first two years.” He then signed it “Gilbert G Church by H Bagley.” The Lundbergs bred four mares, which resulted in one live foal Church then moved Imperial Guard from Illinois to Oklahoma The Lundbergs sued Church for breaching the contract by moving the horse Church claimed that Bagley was not authorized to sign contracts for Church or to change or add terms, but only to present preprinted contracts to potential buyers Church testified that although Bagley was his farm manager and the contact person for breeding rights, Bagley had never before modified the preprinted forms or signed Church’s name on these contracts The jury found in favor of the Lundbergs and awarded $147,000 in damages Church appealed IN THE LANGUAGE OF THE COURT Justice UNVERZAGT delivered the opinion of the court * * * * * * * Defendant contends that plaintiffs have failed to establish that Bagley had apparent authority to negotiate and sign the Lundberg contract for Church Farm * * * The party asserting an agency has the burden of proving its existence * * * but may so by ­inference and circumstantial evidence * * * Additionally, an agent may bind his principal by acts which the principal has not given him actual authority to perform, but which he appears authorized to perform * * * An agent’s apparent authority is that authority which “the principal knowingly permits the agent to assume or which he holds his agent out as possessing It is the authority that a reasonably prudent man, exercising diligence and discretion, in view of the principal’s conduct, would naturally suppose the agent to possess.” [Emphasis added.] Plaintiffs produced evidence at trial that Gil Church approved the Imperial Guard advertisement listing Herb Bagley as Church Farm’s manager, and directing all inquiries to him Church also permitted Bagley to live on the farm and to handle its daily operations Bagley Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 20  Agency  CASE 20.2 CONTINUEd 477 was the only person available to visitors to the farm Bagley answered Church Farm’s phone calls, and there was a preprinted signature line for him on the breeding rights package The conclusion is inescapable that Gil Church affirmatively placed Bagley in a managerial position giving him complete control of Church Farm and its dealings with the public We believe that this is just the sort of “holding out” of an agent by a principal that justifies a third person’s reliance on the agent’s authority We cannot accept defendant’s contention that the Lundbergs were affirmatively obligated to seek out Church to ascertain the actual extent of Bagley’s authority Where an agent has apparent authority to act, the principal will be liable in spite of any undisclosed limitations the principal has placed on that authority DECISION AND REMEDY  The state appellate court affirmed the lower court’s judgment in favor of the Lundbergs for $147,000 Because Church allowed circumstances to lead the Lundbergs to believe Bagley had the authority, Church was bound by Bagley’s actions THE LEGAL ENVIRONMENT DIMENSION  The court held that Church had allowed the Lundbergs to believe that Bagley was his agent What steps could Church have taken to protect himself against a finding of apparent authority? THE ethical DIMENSION  Does a principal have an ethical responsibility to inform an unaware third party that an apparent agent does not in fact have the authority to act on the principal’s behalf? Emergency Powers When an unforeseen emergency demands action by the agent to protect or preserve the property and rights of the principal, but the agent is unable to communicate with the principal, the agent has emergency power ▶  Example 20.16  Rob Fulsom is an engineer for Pacific Drilling Company While Fulsom is acting within the scope of his employment, he is severely injured in an accident at an oil rig many miles from home Acosta, the rig supervisor, directs Thompson, a physician, to give medical aid to Fulsom and to charge Pacific for the medical services Acosta, an agent, has no express or implied authority to bind the principal, Pacific Drilling, for Thompson’s medical services Because of the emergency situation, however, the law recognizes Acosta as having authority to act appropriately under the circumstances.  ◀ Ratification Ratification occurs when the principal affirms, or accepts responsibility for, an agent’s unauthorized act When ratification occurs, the principal is bound to the agent’s act, and the act is treated as if it had been authorized by the principal from the outset Ratification can be either express or implied If the principal does not ratify the contract, the principal is not bound, and the third party’s agreement with the agent is viewed as merely an unac- cepted offer Because the third party’s agreement is an unaccepted offer, the third party can revoke it at any time, without liability, before the principal ratifies the contract The agent, however, may be liable to the third party for misrepresenting her or his authority The requirements for ratification can be summarized as follows: The agent must have acted on behalf of an identified principal who subsequently ratifies the action The principal must know all of the material facts involved in the transaction If a principal ratifies a contract without knowing all of the facts, the principal can rescind (cancel) the contract.13 The principal must affirm the agent’s act in its entirety The principal must have the legal capacity to authorize the transaction at the time the agent engages in the act and at the time the principal ratifies The third party must also have the legal capacity to engage in the transaction The principal’s affirmation (ratification) must occur before the third party withdraws from the transaction The principal must observe the same formalities when ratifying the act as would have been required to authorize it initially 13 If the third party has changed position in reliance on the apparent contract, however, the principal can rescind but must reimburse the third party for any costs Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 478  Unit Five  The Employment Environment Concept Summary 20.2 below summarizes the rules concerning an agent’s authority to bind the principal and a third party SECTION Liability for Contracts Liability for contracts formed by an agent depends on how the principal is classified and on whether the actions of the agent were authorized or unauthorized Principals are classified as disclosed, partially disclosed, or undisclosed.14 An undisclosed principal is a principal whose identity is totally unknown by the third party In addition, the third party has no knowledge that the agent is acting in an agency capacity at the time the contract is made Authorized Acts If an agent acts within the scope of her or his authority, normally the principal is obligated to perform the contract regardless of whether the principal was disclosed, partially disclosed, or undisclosed Whether the agent may also be held liable under the contract, however, depends on the disclosed, partially disclosed, or undisclosed status of the principal A disclosed principal is a principal whose identity is known by the third party at the time the contract is made by the agent A partially disclosed principal is a principal whose identity is not known by the third party Nevertheless, the third party knows that the agent is or may be acting for a principal at the time the contract is made ▶  Example 20.17  Eileen has contracted with a real estate agent to sell certain property She wishes to keep her identity a secret, but the agent makes it clear to potential buyers of the property that the agent is acting in an agency capacity In this situation, Eileen is a partially disclosed principal.  ◀ Disclosed or Partially Disclosed Principal  A disclosed or partially disclosed principal is liable to a third party for a contract made by the agent If the principal is disclosed, the agent has no contractual liability for the nonperformance of the principal or the third party If the principal is partially disclosed, in most states the agent is also treated as a party to the contract, and the third party can hold the agent liable for contractual nonperformance.15 ▶  Case in Point 20.18  Walgreens leased commercial property at a mall owned by Kedzie Plaza Associates 14 Restatement (Third) of Agency, Section 1.04(2) 15 Restatement (Third) of Agency, Section 6.02 Concept Summary Summary20.2 8.1 Concept Authority of an Agent to Bind the Principal and a Third Party Authority of Agent Definition Effect on Principal and Third Party Express Authority Authority expressly given by the principal to the agent Principal and third party are bound in contract Implied Authority Authority implied (1) by custom, (2) from the position Principal and third party are bound in contract in which the principal has placed the agent, or (3) because such authority is necessary if the agent is to carry out expressly authorized duties and responsibilities Apparent Authority Authority created when the conduct of the principal leads a third party to believe that the principal’s agent has authority Principal and third party are bound in contract Unauthorized Acts Acts committed by an agent that are outside the scope of his or her express, implied, or apparent authority Principal and third party are not bound in contract—unless the principal ratifies prior to the third party’s withdrawal Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 20  Agency  Kedzie used Taxman Corporation, a property management company Taxman signed the lease with Walgreens on behalf of the principal, Kedzie The lease required the landlord to keep the sidewalks free of snow and ice Therefore, Taxman, on behalf of Kedzie, contracted with another company to remove ice and snow from the sidewalks surrounding the Walgreens store When a Walgreens employee slipped on ice outside the store and was injured, she sued Taxman, among others, for negligence Because the identity of the principal (Kedzie) was fully disclosed in the snowremoval contract, however, the court ruled that the agent, Taxman, could not be held liable Taxman did not assume a contractual obligation to remove the snow but merely retained a contractor to so on behalf of the owner.16  ◀ Undisclosed Principal  When neither the fact of an agency relationship nor the identity of the principal is disclosed, the undisclosed principal is bound to perform just as if the principal had been fully disclosed at the time the contract was made When a principal’s identity is undisclosed and the agent is forced to pay the third party, the agent is entitled to be indemnified (compensated) by the principal The principal had a duty to perform, even though his or her identity was undisclosed, and failure to so will make the principal ultimately liable Once the undisclosed principal’s identity is revealed, the third party generally can elect to hold either the principal or the agent liable on the contract Conversely, the undisclosed principal can require the third party to fulfill the contract, unless one of the following is true: The undisclosed principal was expressly excluded as a party in the written contract The contract is a negotiable instrument signed by the agent with no indication of signing in a representative capacity.17 The performance of the agent is personal to the contract, thus allowing the third party to refuse the principal’s performance Unauthorized Acts If an agent has no authority but nevertheless contracts with a third party, the principal cannot be held 16 McBride v Taxman Corp., 327 Ill.App.3d 992, 765 N.E.2d 51 (2002) 17 Under the Uniform Commercial Code (UCC), only the agent is liable if the instrument neither names the principal nor shows that the agent signed in a representative capacity [UCC 3–402(b)(2)] 479 liable on the contract It does not matter whether the principal was disclosed, partially disclosed, or undisclosed The agent is liable, however ▶  Example 20.19  Chu signs a contract for the purchase of a truck, purportedly acting as an agent under authority granted by Navarro In fact, Navarro has not given Chu any such authority Navarro refuses to pay for the truck, claiming that Chu had no authority to purchase it The seller of the truck is entitled to hold Chu liable for payment.  ◀ Implied Warranty  If the principal is disclosed or partially disclosed, and the agent contracts with a third party without authorization, the agent is liable to the third party who relied on the agency status The agent’s liability here is based on his or her breach of the implied warranty of authority, not on the breach of the contract itself.18 An agent impliedly warrants that he or she has the authority to enter a contract on behalf of the principal Third Party’s Knowledge  Note that if the third party knows at the time the contract is made that the agent does not have authority, then the agent is not liable Similarly, if the agent expressed to the third party uncertainty as to the extent of her or his authority, the agent is not personally liable Actions by E-Agents Although in the past standard agency principles applied only to human agents, today these same agency principles also apply to e-agents An electronic agent, or e-agent, is a semiautonomous computer program that is capable of executing specific tasks For instance, software that can search through many databases and retrieve only relevant information for the user is an e-agent The Uniform Electronic Transactions Act (UETA), which was discussed in Chapter 9, sets forth provisions relating to the principal’s liability for the actions of e-agents According to Section 15 of the UETA, e-agents can enter into binding agreements on behalf of their principals—at least, in those states that have adopted the act Thus, if consumers place an order over the Internet, and the company (principal) takes the order via an e-agent, the company cannot later claim that it did not receive the order 18 The agent is not liable on the contract because the agent was never intended personally to be a party to the contract Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 480  Unit Five  The Employment Environment The UETA also stipulates that if an e-agent does not provide an opportunity to prevent errors at the time of the transaction, the other party to the transaction can avoid the transaction Therefore, if an e-agent fails to provide an on-screen confirmation of a purchase or sale, the other party can avoid the effect of any errors ▶  Example 20.20  Bigelow wants to purchase three copies of three different books (a total of nine items) The e-agent mistakenly records an order for thirty-three of a single book and does not provide an on-screen verification of the order If thirty-three books are then sent to Bigelow, he can avoid the contract to purchase them.  ◀ SECTION Liability for Torts and Crimes Obviously, any person, including an agent, is liable for his or her own torts and crimes Whether a principal can also be held liable for an agent’s torts and crimes depends on several factors, which we examine here In some situations, a principal may be held liable not only for the torts of an agent but also for torts committed by an independent contractor Principal’s Tortious Conduct A principal who acts through an agent may be liable for harm resulting from the principal’s own negligence or recklessness Thus, a principal may be liable if he or she gives improper instructions, authorizes the use of improper materials or tools, or establishes improper rules that result in the agent’s committing a tort ▶  Example 20.21  Parker knows that Audrey’s driver’s license has been suspended but nevertheless tells her to use the company truck to deliver some equipment to a customer If someone is injured as a result, Parker will be liable for his own negligence in instructing Audrey to drive without a valid license.  ◀ ther of them has the right to The harvest is therefore a trespass (a tort), and Pedro is liable to the owner of the corn.  ◀ Note that an agent acting at the principal’s direction can be liable as a tortfeasor (one who commits a wrong, or tort), along with the principal, for committing the tortious act even if the agent was unaware that the act was wrong Assume in Example 20.22 that Andy, the agent, did not know that Pedro lacked the right to harvest the corn Andy can still be held liable to the owner of the field for damages, along with Pedro, the principal Liability for Agent’s Misrepresentation A principal is exposed to tort liability whenever a third person sustains a loss due to the agent’s misrepresentation The principal’s liability depends on whether the agent was actually or apparently authorized to make representations and whether the representations were made within the scope of the agency The principal is always directly responsible for an agent’s misrepresentation made within the scope of the agent’s authority ▶  Example 20.23  Ainsley is a demonstrator for Pavlovich’s products Pavlovich sends Ainsley to a home show to demonstrate the products and to answer questions from consumers Pavlovich has given Ainsley authority to make statements about the products If Ainsley makes only true representations, all is fine But if he makes false claims, Pavlovich will be liable for any injuries or damages sustained by third parties in reliance on Ainsley’s false representations.  ◀ Principal’s Authorization of Agent’s Tortious Conduct Apparent Implied Authority  When a principal has placed an agent in a position of apparent authority—making it possible for the agent to defraud a third party—the principal may also be liable for the agent’s fraudulent acts For instance, partners in a partnership generally have the apparent implied authority to act as agents of the firm, as was discussed in Chapter 17 Thus, if one of the partners commits a tort or a crime, the partnership itself—and often the other partners personally—can be held liable for the loss Similarly, a principal who authorizes an agent to commit a tort may be liable to persons or property injured thereby, because the act is considered to be the principal’s ▶  Example 20.22  Pedro directs his agent, Andy, to cut the corn on specific acreage, which nei- Innocent Misrepresentation  Tort liability based on fraud requires proof that a material misstatement was made knowingly and with the intent to deceive An agent’s innocent misstatements in a contract or Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 20  Agency  warranty transaction can also provide grounds for the third party’s rescission of the contract and the award of damages Justice dictates that when a principal knows that an agent is not accurately advised of facts but does not correct either the agent’s or the third party’s impressions, the principal is responsible The point is that the principal is always directly responsible for an agent’s misrepresentation made within the scope of authority Liability for Agent’s Negligence Under the doctrine of respondeat superior (a Latin term meaning “let the master respond),”19 a principal may also be liable for harm that his or her agent causes to a third party This doctrine imposes vicarious liability, or indirect liability, on an employer that is similar to strict liability (see Chapter 13), in that both are imposed regardless of fault Under this doctrine, the employer is liable for torts committed by an employee acting within the course or scope of employment (Of course, the employee is also liable for any torts that she or he commits.) Third parties injured through the negligence of an employee can sue either that employee or the employer, if the employee’s negligent conduct occurred while the employee was acting within the scope of employment ▶  Case in Point 20.24  Aegis Communications hired Southwest Desert Images (SDI) to provide landscaping services for its property An herbicide sprayed by SDI employee David Hoggatt entered the Aegis building through the air-­ conditioning system and caused Catherine Warner, an Aegis employee, to suffer a heart attack Warner sued SDI and Hoggatt for negligence, but the lower court dismissed the suit against Hoggatt On appeal, the court found that Hoggatt was also liable An agent is not excused from responsibility for tortious conduct just because he is working for a principal Both the agent and the principal are liable.20  ◀ The Doctrine of Respondeat Superior  At early common law, a servant (employee) was viewed as the master’s (employer’s) property The master was deemed to have absolute control over the servant’s acts and was held strictly liable for them, no mat19 Pronounced ree-spahn-dee-uht soo-peer-ee-your The doctrine of respondeat superior applies not only to employer-employee relationships but also to other principal-agent relationships in which the principal has the right of control over the agent 20 Warner v Southwest Desert Images, LLC, 218 Ariz 121, 180 P.3d 986 (2008) 481 ter how carefully the master supervised the servant Although employers today are not masters of their employees, control is still a central concept to liability Underlying Rationale.  The rationale for the doctrine of respondeat superior is based on the social duty that requires every person to manage his or her affairs so as not to injure another This duty applies even when a person acts through an agent (controls the conduct of another) Public Policy.  Generally, public policy requires that an injured person be afforded effective relief, and a business enterprise is usually better able to provide that relief than is an individual employee Employers normally carry liability insurance to cover any damages awarded as a result of such lawsuits They are also able to spread the cost of risk over the entire business enterprise The courts have applied the doctrine of respondeat superior for nearly two centuries It continues to have practical implications in all situations involving principal-­agent (employer-employee) relationships Today, the small-town grocer with one clerk and the multinational corporation with thousands of employees are equally subject to the doctrine (Keep this principle in mind when you read Chapters 21 and 22.) Determining the Scope of Employment  The key to determining whether a principal may be liable for the torts of an agent under the doctrine of respondeat superior is whether the torts are committed within the scope of the agency or employment Courts may consider the following factors in determining whether a particular act occurred within the course and scope of employment: Whether the employee’s act was authorized by the employer The time, place, and purpose of the act Whether the act was one commonly performed by employees on behalf of their employers The extent to which the employer’s interest was advanced by the act The extent to which the private interests of the employee were involved Whether the employer furnished the means or instrumentality (for example, a truck or a machine) by which an injury was inflicted Whether the employer had reason to know that the employee would perform the act in question and whether the employee had done it before Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 482  Unit Five  The Employment Environment Whether the act involved the commission of a serious crime within the salesperson’s scope of employment was at issue in the following case Whether a real estate salesperson’s actions in connection with certain real estate transactions fell C A S E ANALY S IS Case 20.3  Auer v Paliath Court of Appeals of Ohio, Second District, 2013 -Ohio- 391, 986 N.E.2d 1052 (2013) In the language of the court Froelich, J [Judge] * * * * Torri Auer [a California resident] brought suit [in an Ohio state court] against real estate salesperson Jamie Paliath, real estate broker Keller Williams Home Town Realty, and others based on alleged fraud by Paliath in the sale of several rental properties [in Dayton, Ohio] to Auer * * *  After a jury trial * * * , Paliath was found liable to Torri Auer in the amount of $135,200 for fraud in the inducement of Auer’s purchases of the properties * * * The jury also awarded $135,200 to Auer from Home Town Realty, based on the broker’s vicarious liability for Paliath’s actions in connection with Auer’s purchases of the properties Home Town Realty appeals from the trial court’s judgment * * * * * * * Under [Ohio Revised Code (R.C.) Section 4735.01] the term “real estate broker” includes “any person, partnership, association, limited liability company, limited liability partnership, or corporation * * * who for another * * * and who for a fee, commission, or other valuable consideration” engages in various activities regarding real estate, including selling, purchasing, leasing, renting, listing, auctioning, buying, managing, and advertising real estate A real estate salesperson generally means “any person associated with a licensed real estate broker to or to deal with any acts or transactions set out or comprehended by the definition of a real estate broker, for compensation or otherwise.” Under R.C Section 4735.21, no real estate salesperson may collect any money in connection with any real estate transaction, except as in the name of and with the consent of the licensed real estate broker under whom the salesperson is licensed * * * * * * * A real estate broker will be held vicariously liable for intentional torts committed by salesmen acting within the scope of their authority Vicarious liability is appropriate because a real estate salesman has no independent status or right to conclude a sale and can only function through the broker with whom he is associated A salesman is required to be under the supervision of a licensed broker in all of his activities related to real estate transactions [Emphasis added.] * * * * * * * When a real estate salesperson acts in the name of a real estate broker in connection with the type of real estate transaction for which he or she was hired and the broker collects a commission for the transaction, the salesperson’s actions in connection with that real estate transaction are within the scope of the salesperson’s employment, as a matter of law In this case, Paliath contracted with Home Town Realty as a real estate salesperson to assist clients with the purchase and sale of real estate Paliath advised and assisted Auer in the purchase of the * * * properties, and her fraudulent conduct involved misrepresentations regarding those properties Reviewing the properties separately, the evidence at trial established that Home Town Realty was listed as the real estate broker on the purchase contract, the agency disclosure statement, and the settlement statement for the Belton Street sale Home Town Realty received a commission check of $180 from the title company that conducted the closing Based on this evidence, it was established, as a matter of law, that Paliath acted within the scope of her employment as a real estate salesperson with Home Town Realty in relation to Auer’s purchase of the Belton property Similarly, Paliath’s actions with respect to the 1111–1115 Richmond Avenue properties were taken as a real estate salesperson assisting Auer with the purchase of the properties Home Town was listed as a broker on the purchase contract, the agency disclosure statement, and the settlement statement for 1111 Richmond Avenue, and it received a commission of $2,400 following the closing * * * The evidence thus demonstrated, as a matter of law, that Paliath was acting in the scope of her employment regarding the sale of 1111 Richmond Avenue * * * * * * * The trial court’s judgment will be affirmed Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 20  Agency  483 CASE 20.3 CONTINUEd Legal Reasoning Questions What conduct was at the center of the dispute in this case? Who did the plaintiff allege was liable for this conduct? Which of these parties was the principal, and which was the agent? What factors did the court apply to determine liability in this case? How did the court rule on the question of vicarious liability? The Distinction between a “Detour” and a “Frolic”  A useful insight into the concept of “scope of employment” may be gained from Judge Baron Parke’s classic distinction between a “detour” and a “frolic” in the case of Joel v Morison (1834).21 In this case, the English court held that if a servant merely took a detour from his master’s business, the master will be responsible If, however, the servant was on a “frolic of his own” and not in any way “on his master’s business,” the master will not be liable ▶  Example 20.25  Mandel, a traveling salesperson, while driving his employer’s vehicle to call on a customer, decides to stop at the post office—which is one block off his route—to mail a personal letter As Mandel approaches the post office, he negligently runs into a parked vehicle owned by Chan In this situation, because Mandel’s detour from the employer’s business is not substantial, he is still acting within the scope of employment, and the employer is liable The result would be different, though, if Mandel had decided to pick up a few friends for drinks in another city and in the process had negligently run his vehicle into Chan’s In that circumstance, the departure from the employer’s business would be substantial, and the employer normally would not be liable to Chan for damages Mandel would be considered to have been on a “frolic” of his own.  ◀ Employee Travel Time  An employee going to and from work or to and from meals usually is considered to be outside the scope of employment In contrast, all travel time of traveling salespersons or others whose jobs require travel is normally considered to be within the scope of employment for the duration of the business trip, including the return trip home 21 Car & P 501, 172 Eng.Rep 1338 (1834) Notice of Dangerous Conditions  The employer is charged with knowledge of any dangerous conditions discovered by an employee and pertinent to the employment situation ▶  Example 20.26  Brad, a maintenance employee in an apartment building, notices a lead pipe protruding from the ground in the building’s courtyard Brad neglects either to fix the pipe or to inform his employer of the danger John trips on the pipe and is injured The employer is charged with knowledge of the dangerous condition regardless of whether Brad actually informed the employer That knowledge is imputed to the employer by virtue of the employment relationship.  ◀ Liability for Agent’s Intentional Torts Most intentional torts that individuals commit have no relation to their employment, and their employers will not be held liable Nevertheless, under the doctrine of respondeat superior, the employer can be liable for intentional torts that an employee commits within the course and scope of employment For instance, an employer is liable when an employee (such as a “bouncer” at a nightclub or a security guard at a department store) commits the tort of assault and battery or false imprisonment while acting within the scope of employment In addition, an employer who knows or should know that an employee has a propensity for committing tortious acts is liable for the employee’s acts even if they would not ordinarily be considered within the scope of employment ▶  Example 20.27  Chaz, the owner of the Comedy Club, hires Alec as a bouncer for the club even though he knows that Alec has a history of arrests for criminal assault and battery In this situation, Chaz may be liable if Alec viciously Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 484  Unit Five  The Employment Environment attacks a customer in the parking lot after hours. ◀ An employer is also liable for permitting an employee to engage in reckless actions that can injure others, such as smoking next to highly flammable liquids Liability for Independent Contractor’s Torts Generally, an employer is not liable for physical harm caused to a third person by the negligent act of an independent contractor in the performance of the contract This is because the employer does not have the right to control the details of an independent contractor’s performance Courts make an exception to this rule when the contract involves unusually hazardous activities, such as blasting operations, the transportation of highly volatile chemicals, or the use of poisonous gases In these situations, strict liability (discussed in Chapter  13) is imposed, so an employer cannot be shielded from liability merely by using an independent contractor Liability for Agent’s Crimes An agent is liable for his or her own crimes A principal or employer normally is not liable for an agent’s crime even if the crime was committed within the scope of authority or employment An exception to this rule is made when the principal or employer participated in the crime by conspiracy or other action Also, in some jurisdictions, a principal may be liable under specific statutes if an agent, in the course and scope of employment, violates certain regulations For instance, a principal might be liable for an agent’s violation of sanitation rules or regulations governing prices, weights, and the sale of liquor SECTION Termination of an Agency Agency law is similar to contract law in that both an agency and a contract may be terminated by an act of the parties or by operation of law Once the relationship between the principal and the agent has ended, the agent no longer has the right (actual authority) to bind the principal For an agent’s apparent authority to be terminated, though, third persons may also need to be notified that the agency has been terminated Termination by Act of the Parties An agency relationship may be terminated by act of the parties in any of the following ways: Lapse of time. When an agency agreement specifies the time period during which the agency relationship will exist, the agency ends when that time period expires If no definite time is stated, then the agency continues for a reasonable time and can be terminated at will by either party What constitutes a reasonable time depends on the circumstances and the nature of the agency relationship Purpose achieved.  If an agent is employed to accomplish a particular objective, such as the purchase of breeding stock for a cattle rancher, the agency automatically ends after the cattle have been purchased If more than one agent is employed to accomplish the same purpose, such as the sale of real estate, the first agent to complete the sale automatically terminates the agency relationship for all the others Occurrence of a specific event. When an agency relationship is to terminate on the happening of a certain event, the agency automatically ends when the event occurs ▶  Example 20.28  If Posner appoints Rubik to handle her business affairs while she is away, the agency automatically terminates when Posner returns.  ◀ Mutual agreement.  The parties to an agency can cancel (rescind) their contract by mutually agreeing to terminate the agency relationship, even if it was for a specific (longer) duration Termination by one party. As a general rule, either party can terminate the agency relationship The act of termination is called revocation if done by the principal and renunciation if done by the agent Although both parties may have the power to terminate the agency, they may not possess the right and therefore may be liable for breach of contract or wrongful termination Wrongful Termination  Wrongful termination can subject the canceling party to a lawsuit for breach of contract ▶  Example 20.29  Rawlins has a one-year employment contract with Munro to act as agent in return for $65,000 Although Munro has the power to discharge Rawlins before the contract period expires, if he does so, he can be sued for breaching the contract because he had no right to terminate the agency.  ◀ Even in an agency at will—in which either party may terminate at any time—the principal who wishes Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 20  Agency  to terminate must give the agent reasonable notice The notice must be at least sufficient to allow the agent to recoup his or her expenses and, in some situations, to make a normal profit Agency Coupled with an Interest  A special rule applies to an agency coupled with an interest In an agency coupled with an interest, the agent has some legal right to (an interest in) the property that is the subject of the agency For instance, a principal might provide inventory for the agent to sell and then to keep the profits Because the agent has an additional interest in the property beyond the normal commission for selling it, the agent’s position cannot be terminated until the agent’s interest ends This type of agency is not an agency in the usual sense because it is created for the agent’s benefit instead of for the principal’s benefit ▶  Example 20.30  Julie borrows $5,000 from Rob, giving Rob some of her jewelry and signing a letter authorizing him to sell the jewelry as her agent if she fails to repay the loan After Julie receives the $5,000 from Rob, she attempts to revoke his authority to sell the jewelry as her agent Julie will not succeed in this attempt because a principal cannot revoke an agency created for the agent’s benefit.  ◀ An agency coupled with an interest should not be confused with a situation in which the agent merely derives proceeds or profits from the sale of the subject matter Many agents are paid a commission for their services, but the agency relationship involved does not constitute an agency coupled with an interest For instance, a real estate agent who merely receives a commission from the sale of real property does not have a beneficial interest in the property itself Notice of Termination  When the parties terminate an agency, it is the principal’s duty to inform any third parties who know of the existence of the agency that it has been terminated No particular form is required for notice of termination of the principalagent relationship to be effective The principal can personally notify the agent, or the agent can learn of the termination through some other means Although an agent’s actual authority ends when the agency is terminated, an agent’s apparent authority continues until the third party receives notice (from any source) that such authority has been terminated ▶  Example 20.31  Manning bids on a shipment of steel, and Stone is hired as an agent to arrange transportation for the shipment When 485 Stone learns that Manning has lost the bid, Stone’s authority to make the transportation arrangement terminates.  ◀ If the principal knows that a third party has dealt with the agent, the principal is expected to notify that person directly For third parties who have heard about the agency but have not yet dealt with the agent, constructive notice is sufficient.22 If the agent’s authority is written, however, normally it must be revoked in writing (unless the written document contained an expiration date) Termination by Operation of Law Certain events terminate agency authority automatically because their occurrence makes it impossible for the agent to perform or improbable that the principal would continue to want performance We look at these events here Note that when an agency terminates by operation of law, there is no duty to notify third persons—unless the agent’s authority is coupled with an interest Death or insanity. The general rule is that the death or insanity of either the principal or the agent automatically and immediately terminates an ordinary agency relationship.23 Knowledge of the death or insanity is not required ▶  Example 20.32  Grey sends Bosley to Japan to purchase a rare book Before Bosley makes the purchase, Grey dies Bosley’s agent status is terminated at the moment of Grey’s death, even though Bosley does not know that Grey has died.  ◀ (Some states, however, have enacted statutes that change the common law rule to require an agent’s knowledge of the principal’s death before termination.) Impossibility. When the specific subject matter of an agency is destroyed or lost, the agency terminates ▶  Example 20.33  Tsang employs Arnez to sell Tsang’s house Prior to any sale, the house is destroyed by fire Arnez’s agency and authority to sell the house terminate.  ◀ Similarly, when it is impossible for the agent to perform the agency lawfully because of a change in the law, the agency terminates 22 With constructive notice of a fact, knowledge of the fact is imputed by law to a person if he or she could have discovered the fact by proper diligence Constructive notice is often accomplished by publication in a newspaper 23 An exception to this rule exists in the bank-customer relationship A bank, as agent, can continue to exercise specific types of authority even after the customer’s death or insanity, and can continue to pay checks drawn by the customer for ten days after death Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 486  Unit Five  The Employment Environment Changed circumstances. Sometimes, an event occurs that has such an unusual effect on the subject matter of the agency that the agent can reasonably infer that the principal will not want the agency to continue In such situations, the agency terminates ▶  Example 20.34  Baird hires Joslen to sell a tract of land for $40,000 Subsequently, Joslen learns that there is oil under the land and that the land is therefore worth $1 million The agency and Joslen’s authority to sell the land for $40,000 are terminated.  ◀ Bankruptcy If either the principal or the agent petitions for bankruptcy, the agency is usually terminated In certain circumstances, such as when the agent’s financial status is irrelevant to the purpose of the agency, the agency relationship may continue Insolvency (the inability to pay debts when they come due or when liabilities exceed assets), as distinguished from bankruptcy, does not necessarily terminate the relationship War When the principal’s country and the agent’s country are at war with each other, the agency is terminated In this situation, the agency is automatically suspended or terminated because there is no way to enforce the legal rights and obligations of the parties See Concept Summary 20.3 below for a synopsis of the rules governing the termination of an agency Concept 33.2 Concept Summary Summary 20.3 Termination of an Agency Method of Termination Rules Act of the Parties Lapse of time Automatic at end of the stated time Purpose achieved Automatic on the completion of the purpose Occurrence of a specific Normally automatic on the happening of the event event Mutual agreement Mutual consent required At the option of one party (revocation, if by principal, renunciation, if by agent) Either party normally has a right to terminate the agency but may lack the power to so, which can lead to liability for breach of contract Operation of Law Death or insanity Termination of Agent’s Authority Notice to Third Parties Required— Direct to those who have dealt with agency Constructive to all others Automatic on the death or insanity of either the principal or the agent (except when the agency is coupled with an interest) Impossibility— destruction of the specific subject matter Applies any time the agency cannot be performed because of an event beyond the parties’ control Changed circumstances Events so unusual that it would be inequitable to allow the agency to continue to exist Bankruptcy Bankruptcy petition (not mere insolvency) usually terminates the agency War between principal’s country and agent’s country Automatically suspends or terminates agency—no way to enforce legal rights No Notice Required— Automatic on the happening of the event Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 20  Agency  487 Reviewing: Agency Lynne Meyer, on her way to a business meeting and in a hurry, stopped at a Buy-Mart store for a new car charger for her smartphone There was a long line at one of the checkout counters, but a cashier, Valerie Watts, opened another counter and began loading the cash drawer Meyer told Watts that she was in a hurry and asked Watts to work faster Instead, Watts slowed her pace At this point, Meyer hit Watts It is not clear whether Meyer hit Watts intentionally or, in an attempt to retrieve the car charger, hit her inadvertently In response, Watts grabbed Meyer by the hair and hit her repeatedly in the back of the head, while Meyer screamed for help Management personnel separated the two women and questioned them about the incident Watts was immediately fired for violating the store’s no-fighting policy Meyer subsequently sued Buy-Mart, alleging that the store was liable for the tort (assault and battery) committed by its employee Using the information presented in the chapter, answer the following questions Under what doctrine discussed in this chapter might Buy-Mart be held liable for the tort committed by Watts? What is the key factor in determining whether Buy-Mart is liable under this doctrine? How is Buy-Mart’s potential liability affected by whether Watts’s behavior constituted an intentional tort or a tort of negligence? Suppose that when Watts applied for the job at Buy-Mart, she disclosed in her application that she had previously been convicted of felony assault and battery Nevertheless, Buy-Mart hired Watts as a cashier How might this fact affect Buy-Mart’s liability for Watts’s actions? Debate This  The doctrine of respondeat superior should be modified to make agents solely liable for their tortious (wrongful) acts committed within the scope of employment Terms and Concepts agency 466 agency coupled with an interest 485 apparent authority 476 disclosed principal 478 e-agent 479 equal dignity rule 474 exclusive agency 473 express authority 474 fiduciary 466 implied authority 474 independent contractor 467 notary public 474 partially disclosed principal 478 power of attorney 474 ratification 477 respondeat superior 481 undisclosed principal 478 vicarious liability 481 ExamPrep Issue Spotters Dimka Corporation wants to build a new mall on a specific tract of land Dimka contracts with Nadine to buy the property When Nadine learns of the difference between the price that Dimka is willing to pay and the price at which the owner is willing to sell, she wants to buy the land and sell it to Dimka herself Can she this? Discuss (See page 472.) Davis contracts with Estee to buy a certain horse on her behalf Estee asks Davis not to reveal her identity Davis makes a deal with Farmland Stables, the owner of the horse, and makes a down payment Estee does not pay the rest of the price Farmland Stables sues Davis for breach of contract Can Davis hold Estee liable for whatever damages he has to pay? Why or why not? (See page 479.) •  Check your answers to the Issue Spotters against the answers provided in Appendix E at the end of this text Before the Test  Go to www.cengagebrain.com, enter the ISBN 9781285428949, and click on “Find” to locate this Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 488  Unit Five  The Employment Environment textbook’s Web site Then, click on “Access Now” under “Study Tools,” and select Chapter 20 at the top There, you will find an Interactive Quiz that you can take to assess your mastery of the concepts in this chapter, as well as Flashcards and a Glossary of important terms Business Scenarios 20–1. Duty of Loyalty. Peter hires Alice as an agent to sell a piece of property he owns The price is to be at least $30,000 Alice discovers that the fair market value of Peter’s property is actually at least $45,000 and could be higher because a shopping mall is going to be built nearby Alice forms a real estate partnership with her cousin Carl Then she prepares for Peter’s signature a contract for the sale of the property to Carl for $32,000 Peter signs the contract Just before closing and passage of title, Peter learns about the shopping mall and the increased fair market value of his property Peter refuses to deed the property to Carl Carl claims that Alice, as Peter’s agent, solicited a price above that agreed on when the agency was created and that the contract is therefore binding and enforceable Discuss fully whether Peter is bound to this contract (See page 472.) 20–2.  Respondeat Superior. ABC Tire Corp hires Arnez as a traveling salesperson and assigns him a geographic area and time schedule in which to solicit orders and service customers Arnez is given a company car to use in covering the territory One day, Arnez decides to take his personal car to cover part of his territory It is 11:00 a.m., and Arnez has just finished calling on all customers in the city of Tarrytown His next appointment is at 2:00 p.m in the city of Austex, twenty miles down the road Arnez starts out for Austex, but halfway there he decides to visit a former college roommate who runs a farm ten miles off the main highway Arnez is enjoying his visit with his former roommate when he realizes that it is 1:45 p.m and that he will be late for the appointment in Austex Driving at a high speed down the country road to reach the main highway, Arnez crashes his car into a tractor, severely injuring Thomas, the driver of the tractor Thomas claims that he can hold ABC Tire Corp liable for his injuries Discuss fully ABC’s liability in this situation (See page 481.) Business Case Problems 20–3. Spotlight on Agency—Independent Contractors. Frank Frausto delivered newspapers under a renewable six-month contract called a “Delivery Agent Agreement.” The agreement identified Frausto as an independent contractor The company collected payment from customers and took complaints about delivery Frausto was given the route for his paper delivery and was required to deliver the paper within a certain time period each day Frausto delivered the papers using his own vehicle and had to provide proof of insurance to the company The company provided health and disability insurance but did not withhold taxes from Frausto’s weekly income One morning, Frausto was delivering papers and collided with Santiago on his motorcycle Santiago filed a negligence action against Frausto and the newspaper company The newspaper company argued that it should not be liable because Frausto was an independent contractor What was the result? Why? [Santiago v Phoenix Newspapers, Inc., 794 P.2d 138 (Ariz 1990)] (See page 467.) 20–4. Disclosed Principal.  To display desserts in restaurants, Mario Sclafani ordered refrigeration units from Felix Storch, Inc Felix faxed a credit application to Sclafani The application was faxed back with a signature that appeared to be Sclafani’s Felix delivered the units When they were not paid for, Felix filed a suit against Sclafani to collect Sclafani denied that he had seen the application or signed it He testified that he referred all credit questions to “the girl in the office.” Who was the principal? Who was the agent? Who is liable on the contract? Explain [Felix Storch, Inc v Martinucci Desserts USA, Inc., 30 Misc.2d 1217, 924 N.Y.S.2d 308 (Suffolk Co 2011)] (See page 478.) 20–5. Employment Relationships. William Moore owned Moore Enterprises, a wholesale tire business William’s son, Jonathan, worked as a Moore Enterprises employee while he was in high school Later, Jonathan started his own business, called Morecedes Tire Morecedes regrooved tires and sold them to businesses, including Moore Enterprises A decade after Jonathan started Morecedes, William offered him work with Moore Enterprises On the first day, William told Jonathan to load certain tires on a trailer but did not tell him how to it Was Jonathan an independent contractor? Discuss [ Moore v Moore, 152 Idaho 245, 269 P.3d 802 (2011)] (See page 467.) 20–6.  Business Case Problem with Sample Answer:  Liability for Contracts Thomas Huskin and his wife entered into a contract to have their home remodeled by House Medic Handyman Service Todd Hall signed the contract as an authorized representative of House Medic It turned out that House Medic was a fictitious name for Hall Hauling, Ltd The contract did not indicate this, however, and Hall did not inform the Huskins about Hall Hauling When a contract dispute later arose, the Huskins sued Todd Hall per- Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 20  Agency  sonally for breach of contract Can Hall be held personally liable? Why or why not? [Huskin v Hall, 2012 WL 553136 (Ohio Ct.App 2012)] (See page 478.) •  For a sample answer to Problem 20–6, go to Appendix F at the end of this text 20–7. Agent’s Duties to Principal.  William and Maxine Miller were shareholders of Claimsco International, Inc They filed a suit against the other shareholders, Michael Harris and Kenneth Hoxie, and the accountant who worked for all of them—John Verchota The Millers alleged that Verchota had breached a duty that he owed them They claimed that at Harris’s instruction, Verchota had adjusted Claimsco’s books to maximize the Millers’ financial liabilities, falsely reflect income to them without actually transferring that income, and unfairly disadvantage them compared to the other shareholders Which duty are the Millers referring to? If the allegations can be proved, did Verchota breach this duty? Explain [Miller v Harris, 2013 IL App (2d) 120512, 985 N.E.2d 671 (Ill.App Dist 2013)] (See page 472.) 20–8. Agent’s Authority.  Basic Research, L.L.C., advertised its products on television networks owned by Rainbow Media Holdings, Inc., through an ad agency, Icebox Advertising, Inc As Basic’s agent, Icebox had the express authority to buy ads from Rainbow on Basic’s behalf, but the authority was limited to buying ads with cash in advance Despite this limit, Rainbow sold ads to Basic through Icebox on credit Basic paid Icebox for the ads, but Icebox did not pass all of the payments on to Rainbow Icebox filed for bankruptcy Can Rainbow recoup the unpaid amounts from Basic? Explain [American Movie Classics v Rainbow Media Holdings, 2013 WL 323229 (10th Cir 2013)] (See page 474.) 489 20–9.  A Question of Ethics:  Agency Formation and Duties Western Fire Truck, Inc., contracted with Emergency One, Inc (EO), to be its exclusive dealer in Colorado and Wyoming through December 2003 James Costello, a Western salesperson, was authorized to order EO vehicles for his customers Without informing Western, Costello e-mailed EO about Western’s difficulties in obtaining cash to fund its operations He asked about the viability of Western’s contract and his possible employment with EO On EO’s request, and in disregard of Western’s instructions, Costello sent some payments for EO vehicles directly to EO In addition, Costello, with EO’s help, sent a competing bid to a potential Western customer EO’s representative e-mailed Costello, “You have my permission to kick [Western’s] ass.” In April 2002, EO terminated its contract with Western, and, after reviewing Costello’s e-mail, fired Costello Western filed a suit in a Colorado state court, alleging that Costello breached his duty as an agent and that EO aided and abetted the breach [ Western Fire Truck, Inc v Emergency One, Inc., 134 P.3d 570 (Colo App 2006)] (See page 470.) (a) Was there an agency relationship between Western and Costello? Western required monthly reports from its sales staff, but Costello did not report regularly Does this indicate that Costello was not Western’s agent? In determining whether an agency relationship exists, is the right to control or the fact of control more important? Explain (b) Did Costello owe Western a duty? If so, what was the duty? Did Costello breach it? If so, how? (c) A Colorado state statute allows a court to award punitive damages in “circumstances of fraud, malice, or willful and wanton conduct.” Did any of these circumstances exist in this case? Should punitive damages be assessed against either defendant? Why or why not? Legal Reasoning Group Activity 20–10. Liability for Independent Contractor’s Torts. Dean Brothers Corp owns and operates a steel drum manufacturing plant Lowell Wyden, the plant superintendent, hired Best Security Patrol, Inc (BSP), a security company, to guard Dean property and “deter thieves and vandals.” Some BSP security guards, as Wyden knew, carried firearms Pete Sidell, a BSP security guard, was not certified as an armed guard but nevertheless came to work with his gun (in a briefcase) While working at the Dean plant on October 31, 2014, Sidell fired his gun at Tyrone Gaines, in the belief that Gaines was an intruder The bullet struck and killed Gaines Gaines’s mother filed a lawsuit claiming that her son’s death was the result of BSP’s negligence, for which Dean was responsible (See page 480.) (a) The first group will determine what the plaintiff’s best argument is to establish that Dean is responsible for BSP’s actions (b) The second group will discuss Dean’s best defense and formulate arguments in support of it Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 21 Employment Relationships U ntil the early 1900s, most employer-employee relationships were governed by the common law Even today, under the common law employment-at-will ­doctrine, private employers have considerable freedom to hire and fire workers at will, regardless of the employees’ performance In addition, however, numerous statutes and administrative agency regulations now govern the workplace Thus, to a large extent, statutory law has displaced common law doctrines In this chapter and the next two chapters, we look at the most significant laws regulating employment relationships In this chapter, we discuss federal statutes that regulate various aspects of the workplace, including employee wages, hours, medical leave, safety, and pension and health plans We SECTION Employment at Will Employment relationships have traditionally been governed by the common law doctrine of ­employment at will Under this doctrine, either party may terminate the employment relationship at any time and for any reason, unless doing so violates an employee’s statutory or contractual rights Today, the majority of U.S workers continue to have the legal status of “employees at will.” In other words, this common law doctrine is still in widespread use, and only one state (Montana) does not apply it Nonetheless, federal and state statutes governing employment relationships prevent the doctrine from being applied in a number of circumstances An employer may not fire an employee if doing so would violate a federal or state statute, such as one prohibiting employment discrimination (see Chapter 22) Note that the distinction made under agency law (discussed in Chapter 20) between employee status and independent-contractor status is important here The employment laws that will be discussed in this chapter and in Chapters 22 and 23 apply only to the employer-employee relationship They not apply to independent contractors consider employee privacy rights and such issues as the use of electronic monitoring by employers and drug testing We deal with other important laws regulating the workplace—those that prohibit employment discrimination, restrict immigration, and regulate labor unions—in Chapters 22 and 23 Exceptions to the Employment-at-Will Doctrine Because of the harsh effects of the employment-atwill doctrine for employees, courts have carved out various exceptions to it These exceptions are based on contract theory, tort theory, and public policy Exceptions Based on Contract Theory Some courts have held that an implied employment contract exists between the employer and the employee If the employee is fired outside the terms o6f the implied contract, he or she may succeed in an action for breach of contract even though no written employment contract exists ▶  Example 21.1  BDI Enterprise’s employment manual and personnel bulletin both state that, as a matter of policy, workers will be dismissed only for good cause Jing Chin is an employee at BDI If Chin reasonably expects BDI to follow this policy, a court may find that there is an implied contract based on the terms stated in the manual and bulletin.  ◀ Generally, the key consideration in determining whether an employment manual creates an implied contractual obligation is the employee’s reasonable expectations Courts in a few states have gone further and held that all employment contracts contain an implied covenant of good faith This means that both sides promise 490 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 21  Employment Relationships  to abide by the contract in good faith If an employer fires an employee for an arbitrary or unjustified reason, the employee can claim that the employer breached the covenant of good faith and violated the contract In the following case, an employment contract that explicitly stated that the employment was “at 491 will” also contained provisions relating to the contract’s renewal under certain circumstances Was this an at-will contract, or was the employer bound by the renewal provisions? That was the issue before the court C as e Analy A naly s is Case 21.1  Ellis v BlueSky Charter School Court of Appeals of Minnesota, 2010 WL 1541352 (2010) In the Language of the Court CRIPPEN, Judge.  Challenging his termination as director of respondent BlueSky Charter School, relatora Thomas Ellis argues that the termination breached his contract with respondent In November 2008, the parties signed an employment agreement providing that relator was to serve as the director of the school for the 2008–09 school year The title of the agreement states the dates “July 01/2008–June 30/2009.” The first sentence of the agreement lists the administrative positions to which the agreement applies and states, “This is a general at will ­agreement.” [Emphasis in original.] Yet the agreement provides that “positions will automatically renew for one year after one year of service unless specific actions are taken by the board before April 15th of each year.” It defines the work year as 220 days from July to June 30 * * *  Respondent terminated relator’s contract at a meeting of its board of directors on May 7, 2009 a A relator is a private person at whose prompting or complaint an action against a public office or organization is undertaken * * * * Relator argues that, under his contract, because his contract was terminated after April 15, 2009, respondent was obligated to employ him for the remainder of the 2008–09 school year and through the 2009–10 school year He seeks damages for pay he was owed as of May 2009 and thereafter through the school year ending in 2010 He also seeks future damages for lost benefits and diminution in value of retirement benefits, as well as severance pay and other amounts associated with termination * * * * In Minnesota, an employment contract of indefinite duration is generally interpreted to be a contract for employment at will, which may be terminated at any time without cause Conversely, an employment agreement for a fixed term is generally interpreted as terminable only for cause Express language may override these general rules of interpretation [Emphasis added.] The employment agreement of the parties unambiguously declared “at will” employment Without qualification or limitation, the first line of the agreement states that it is a “general at will agreement covering the [listed] positions.” The words “at will agreement” are the only terms that appear in bold type in the text of the contract * * * * The agreement refers to a work year from July 1, 2008 to June 30, 2009 * * * Relator argues that these references establish a fixed-term contract Although the contract is not expressly declared an agreement for a set term, the references to start and end dates, standing alone, would likely be sufficient to establish a term contract terminable only for cause But * * * the general rule for construing indefinite contracts is overcome by express terms in a contract The plain language of the “at will” phrase overrides the general rule for construing a fixed-term contract, expressly replacing any implication that might have been drawn from the reference to start and end dates * * * * To the extent the damages relator seeks are based on a breach of his employment agreement, he is not entitled to recover because his position was at-will * * * * Affirmed; motion denied Legal Reasoning Questions Why did Ellis, the relator, believe that his employment was not at will but based on an employment contract? What was Ellis seeking as damages in this lawsuit? CASE 21.1 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 492  Unit Five  The Employment Environment CASE 21.1 CONTINUEd According to the court, was Ellis an at-will employee? What reasons did the court give to support its conclusion? Exceptions Based on Tort Theory  In some situations, the discharge of an employee may give rise to an action for wrongful discharge under tort theories Abusive discharge procedures may result in a lawsuit for intentional infliction of emotional distress or defamation In addition, some courts have permitted workers to sue under the tort theory of fraud when an employer made false promises to a prospective employee ▶  Example 21.2  Goldfinch Consulting, Inc., induces Brianna to leave a lucrative job and move to another state by offering her “a long-term job with a thriving business.” In fact, Goldfinch is not only having significant financial problems but is also planning a merger that will result in the elimination of the position offered to Brianna If she takes the job in reliance on Goldfinch’s representations and is fired shortly thereafter, Brianna may be able to bring an action against the employer for fraud.  ◀ Exceptions Based on Public Policy  The most common exception to the employment-at-will doctrine is made on the basis that the employer’s reason for firing the employee violates a fundamental public policy of the jurisdiction Generally, the courts require that the public policy involved be expressed clearly in the statutory law governing the jurisdiction The public-policy exception may apply to an employee who is discharged for whistleblowing— that is, telling government authorities, upper-level managers, or the media that her or his employer is engaged in some unsafe or illegal activity ▶ Case in Point 21.3  Rebecca Wendeln was the staff coordinator at a nursing home She discovered that a patient at the home had been improperly moved and had been injured as a result Wendeln reported the incident to state authorities, as she was required to by state law Her supervisor was angry about the report, and Wendeln was fired shortly thereafter When Wendeln sued, the court held that although she was an employee at will, she was protected in this instance from retaliatory firing because a clear mandate of public policy had been violated.1  ◀ (Normally, whistleblowers seek protection from retaliatory discharge under federal and state statutes, such as the Whistleblower Protection Act of 1989.2) In the following case, an employer fired an employee after he complained about how his supervisor performed her job The court had to decide whether the employee was protected by the employer’s whistleblower policy even though it was implemented after he was hired Wendeln v The Beatrice Manor, Inc., 271 Neb 373, 712 N.W.2d 226 (2006) U.S.C Section 1201 Case 21.2 Waddell v Boyce Thompson Institute for Plant Research, Inc Supreme Court of New York, Appellate Division, 92 A.D.3d 1172, 940 N.Y.S.2d 331 (2012) BACKGROUND AND FACTS  Donald Waddell worked as a business office supervisor for the Boyce Thompson Institute for Plant Research Waddell did not have an employment contract for a fixed term The Institute’s employee manual said that his job was “terminable at the will of either the employee or [the Institute], at any time, with or without cause.” Several months after hiring Waddell, the Institute implemented a whistleblower policy designed to encourage “the highest standards of financial reporting and lawful and ethical behavior.”  The whistleblower policy stated that the Institute would not retaliate against an employee for making a complaint “in good faith pursuant to this policy.” Beginning in May 2010, Waddell repeatedly complained that his supervisor, Sophia Darling, needed to file certain financial documents more promptly In August 2010, Darling fired Waddell, telling him that his disrespectful and insubordinate conduct violated the Institute’s Code of Conduct Waddell then sued the Institute, and the trial court held that he failed to state a proper claim for breach of an implied contract Waddell appealed Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 21  Employment Relationships  493 IN THE LANGUAGE OF THE COURT CASE 21.2 CONTINUEd PETERS, J.P [Justice Presiding] **** * * * It is well settled that, “absent an agreement establishing a fixed duration, an employment relationship is presumed to be a hiring at will, terminable at any time by either party.” This presumption may be rebutted by proof establishing that “the employer made the employee aware of its express written policy limiting its right of discharge and that the employee detrimentally relied on that policy in accepting the employment.” Notably, “the requirements for such an implied contract of employment have been strictly construed, and the successful plaintiff must sustain an ‘explicit and difficult pleading burden.’ ” [Emphasis added.] * * * We find that plaintiff has failed to state a cause of action for breach of an implied contract It is undisputed that the Whistleblower Policy had not been implemented until several months after plaintiff began employment with defendant As such, [the trial court] correctly found that the essential element of detrimental reliance in accepting employment was lacking Further, plaintiff did not allege that he forsook any other employment opportunities in reliance upon defendant’s Whistleblower Policy or because of what he believed to be defendant’s termination policy Nor is the quality of plaintiff’s service relevant in determining whether the presumption of at-will employment has been overcome * * * Accordingly, plaintiff’s claim for breach of an implied employment contract was properly dismissed DECISION AND REMEDY  The New York appellate court found that Waddell did not state a proper claim for breach of contract It therefore affirmed the judgment for the Institute THE LEGAL ENVIRONMENT DIMENSION  If Waddell had been allowed to bring a claim for breach of contract, how might his supervisor, Sophia Darling, have defended her conduct? Explain your answer THE ETHICAL DIMENSION  Is the at-will employment doctrine fair to employees? Why or why not? Wrongful Discharge Whenever an employer discharges an employee in violation of an employment contract or a statutory law protecting employees, the employee may bring an action for wrongful discharge Even if an employer’s actions not violate any express employment contract or statute, the employer may still be subject to liability under a common law doctrine, such as a tort theory or agency For instance, if an employer discharges a female employee while publicly disclosing private facts about her sex life to her co-workers, the employee could bring a wrongful discharge suit based on an invasion of privacy (see Chapter 12) construction projects to pay “prevailing wages” to their employees The Walsh-Healey Act applies to U.S government contracts It requires that a minimum wage, as well as overtime pay at 1.5 times regular pay rates, be paid to employees of manufacturers or suppliers entering into contracts with agencies of the federal government The Fair Labor Standards Act (FLSA)5 extended wage-hour requirements to cover all employers engaged in interstate commerce or in producing goods for interstate commerce, plus selected other types of businesses The FLSA, as amended, provides the most comprehensive federal regulation of wages and hours today SECTION Wages, Hours, and Layoffs In the 1930s, Congress enacted several laws to regulate the wages and working hours of employees, including the following: The Davis-Bacon Act requires contractors and subcontractors working on federal government 40 U.S.C Sections 276a–276a-5 Child Labor The FLSA prohibits oppressive child labor Children under fourteen years of age are allowed to only certain types of work, such as deliver newspapers, work for their parents, and be employed in entertainment and (with some exceptions) agriculture Children 41 U.S.C Sections 35–45 29 U.S.C Sections 201–260 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 494  Unit Five  The Employment Environment aged fourteen and fifteen are allowed to work, but not in hazardous occupations There are also numerous restrictions on how many hours per day and per week children can work Working times and hours are not restricted for persons between the ages of sixteen and eighteen, but they cannot be employed in hazardous jobs None of these restrictions apply to those over the age of eighteen Minimum Wages The FLSA provides that a minimum wage of $7.25 per hour must be paid to employees in covered industries (by the time you read this text, the minimum wage may be higher) Congress periodically revises this minimum wage Additionally, many states have minimum wages When the state minimum wage is greater than the federal minimum wage, the employee is entitled to the higher wage When an employee receives tips while on the job, the employer is required to pay only $2.13 an hour in direct wages—if that amount, plus the tips received, equals at least the federal minimum wage If an employee’s tips and direct wages not equal the federal minimum wage, the employer must make up the difference If employers pay at least the federal minimum wage, the FLSA allows them to take employee tips and make other arrangements for their distribution Overtime Provisions and Exemptions Under the FLSA, any employee who works more than forty hours per week must be paid no less than 1.5 times her or his regular pay for all hours over forty The FLSA overtime provisions apply only after an employee has worked more than forty hours per week, so employees who work ten hours a day, four days per week, are not entitled to overtime pay Certain employees—usually administrative, executive, and professional employees, as well as outside salespersons and computer programmers—are exempt from the FLSA’s overtime provisions Employers are not required to pay overtime wages to exempt employees An employer can voluntarily pay overtime to ineligible employees but cannot waive or reduce the overtime requirements of the FLSA Executive Employees  An executive employee is one whose primary duty is management An employee’s primary duty is determined by what he or she does that is of principal value to the employer, not by how much time the employee spends doing particu- lar tasks An employer cannot deny overtime wages based only on an employee’s job title, however, and must be able to show that the employee’s primary duty qualifies her or him for an exemption.6 ▶ Case in Point 21.4  Kevin Keevican, a manager at a Starbucks store, worked seventy hours a week for $650 to $800, a 10 to 20 percent bonus, and paid sick leave Keevican (and other former managers) filed a claim against Starbucks for unpaid overtime Keevican claimed that he had spent 70 to 80 percent of his time waiting on customers and thus was not an executive employee The court, however, found that Keevican was “the single highest-ranking employee” in his particular store He was responsible on site for that store’s day-to-day overall operations Because his primary duty was managerial, Starbucks was not required to pay overtime.7  ◀ Administrative Employees  To qualify under the administrative employee exemption, the employee must be paid a salary, not hourly wages, and have a primary duty directly related to management or the employer’s general business operations In addition, the employee’s primary duty must include the exercise of discretion and independent judgment with respect to matters of significance ▶ Case in Point 21.5  Patty Lee Smith was a pharmaceutical sales representative at Johnson and Johnson (J&J) She traveled to ten physicians’ offices a day to promote the benefits of J&J’s drug Concerta Smith’s work was unsupervised, she controlled her own schedule, and she received a salary of $66,000 When she filed a claim for overtime pay, the court held that she was an administrative employee and therefore exempt from the FLSA’s overtime provisions.8  ◀ Layoffs During the latest economic recession, millions of workers were laid off from their jobs as companies reduced costs by restructuring their operations and downsizing their workforces In this section, we discuss the laws pertaining to employee layoffs, an area that is increasingly the subject of litigation The Worker Adjustment and Retraining Notification Act The Worker Adjustment and Retraining Notification (WARN) Act applies to See, for example, Slusser v Vantage Builders, Inc., 576 F.Supp.2d 1207 (D.N.M 2008) Mims v Starbucks Corp., 2007 WL 10369 (S.D.Tex 2007) Smith v Johnson and Johnson, 593 F.3d 280 (3d Cir 2010) 29 U.S.C Sections 2101 et seq Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 21  Employment Relationships  employers with at least one hundred full-time employees It requires an employer to provide sixty days’ notice before implementing a mass layoff or closing a plant that employs more than fifty full-time workers A mass layoff is a layoff of at least one-third of the full-time employees at a particular job site Notification Requirements. Employers must provide advance notice of the layoff to the affected workers or their representative (if the workers are members of a labor union) Employers must also notify state and local government authorities so that they can provide resources, such as job training, to displaced workers Any part-time and seasonal employees who are being laid off must be notified, even though these workers not count in determining whether the act’s provisions are triggered Even companies that anticipate filing for bankruptcy normally must provide notice under the WARN Act before implementing a mass layoff Remedies for Violations.  If sued, an employer that orders a mass layoff or plant closing in violation of the WARN Act can be fined up to $500 for each day of the violation Employees can recover back pay for each day of the violation (up to sixty days), plus reasonable attorneys’ fees An employee can also recover benefits under an employee benefit plan, including the cost of medical expenses that would have been covered by the plan Because the WARN Act applies to large employers that lay off thousands of workers, lawsuits can be expensive The amount that an employer must pay grows larger each day and is multiplied by the number of employees involved in the suit State Laws May Also Require Layoff Notices  Many states also have statutes requiring employers to provide notice before initiating mass layoffs These laws may have requirements different from and even stricter than those in the WARN Act In New York, for instance, companies with fifty or more employees must provide ninety days’ notice before any layoff that affects twenty-five or more full-time employees SECTION Family and Medical Leave In 1993, Congress passed the Family and Medical Leave Act (FMLA)10 to allow employees to take time 10 29 U.S.C Sections 2601, 2611–2619, 2651–2654 495 off work for family or medical reasons A majority of the states also have legislation allowing for family or medical leave Many employers voluntarily choose to maintain family-leave plans for their workers The FMLA does not supersede any state or local law that provides more generous family- or medical-leave protection Additional categories of FMLA leave were created in 2009 for military caregivers and for qualifying exigencies that arise due to military service Coverage and Application The FMLA requires employers that have fifty or more employees to provide an employee with up to twelve weeks of unpaid family or medical leave during any twelve-month period The FMLA expressly covers private and public (government) employees who have worked for their employers for at least a year An eligible employee may take up to twelve weeks of leave within a twelve-month period for any of the following reasons: To care for a newborn baby within one year of birth To care for an adopted or foster child within one year of the time the child is placed with the employee To care for the employee’s spouse, child, or parent who has a serious health condition If the employee suffers from a serious health condition and is unable to perform the essential functions of her or his job For any qualifying exigency (nonmedical emergency) arising out of the fact that the employee’s spouse, son, daughter, or parent is a covered military member on active duty.11 For instance, an employee can take leave to arrange for child care or to deal with financial or legal matters when a spouse is being deployed to Korea In addition, an employee may take up to twenty-six weeks of military caregiver leave within a twelve-month period to care for a family member with a serious injury or illness incurred as a result of military duty.12 Benefits and Protections When an employee takes FMLA leave, the employer must continue the worker’s health-care coverage on the same terms as if the employee had continued to 11 29 C.F.R Section 825.126 12 29 C.F.R Section 825.200 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 496  Unit Five  The Employment Environment work On returning from FMLA leave, most employees must be restored to their original position or to a comparable position (with nearly equivalent pay and benefits, for example) An important exception allows the employer to avoid reinstating a key employee— defined as an employee whose pay falls within the top 10 percent of the firm’s workforce Violations An employer that violates the FMLA can be required to provide various remedies, including the following: Damages to compensate the employee for lost wages and benefits, denied compensation, and actual monetary losses (such as the cost of providing for care of a family member) Compensatory damages are available up to an amount equivalent to the employee’s wages for twelve weeks Job reinstatement Promotion, if a promotion has been denied A successful plaintiff is also entitled to court costs and attorneys’ fees If bad faith on the part of the employer is shown, the plaintiff can receive twice the amount of damages awarded by the judge or jury Supervisors can also be held personally liable, as employers, for violations of the act Employers generally are required to notify employees when an absence will be counted against FMLA leave If an employer fails to provide such notice, and the employee consequently incurs costs or is otherwise harmed because he or she did not receive notice, the employer may be sanctioned.13 SECTION Worker Health and Safety Under the common law, employees who were injured on the job had to file lawsuits against their employers to obtain recovery Today, numerous state and federal statutes protect employees from the risk of accidental injury, death, or disease resulting from their employment The Occupational Safety and Health Act At the federal level, the primary legislation protecting employees’ health and safety is the Occupational 13 Ragsdale v Wolverine World Wide, Inc., 535 U.S 81, 122 S.Ct 1155, 152 L.Ed.2d 167 (2002) Safety and Health Act,14 which is administered by the Occupational Safety and Health Administration (OSHA) The act imposes on employers a general duty to keep the workplace safe To this end, OSHA has established specific safety standards that employers must follow depending on the industry For instance, OSHA regulations require the use of safety guards on certain mechanical equipment and set maximum levels of exposure to substances in the workplace that may be harmful to a worker’s health Notices, Records, and Reports  The act requires that employers post certain notices in the workplace, maintain specific records, and submit reports Employers with eleven or more employees are required to keep occupational injury and illness records for each employee Each record must be made available for inspection when requested by an OSHA compliance officer Whenever a work-related injury or disease occurs, employers must make reports directly to OSHA If an employee dies or three or more employees are hospitalized because of a work-related incident, the employer must notify OSHA within eight hours A company that fails to so will be fined Following the incident, a complete inspection of the premises is mandatory Inspections  OSHA compliance officers may enter and inspect the facilities of any establishment covered by the Occupational Safety and Health Act Employees may also file complaints of violations Under the act, an employer cannot discharge an employee who files a complaint or who, in good faith, refuses to work in a high-risk area if bodily harm or death might result State Workers’ Compensation Laws State workers’ compensation laws establish an administrative procedure for compensating workers injured on the job Instead of suing, an injured worker files a claim with the state agency or board that administers local workers’ compensation claims Most workers’ compensation statutes are similar No state covers all employees Typically, domestic workers, agricultural workers, temporary employees, and employees of common carriers (companies that provide transportation services to the public) are excluded, but minors are covered 14 29 U.S.C Sections 553, 651–678 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 21  Employment Relationships  Usually, the statutes allow employers to purchase insurance from a private insurer or a state fund to pay workers’ compensation benefits in the event of a claim Most states also allow employers to be selfinsured—that is, employers that show an ability to pay claims not need to buy insurance Workers’ Compensation Requirements  In general, the only requirements to recover benefits under state workers’ compensation laws are: The existence of an employment relationship An accidental injury that occurred on the job or in the course of employment, regardless of fault (An injury that occurs while an employee is commuting to or from work usually is not covered because it did not occur on the job or in the course of employment.) An injured employee must notify her or his employer promptly (usually within thirty days of the accident) Generally, an employee must also file a workers’ compensation claim within a certain period (sixty days to two years) from the time the injury is first noticed, rather than from the time of the accident Workers’ Compensation versus Litigation  If an employee accepts workers’ compensation benefits, he or she may not sue for injuries caused by the employer’s negligence By barring lawsuits for negligence, workers’ compensation laws also prevent employers from avoiding liability by using defenses, such as contributory negligence or assumption of risk A worker may sue an employer who intentionally injures the worker, however SECTION Income Security Federal and state governments participate in insurance programs designed to protect employees and their families from the financial impact of retirement, disability, death, hospitalization, and unemployment The key federal law on this subject is the Social Security Act.15 Social Security The Social Security Act provides for old-age (retirement), survivors’, and disability insurance The act is 15 42 U.S.C Sections 301–1397e 497 therefore often referred to as OASDI Both employers and employees must “contribute” under the Federal Insurance Contributions Act (FICA)16 to help pay for benefits that will partially make up for the employees’ loss of income on retirement The basis for the employee’s and the employer’s contribution is the employee’s annual wage base— the maximum amount of the employee’s wages that is subject to the tax The employer withholds the employee’s FICA contribution from the employee’s wages and then matches this contribution The annual wage base is adjusted each year as needed to take into account the rising cost of living In 2013, employers were required to withhold 6.2 percent of each employee’s wages, up to a maximum wage base of $113,700, and to match this contribution Retired workers are eligible to receive monthly payments from the Social Security Administration, which administers the Social Security Act Social Security benefits are fixed by statute but increase automatically with increases in the cost of living Medicare Medicare is a federal government health-­ insurance program administered by the Social Security Administration for people sixty-five years of age and older and for some under age sixty-five who are disabled It originally had two parts, one pertaining to hospital costs and the other to nonhospital medical costs, such as visits to physicians’ offices Additional Coverage Options Medicare now offers additional coverage options and a prescriptiondrug plan People who have Medicare hospital insurance can obtain additional federal medical insurance if they pay small monthly premiums Tax Contributions  Like Social Security, Medicare is funded by “contributions” from the employer and the employee, but there is no cap on the amount of wages subject to the Medicare tax In 2013, both the employer and the employee were required to pay 1.45 percent of all wages and salaries to finance Medicare Thus, for Social Security and Medicare together, in 2013 the employer and employee each paid 7.65 percent of the first $113,700 of income (6.2 percent for Social Security + 1.45 percent for Medicare), for a combined total of 15.3 percent In addition, all wages and salaries above $113,700 were taxed at a 16 26 U.S.C Sections 3101–3125 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 498  Unit Five  The Employment Environment combined (employer and employee) rate of 2.9 percent for Medicare.17 Self-employed persons pay both the employer and the employee portions of the Social Security and Medicare taxes In addition, as of 2013, a Medicare tax of 3.8 percent is applied to all investment income for single wage earners making more than $200,000 and married couples making more than $250,000 Private Pension Plans The major federal statute that regulates employee retirement plans is the Employee Retirement Income Security Act (ERISA).18 Its provisions governing employers who have private pension funds for their employees are enforced by the U.S Department of Labor ERISA created the Pension Benefit Guaranty Corporation (PBGC), an independent federal agency, to provide timely and uninterrupted payment of voluntary private pension benefits The pension plans pay annual insurance premiums (at set rates adjusted for inflation) to the PBGC, which then pays benefits to participants in the event that a plan is unable to do so ERISA does not require an employer to establish a pension plan When a plan exists, however, ERISA provides standards for its management ERISA also imposes detailed record-keeping and reporting requirements Vesting  A key provision of ERISA concerns vesting Vesting gives an employee a legal right to receive pension benefits at some future date when she or he stops working Before ERISA was enacted, some employees who had worked for companies for as long as thirty years received no pension benefits when their employment terminated because those benefits had not vested ERISA establishes complex vesting rules Generally, however, all of an employee’s contributions to a pension plan vest immediately, and the employee’s rights to the employer’s contributions vest after five years of employment Investment of Pension Funds  In an attempt to prevent mismanagement of pension funds, ERISA established rules on how they must be invested Managers must choose investments cautiously and must diversify the plan’s investments to minimize the risk of large losses 17 As a result of the Health Care and Education Reconciliation Act of 2010, Medicare tax rates will rise, and the applicable compensation base will include more than just salary incomes 18 29 U.S.C Sections 1001 et seq Unemployment Insurance The Federal Unemployment Tax Act (FUTA)19 created a state-administered system that provides unemployment compensation to eligible individuals who have lost their jobs The FUTA and state laws require employers that fall under the provisions of the act to pay unemployment taxes at regular intervals The proceeds from these taxes are then paid out to qualified unemployed workers To be eligible for unemployment compensation, a worker must be willing and able to work Workers who have been fired for misconduct or who have voluntarily left their jobs are not eligible for benefits Normally, workers must be actively seeking employment to continue receiving benefits Temporary measures recently enacted in response to persistent high unemployment rates also allow some jobless persons to retain unemployment benefits while pursuing additional education and training COBRA Federal law also enables employees to continue health-care coverage after their jobs have been terminated and they are no longer eligible for group ­health-insurance plans The Consolidated Omnibus Budget Reconciliation Act (COBRA)20 prohibits an employer from eliminating a worker’s medical, vision, or dental insurance on the voluntary or involuntary termination of the worker’s employment Employers, with some exceptions, must inform employees of COBRA’s provisions when they face termination or a reduction of hours that would affect their eligibility for coverage under the plan Only workers fired for gross misconduct are excluded An employer that does not comply with COBRA risks substantial penalties, such as a tax of up to 10 percent of the annual cost of the group plan or $500,000, whichever is less Procedures  A worker has sixty days (from the date that the group coverage would stop) to decide whether to continue with the employer’s group insurance plan If the worker chooses to discontinue the coverage, the employer has no further obligation If the worker chooses to continue coverage, the employer is obligated to keep the policy active for up to eighteen months (twenty-nine months if the worker is disabled) The coverage must be the same as that provided to the worker prior to the termination 19 26 U.S.C Sections 3301–3310 20 29 U.S.C Sections 1161–1169 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 21  Employment Relationships  or reduction of work If family members were originally included, COBRA prohibits their exclusion Payment  Generally, an employer can require the employee to pay all of the premiums, plus a percent administrative charge If the worker fails to pay the premiums, becomes eligible for Medicare, or obtains coverage under another plan (or if the employer completely eliminates its group plan), the employer is relieved of further responsibility Employer-Sponsored Group Health Plans The Health Insurance Portability and Accountability Act (HIPAA),21 discussed in Chapter 5, also affects employer-sponsored group health plans HIPAA does not require employers to provide health insurance, but it does establish requirements for those that Under HIPAA, employers must give credit to employees for previous health coverage (including COBRA coverage) to decrease any waiting period before their coverage becomes effective In addition, HIPAA restricts the manner in which employers collect, use, and disclose the health information of employees and their families Employers must train employees, designate privacy officials, and distribute privacy notices to ensure that employees’ health information is not disclosed to unauthorized parties Failure to comply with HIPAA regulations can result in civil penalties of up to $100 per person per violation (with a cap of $25,000 per year) The employer is also subject to criminal prosecution for certain types of HIPAA violations and can face up to $250,000 in criminal fines and imprisonment for up to ten years if convicted Affordable Care Act Under the Affordable Care Act22 (ACA, commonly referred to as Obamacare), most employers with fifty or more full-time employees are required to offer healthinsurance benefits There is no requirement to provide health benefits if fewer than fifty people are employed Any business offering health benefits to its employees (even if not legally required to so) may be eligible for tax credits of up to 35 percent to offset the costs 21 29 U.S.C Sections 1181 et seq 22 Pub L No 111-148, 124 Stat 119, March 23, 2010, codified in various sections of 42 U.S.C 499 An employer who fails to provide health benefits as required under the statute can be fined up to $2,000 for each employee after the first thirty people (This is known as the 50/30 rule: employers with fifty employees must provide insurance, and those failing to so will be fined for each employee after the first thirty.) An employer who offers a plan that costs an employee more than 9.5 percent of the employee’s income may receive a penalty of $3,000 Employers will be fined for failing to provide benefits only if one of their employees receives a federal subsidy to buy health insurance through a healthinsurance exchange The act provided for these exchanges to establish marketplaces where business owners and individuals can compare premiums and purchase policies SECTION Employee Privacy Rights In the last thirty years, concerns about the privacy rights of employees have arisen as employers purportedly use invasive tactics to monitor and screen workers Perhaps the greatest privacy concern in employment today involves electronic monitoring of employees’ activities Electronic Monitoring More than half of employers engage in some form of electronic monitoring of their employees Many employers review employees’ e-mail, blogs, instant messages, and tweets, as well as their social media, smartphone, and Internet use Employers may also video their employees at work, record and listen to their telephone conversations and voice mail, and read their text messages and social media posts Employee Privacy Protection  Employees of private (nongovernment) employers have some privacy protection under tort law (see Chapter 12) and state constitutions In addition, state and federal statutes may limit an employer’s conduct in certain respects For instance, as discussed in Chapter 15, the Electronic Communications Privacy Act prohibits employers from intercepting an employee’s personal electronic communications unless they are made on devices and systems furnished by the employer Nonetheless, employers have considerable leeway to monitor employees in the workplace Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 500  Unit Five  The Employment Environment Private employers generally are free to use filtering software (discussed in Chapter 5) to block access to certain Web sites, such as sites containing sexually explicit images The First Amendment’s protection of free speech prevents only government employers from restraining speech by blocking Web sites and certain security service firms, may conduct polygraph tests In addition, companies that manufacture and distribute controlled substances may perform liedetector tests Other employers may use polygraph tests when investigating losses attributable to theft, including embezzlement and the theft of trade secrets Was There a Reasonable Expectation of Privacy?  When determining whether an employer Drug Testing  In the interests of public safety and to reduce unnecessary costs, many employers, including the government, require their employees to submit to drug testing should be held liable for violating an employee’s privacy rights, the courts generally weigh the employer’s interests against the employee’s reasonable expectation of privacy Normally, if employees have been informed that their communications are being monitored, they cannot reasonably expect those interactions to be private Also, if the employer provided the e-mail system or blog that the employee used for communications, a court will typically hold that the employee did not have a reasonable expectation of privacy If employees are not informed that certain communications are being monitored, however, the employer may be held liable for invading their privacy Most employers that engage in electronic monitoring notify their employees about the monitoring Nevertheless, a general policy may not sufficiently protect an employer who monitors forms of communications that the policy fails to mention For instance, notifying employees that their e-mails and phone calls may be monitored does not necessarily protect an employer who monitors social media posts or text messages Other Types of Monitoring In addition to monitoring their employees’ online activities, employers also engage in other types of employee screening and monitoring The practices discussed next have often been challenged as violations of employee privacy rights Lie-Detector Tests  At one time, many employers required employees or job applicants to take polygraph examinations (lie-detector tests) Today, the Employee Polygraph Protection Act 23 generally prohibits employers from requiring employees or job applicants to take lie-detector tests or suggesting or requesting that they so The act also restricts employers’ ability to use or ask about the results of any lie-detector test or to take any negative employment action based on the results Certain employers are exempt from these prohibitions Federal, state, and local government employers, 23 29 U.S.C Sections 2001 et seq Public Employers.  Government (public) employers are constrained in drug testing by the Fourth Amendment to the U.S Constitution, which prohibits unreasonable searches and seizures (see Chapter 5) Drug testing of public employees is allowed by statute for transportation workers Courts normally uphold drug testing of certain employees when drug use in a particular job may threaten public safety Also, when there is a reasonable basis for suspecting public employees of drug use, courts often find that drug testing does not violate the Fourth Amendment Private Employers.  The Fourth Amendment does not apply to drug testing conducted by private employers Hence, the privacy rights and drug testing of privatesector employees are governed by state law, which varies from state to state Many states have statutes that allow drug testing by private employers but put restrictions on when and how the testing may be performed A collective bargaining agreement (to be discussed in Chapter 23) may also provide protection against (or authorize) drug testing The permissibility of a private employee’s drug test often hinges on whether the employer’s testing was reasonable Random drug tests and even “zerotolerance” policies (which deny a “second chance” to employees who test positive for drugs) have been held to be reasonable.24 Many workers at U.S government facilities are employees of private contractors, not of the government Until recently, these workers generally were not subject to the drug testing and background checks that are applied to federal government employees In the following case, several contract workers claimed that their privacy rights had been violated by new standards that required them to submit to background checks 24 See CITGO Asphalt Refining Co v Paper, Allied-Industrial, Chemical, and Energy Workers International Union Local No 2-991, 385 F.3d 809 (3d Cir 2004) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 21  Employment Relationships  501 Case 21.3 National Aeronautics and Space Administration v Nelson Supreme Court of the United States, U.S , 131 S.Ct 746, 178 L.Ed.2d 667 (2011) COMPANY PROFILE  The National Aeronautics and Space Administration (NASA) is an independent federal agency charged with planning and conducting “space activities.” One of NASA’s facilities is the Jet Propulsion Laboratory (JPL), which develops and runs most U.S unmanned space missions—from the Explorer satellite in 1958 to the Mars rovers of this century The JPL is owned by NASA but is operated by the California Institute of Technology and is staffed exclusively by contract employees BACKGROUND AND FACTS  In 2007, under newly implemented standards, contract employees with long-term access
to federal facilities were ordered to complete a standard background check The National Agency Check with Inquiries (NACI) performs background checks for the government The NACI
is designed to obtain information on such issues as counseling and treatment, as well as mental and financial stability Robert Nelson and other JPL employees filed a lawsuit in a federal district court against NASA, claiming that the NACI violated their privacy rights The court denied the plaintiffs’ request to prohibit use of the NACI, but the U.S Court of Appeals for the Ninth Circuit reversed this decision NASA appealed to the United States Supreme Court, arguing that the Privacy Act of 1974 provides sufficient protection for employees’ privacy This act allows the government to retain information only for “relevant and necessary” purposes, requires written consent before the information may be disclosed, and imposes criminal liability for violations IN THE LANGUAGE OF THE COURT Justice Alito delivered the opinion of the Court Respondents in this case, federal contract employees at
a Government laboratory, claim that two parts of a standard employment background investigation violate their rights * * * Respondents challenge a section of a form questionnaire that asks employees about treatment or counseling for recent illegal-drug use They also object to certain open-ended questions on a form sent to employees’ designated references **** We will assume for present purposes that the Government’s challenged inquiries implicate a privacy interest of constitutional significance We hold, however, that, whatever the scope of this interest, it does not prevent the Government from asking reasonable questions * * * in an employment background investigation that is subject to the Privacy Act’s safeguards against public disclosure [Emphasis added.] **** * * * The questions challenged by respondents are part of
a standard employment background check of the sort used by millions of private employers The Government itself has been conducting employment investigations since the earliest days of the Republic Since 1871, the President has enjoyed statutory authority to ascertain the fitness of applicants for the civil service as to age, health, character, knowledge and ability for the employment sought and that [statute] appears to have been regarded as a codification of established practice Standard background investigations similar to those at issue here became mandatory for all candidates for the federal civil service in 1953 And the particular investigations challenged in this case arose from a decision to extend that requirement to federal contract employees requiring long-term access to federal facilities As this long history suggests, the Government has an interest in conducting basic employment background checks Reasonable investigations of applicants and employees aid the Government in ensuring the security of its facilities and in employing a competent, reliable workforce DECISION AND REMEDY  The United States Supreme Court reversed the judgment of the lower court and remanded the case The NACI does not violate an individual’s right to privacy because its inquiries are reasonable and the Privacy Act protects against the disclosure of private information CASE 21.3 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 502  Unit Five  The Employment Environment CASE 21.3 CONTINUEd WHAT IF THE FACTS WERE DIFFERENT?  Suppose that after the decision in this case, a JPL employee refused to cooperate in an NACI background check What would be the most likely consequences? THE LEGAL ENVIRONMENT DIMENSION  The U.S Constitution does not explicitly mention a general right to privacy From what sources does the Court infer this right? (Hint: See the section on “Privacy Rights” in Chapter 5.) Genetic Testing  A serious privacy issue arose when some employers began conducting genetic testing of employees or prospective employees in an effort to identify individuals who might develop significant health problems in the future To prevent the improper use of genetic information by employers and healthinsurance providers, in 2008 Congress passed the Genetic Information Nondiscrimination Act (GINA).25 Under GINA, employers cannot make decisions about hiring, firing, job placement, or promotion based on the results of genetic testing GINA also prohibits group health plans and insurers from denying coverage or charging higher premiums based solely on a genetic predisposition to develop a disease in the future 25 26 U.S.C Section 9834; 42 U.S.C Sections 300gg-53, 1320d-9, 2000ff-1 to 2000ff-11 Reviewing: Employment Relationships Rick Saldona began working as a traveling salesperson for Aimer Winery in 2008 Sales constituted 90 percent of Saldona’s work time Saldona worked an average of fifty hours per week but received no overtime pay In June 2014, Saldona’s new supervisor, Caesar Braxton, claimed that Saldona had been inflating his reported sales calls and required Saldona to submit to a polygraph test Saldona reported Braxton to the U.S Department of Labor, which prohibited Aimer from requiring Saldona to take a polygraph test for this purpose In August 2014, Saldona’s wife, Venita, fell from a ladder and sustained a head injury while employed as a full-time agricultural harvester Saldona presented Aimer’s Human Resources Department with a letter from his wife’s physician indicating that she would need daily care for several months, and Saldona took leave until December 2014 Aimer had sixty-three employees at that time When Saldona returned to Aimer, he was informed that his position had been eliminated because his sales territory had been combined with an adjacent territory Using the information presented in the chapter, answer the following questions Would Saldona have been legally entitled to receive overtime pay at a higher rate? Why or why not? What is the maximum length of time Saldona would have been allowed to take leave to care for his injured spouse? Under what circumstances would Aimer have been allowed to require an employee to take a polygraph test? Would Aimer likely be able to avoid reinstating Saldona under the key employee exception? Why or why not? Debate This  The U.S labor market is highly competitive, so state and federal laws that require overtime pay are unnecessary and should be abolished Terms and Concepts employment at will 490 minimum wage 494 vesting 498 whistleblowing 492 workers’ compensation law 496 wrongful discharge 493 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 21  Employment Relationships  503 ExamPrep Issue Spotters American Manufacturing Company (AMC) issues an employee handbook that states that employees will be discharged only for good cause One day, Greg, an AMC supervisor, says to Larry, “I don’t like your looks You’re fired.” Can AMC be held liable for breach of contract? If so, why? If not, why? (See page 490.) Erin, an employee of Fine Print Shop, is injured on the job For Erin to obtain workers’ compensation, does her injury have to have been caused by Fine Print’s negligence? Does it matter whether the action causing the injury was intentional? Explain (See page 496.) •  Check your answers to the Issue Spotters against the answers provided in Appendix E at the end of this text Before the Test  Go to www.cengagebrain.com, enter the ISBN 9781285428949, and click on “Find” to locate this textbook’s Web site Then, click on “Access Now” under “Study Tools,” and select Chapter 21 at the top There, you will find an Interactive Quiz that you can take to assess your mastery of the concepts in this chapter, as well as Flashcards and a Glossary of important terms Business Scenarios 21–1. Wrongful Discharge.  Denton and Carlo were employed at an appliance plant Their job required them to perform occasional maintenance work while standing on a wire mesh twenty feet above the plant floor Other employees had fallen through the mesh, and one of them had been killed by the fall When their supervisor told them to perform tasks that would likely involve walking on the mesh, Denton and Carlo refused because they feared they might suffer bodily injury or death Because they refused to the requested work, the two employees were fired from their jobs Was their discharge wrongful? If so, under what federal employment law? To what federal agency or department should they turn for assistance? (See page 493.) 21–2. Family and Medical Leave Act.  Serge worked for Service Attendant Corporation (SAC) He requested time off under the Family and Medical Leave Act (FMLA) from April 29 through May 31 to undergo treatment for alcoholism For the month of May, he was hospitalized as part of the treatment When he did not return to work on June 1, SAC fired him Did SAC violate Serge’s rights under the FMLA? Explain your answer (See page 495.) Business Case Problems 21–3. Spotlight on Coca Cola—Family and Medical Leave Act.  Jennifer Willis worked for Coca Cola Enterprises, Inc (CCE), in Louisiana as a senior account manager On a Monday in May 2003, Willis called her supervisor to tell him that she was sick and would not be able to work that day She also said that she was pregnant, but she did not say she was sick because of the p ­ regnancy On Tuesday, she called to ask where to report to work and was told that she could not return without a doctor’s release She said that she had a doctor’s appointment on “Wednesday,” which her supervisor understood to be the next day Willis meant the following Wednesday For more than a week, Willis did not contact CCE When she returned to work, she was told that she had violated CCE’s “No Call/No Show” policy Under this policy “an employee absent from work for three consecutive days without notifying the supervisor during that period will be considered to have voluntarily resigned.” She was fired Willis filed a suit in a federal district court against CCE under the Family and Medical Leave Act (FMLA) To be eligible for FMLA leave, an employee must inform an employer of the reason for the leave Did Willis meet this requirement? Did CCE’s response to Willis’s absence violate the FMLA? Explain [Willis v Coca Cola Enterprises, Inc., 445 F.3d 413 (5th Cir 2006)] (See page 495.) 21–4.  Minimum Wage. Misty Cumbie worked as a waitress at the Vita Café in Portland, Oregon The café was owned and operated by Woody Woo, Inc Woody Woo paid its servers an hourly wage that was higher than the state’s minimum wage, but the servers were required to contribute their tips to a “tip pool.” Approximately one-third of the tip-pool funds went to the servers, and the rest was distributed to kitchen staff members, who otherwise rarely received tips for their services Did this tip-pooling arrangement violate the minimum wage provisions of the Fair Labor Standards Act? Explain [Cumbie v Woody Woo, Inc., 596 F.3d 577 (9th Cir 2010)] (See page 494.) 21–5.  Business Case Problem with Sample Answer:  Workers’ Compensation As a safety measure, Dynea USA, Inc., required an employee, Tony Fairbanks, to wear steel-toed boots One of the boots caused a sore on Fairbanks’s leg The skin over the sore broke, and ­within a week, Fairbanks was hospitalized with a methicillinresistant staphylococcus aureus (MRSA) infection He filed a Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 504  Unit Five  The Employment Environment workers’ compensation claim Dynea argued that the MRSA bacteria that caused the infection had been on Fairbanks’s skin before he came to work What are the requirements to recover workers’ compensation benefits? Does this claim qualify? Explain [Dynea USA, Inc v Fairbanks, 241 Or.App 311, 250 P.3d 389 (2011)] (See page 496.) • For a sample answer to Problem 21–5, go to Appendix F at the end of this text 21–6. Exceptions to the Employment-at-Will Doctrine. Li Li worked for Packard Bioscience, and Mark Schmeizl was her supervisor In March 2000, Schmeizl told Li to call Packard’s competitors, pretend to be a potential customer, and request “pricing information and literature.” Li refused to perform the assignment She told Schmeizl that she thought the work was illegal and recommended that he contact Packard’s legal department Although a lawyer recommended against the practice, Schmeizl insisted that Li perform the calls Moreover, he later wrote negative performance reviews because she was unable to get the requested information when she called competitors and identified herself as a Packard employee On June 1, 2000, Li was terminated on Schmeizl’s recommendation Can Li bring a claim for wrongful discharge? Why or why not? [Li v Canberra Industries, 39 A.3d 789 (Conn.App 2012)] (See page 490.) 21–7.  A Question of Ethics:  Workers’ Compensation Law In 1999, after working for Atchison Leather Products, Inc., in Kansas for ten years, Beverly Tull began to complain of hand, wrist, and shoulder pain Atchison recommended that she contact a certain physician, who in April 2000 diagnosed the condition as carpal tunnel syndrome “severe enough” for surgery In August, Tull filed a claim with the state workers’ compensation board Because Atchison changed workers’ compensation insurance companies every year, a dispute arose as to which company should pay Tull’s claim Fearing liability, no insurer would authorize treatment, and Tull was forced to delay surgery until December The board granted her temporary total disability benefits for the subsequent six weeks that she missed work On April 23, 2002, Berger Co bought Atchison The new employer adjusted Tull’s work so that it was less demanding and stressful, but she continued to suffer pain In July, a physician diagnosed her condition as permanent The board granted her permanent partial disability benefits By May 2005, the bickering over the financial responsibility for Tull’s claim involved five insurers—four of which had each covered Atchison for a single year and one of which covered Berger [Tull v Atchison Leather Products, Inc., 37 Kan.App.2d 87, 150 P.3d 316 (2007)] (See page 496.) (a) When an injured employee files a claim for workers’ compensation, a proceeding is held to assess the injury and determine the amount of compensation Should a dispute between insurers over the payment of the claim be resolved in the same proceeding? Why or why not? (b) The board designated April 23, 2002, as the date of Tull’s injury What is the reason for determining the date of a worker’s injury? Should the board in this case have selected this date or a different date? Why? (c)  How should the board assess liability for the payment of Tull’s medical expenses and disability benefits? Would it be appropriate to impose joint and several liability on the insurers (holding each of them responsible for the full amount of damages), or should the individual liability of each of them be determined? Explain Legal Reasoning Group Activity 21–8.  Wrongful Discharge.  Stefan Sorril, a health teacher at Madison Middle School and a triathlete, appeared shirtless and showed off his “ripped” body as an extra on an episode of a new reality TV show A week after the show aired, school officials called him into the district office and asked for his resignation Sorril later claimed that he was pressured and coerced into resigning He said the school officials had informed him that—as a result of his appearance on the show—he would no longer be offered tenure (a senior academic’s contractual right not to be terminated without just cause) Sorril subsequently sued for wrongful discharge (See page 493.) (a)  The first group will discuss whether Sorril was an employee at will and how that status would affect his claim (b)  The second group will determine if Sorril can assert any of the exceptions to the employment-at-will doctrine (c) The third group will decide whether the school district should be held liable for wrongful discharge, and explain their reasoning Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 22 Employment Discrimination O ut of the 1960s civil rights movement to end racial and other forms of discrimination grew a body of law protecting employees against discrimination in the workplace Legislation, judicial decisions, and administrative agency actions restrict employers from discriminating against workers on the basis of race, color, religion, national origin, gender, age, or disability A class of persons defined by one or more of these criteria is known as a protected class Several federal statutes prohibit employment discrimination against members of protected classes The most important statute is Title VII of the Civil Rights Act of 1964.1 Title VII prohibits employment discrimination on the basis of race, color, religion, national origin, and gender The Age Discrimination in Employment Act of 19672 and the Americans with Disabilities Act of 19903 prohibit discrimination on the basis of age and disability, respectively The protections afforded under these laws also extend to U.S citizens who are working 42 U.S.C Sections 2000e–2000e-17 29 U.S.C Sections 621–634 42 U.S.C Sections 12102–12118 SECTION Title VII of the Civil Rights Act of 1964 Title VII of the Civil Rights Act of 1964 and its amendments prohibit job discrimination against employees, applicants, and union members on the basis of race, color, national origin, religion, and gender at any stage of employment It prohibits discrimination in the hiring process, discipline procedures, discharge, promotion, and benefits Title VII applies to employers with fifteen or more employees, labor unions with fifteen or more members, labor unions that operate hiring halls (to which members go regularly to be assigned jobs as they become available), employment agencies, and state and local governing units or agencies The United States Supreme Court has ruled that an employer with fewer than fifteen employees is not automati- abroad for U.S firms or for companies that are controlled by U.S firms (see Chapter 8) This chapter focuses on the kinds of discrimination prohibited by these federal statutes Note, however, that discrimination against employees on the basis of any of the above-mentioned criteria may also violate state human rights statutes or other state laws prohibiting discrimination By encouraging employment of members of protected classes, these laws also promote diversity in the workplace cally shielded from a lawsuit filed under Title VII.4 In addition, the act prohibits discrimination in most federal government employment When Title VII applies to the employer, any employee—including an undocumented (alien) worker—can bring an action for employment discrimination The Equal Employment Opportunity Commission The Equal Employment Opportunity Commission (EEOC) monitors compliance with Title VII An employee alleging discrimination must file a claim with the EEOC before a lawsuit can be brought against the employer The EEOC may investigate the dispute and attempt to obtain the parties’ voluntary consent to an out-of-court settlement If a voluntary Arbaugh v Y&H Corp., 546 U.S 500, 126 S.Ct 1235, 163 L.Ed.2d 1097 (2006) 505 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 506  Unit Five  The Employment Environment agreement cannot be reached, the EEOC may file a suit against the employer on the employee’s behalf The EEOC does not investigate every claim of employment discrimination Generally, it takes only “priority cases,” such as cases that affect many workers and those involving retaliatory discharge (firing an employee in retaliation for submitting a claim to the EEOC) If the EEOC decides not to investigate a claim, the employee may bring his or her own lawsuit against the employer Limitations on Class Actions In 2011, the United States Supreme Court limited the rights of employees to bring discrimination claims against their employer as a group, or class The decision did not affect the rights of individual employees to sue under Title VII, however ▶ Case in Point 22.1  A group of female employees sued Wal-Mart, the nation’s largest private employer The employees alleged that store managers who had discretion over pay and promotions were biased against women and disproportionately favored men The Supreme Court ruled in favor of Wal-Mart, effectively blocking the class action (a lawsuit in which a small number of plaintiffs sue on behalf of a larger group) The Court held that the women had failed to prove a company-wide policy of discrimination that had a common effect on all women included in the class Therefore, they could not maintain a class action.5  ◀ Intentional and Unintentional Discrimination Title VII of the Civil Rights Act of 1964 prohibits both intentional and unintentional discrimination Wal-Mart Stores, Inc v Dukes, _ U.S _, 131 S.Ct 2541, 180 L.Ed.2d 374 (2011) Intentional Discrimination  Intentional discrimination by an employer against an employee is known as disparate-treatment discrimination Because intent may sometimes be difficult to prove, courts have established certain procedures for resolving ­disparate-treatment cases ▶  Example 22.2  Samantha applies for employment with a construction firm and is rejected If she sues on the basis of disparate-treatment discrimination in hiring, she must show that: She is a member of a protected class She applied and was qualified for the job in question She was rejected by the employer The employer continued to seek applicants for the position or filled the position with a person not in a protected class If Samantha can meet these relatively easy requirements, she has made out a prima facie case of illegal discrimination This means that she has met her initial burden of proof and will win unless the employer can present a legally acceptable defense (Defenses to claims of employment discrimination will be discussed later in this chapter.) The burden then shifts to the employer-defendant, who must articulate a legal reason for not hiring the plaintiff For instance, the employer might say that Samantha was not hired because she lacked sufficient experience or training To prevail, the plaintiff must then show that the employer’s reason is a pretext (not the true reason) and that discriminatory intent actually motivated the employer’s decision.  ◀ In the following case, the trial court assumed that the plaintiff had established a prima facie case of discrimination before considering the defendant’s evidence of a nondiscriminatory reason for its decision to discharge the plaintiff The reviewing court had to consider whether to uphold the trial court’s finding C A S E ANALY S IS Case 22.1  Dees v United Rentals North America, Inc United States Court of Appeals, Ninth Circuit, 2013 WL 28405 (2013) Company profile  United Rentals North America, Inc., rents, sells, and services equipment for underground construction, temporary power, climate control, disaster recovery, and more Since its founding in 1997, United Rentals has grown to become the world’s largest rental equipment provider, with more than $7 billion of inventory available at more than 830 locations and online The company’s customer base includes construction and industrial companies, government agencies, local governments, and individual homeowners Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 22  Employment Discrimination  507 CASE 22.1 CONTINUEd In the language of the court per curiam [By the Whole Court] * * * * In * * * 2006 [Ellis Dees, an African American, applied] to United Rentals for employment at its Gulfport, Mississippi location, and was offered a service technician position in St Rose, Louisiana Branch Manager Mike Sauve made the decision to make the offer, which Dees accepted Although the first two years of Dees’ employment in St Rose went smoothly, United Rentals contends that his attitude and work performance deteriorated beginning in 2009 Specifically, it alleges that he began, with increasing frequency, to mark equipment as fit to be rented even though it was not in working order Dees’ managers—Sauve and Lee Vincent—coached him when these incidents occurred, and noted them in his 2009 mid-year and full-year performance reviews Dees was also given written warnings in August 2009, October 2009, February 2010, and March 2010 Dees was given a “final written warning” on March 4, 2010, advising him that “the next incident will result in immediate termination.” Following a further incident six days later, Sauve and Vincent told Dees that he was fired Dees was sixty-two years old at the time Dees filed a charge with the Equal Employment Opportunity Commission, alleging employment discrimination based on his race and age [in violation of Title VII of the Civil Rights Act and the Age Discrimination in Employment Act (ADEA)] After receiving a “right to sue” notice, he filed suit in [a federal district court] United Rentals filed a motion for summary judgment, which the district court granted * * *  Dees timely appealed * * * * * * * [Under Title VII or the ADEA] Dees first must make a prima facie case of discrimination based on age or race To establish a prima facie case, Dees must show that he: (1) was a member of a protected group; (2) qualified for the position in question; (3) was subjected to an adverse employment action; and (4) received less favorable treatment due to his membership in the protected class than did other similarly situated employees who were not members of the protected class, under nearly identical circumstances If Dees makes a prima facie case, the burden then shifts to United Rentals to articulate a legitimate, non-­ discriminatory reason for firing him If it does so, Dees must, as to his Title VII claim, offer sufficient evidence to create a genuine issue of material fact either (1) that United Rentals’ reason is not true, but is instead a pretext for discrimination * * * ; or (2) that United Rentals’ reason, while true, is only one of the reasons for its conduct, and another motivating factor is Dees’ protected characteristic [Emphasis added.] * * * * The district court assumed, without deciding, that Dees established a prima facie case of discrimination under Title VII and the ADEA The district court * * * determined that United Rentals had provided extensive evidence of a legitimate, non-discriminatory reason for Dees’ termination—namely, unsatisfactory job performance * * * The burden shifted back to Dees to produce evidence that United Rentals’ reason was a pretext for discrimination The district court concluded that Dees had only made conclusory [conclusive] allegations that he was discriminated against * * * * His termination notice states that he was terminated for failing to follow United Rentals’ policy of ensuring that the batteries in rental equipment were in good working order prior to delivery of the equipment * * * Dees has presented nothing to tie United Rentals’ final termination decision to a discriminatory motive * * * Dees himself describes United Rentals as motivated by an “I ain’t missing no rents” philosophy that encouraged renting out equipment regardless of its readiness No evidence shows that United Rentals’ philosophy also included discriminating against African Americans or senior workers Similarly, no evidence demonstrates that United Rentals’ decision to discharge Dees was motivated by his race or age * * * Dees’ subjective belief that United Rentals discriminated against him is clearly insufficient to demonstrate pretext * * * * For the reasons set forth above, we AFFIRM the district court’s grant of summary judgment in United Rentals’ favor Legal Reasoning Questions How did the court treat Dees’s attempt to establish a prima facie case of employment discrimination? On what did both the trial court and the appellate court focus their analysis? What did the plaintiff fail to in submitting his side of the case? How did this failure affect his claims? If Dees had been laid off due to a reduction in force of all workers whose performance did not meet the defendant’s standards, would the result in this case have been different? Explain Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 508  Unit Five  The Employment Environment Unintentional Discrimination  Employers often use interviews and tests to choose from among a large number of applicants for job openings Minimum educational requirements are also common Some employer practices, such as those involving educational requirements, may have an unintended discriminatory impact on a protected class Disparate-impact discrimination occurs when a protected group of people is adversely affected by an employer’s practices, procedures, or tests, even though they not appear to be discriminatory In a disparate-impact discrimination case, the complaining party must first show statistically (using the methods discussed next) that the employer’s practices, procedures, or tests are discriminatory in effect Once the plaintiff has made out a prima facie case, the burden of proof shifts to the employer to show that the practices or procedures in question were justified There are two ways of proving that disparateimpact discrimination exists Pool of Applicants.  A plaintiff can prove a disparate impact by comparing the employer’s workforce to the pool of qualified individuals available in the local labor market The plaintiff must show that (1) as a result of educational or other job requirements or hiring procedures, (2) the percentage of nonwhites, women, or members of other protected classes in the employer’s workforce (3) does not reflect the percentage of that group in the pool of qualified applicants If the plaintiff can show a connection between the practice and the disparity, he or she has made out a prima facie case and need not provide evidence of discriminatory intent Rate of Hiring.  A plaintiff can also prove disparateimpact discrimination by comparing the selection rates of whites and nonwhites (or members of another protected class), regardless of the racial balance in the employer’s workforce When an educational or other job requirement or hiring procedure excludes members of a protected class from an employer’s workforce at a substantially higher rate than for nonmembers, discrimination occurs Under EEOC guidelines, a selection rate for a protected class that is less than four-fifths, or 80 percent, of the rate for the group with the highest rate of hiring generally will be regarded as evidence of disparate impact ▶  Example 22.3  One hundred white applicants take an employment test, and fifty pass the test and are hired One hundred minority group applicants take the test, and twenty pass the employment test and are hired Because twenty is less than four-fifths (80 percent) of fifty, the test would be considered discriminatory under the EEOC guidelines.  ◀ Discrimination Based on Race, Color, and National Origin Title VII prohibits employers from discriminating against employees or job applicants on the basis of race, color, or national origin Race is interpreted broadly to apply to the ancestry or ethnic characteristics of a group of persons, such as Native Americans National origin refers to discrimination based on a person’s birth in another country or his or her ancestry or culture, such as Hispanic (For a discussion of whether employers can legally discriminate against employees based on their appearance, see this chapter’s Insight into Ethics on the facing page.) If an employer’s standards or policies for selecting or promoting employees have a discriminatory effect on employees or job applicants in these protected classes, then a presumption of illegal discrimination arises To avoid liability, the employer must show that its standards or policies have a substantial, demonstrable relationship to realistic qualifications for the job in question ▶ Case in Point 22.4  Jiann Min Chang was an instructor at Alabama Agricultural and Mechanical University (AAMU) When AAMU terminated his employment, Chang filed a lawsuit claiming discrimination based on national origin Chang established a prima facie case because he (1) was a member of a protected class, (2) was qualified for the job, (3) suffered an adverse employment action, and (4) was replaced by someone outside his protected class (a non-Asian instructor) When the burden of proof shifted to the employer, however, AAMU showed that Chang had argued with a vice president and refused to comply with her instructions The court ruled that the university had not renewed Chang’s contract for a legitimate reason—insubordination—and therefore was not liable for unlawful discrimination.6  ◀ Reverse Discrimination  Note that Title VII also protects against reverse discrimination—that is, discrimination against majority group individuals, such as white males ▶ Case in Point 22.5  An African American woman fired four white men from their Jiann Min Chang v Alabama Agricultural and Mechanical University, 2009 WL 3403180 (11th Cir 2009) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 22  Employment Discrimination  509 Insight into Ethics Appearance-Based Discrimination Research has shown that short men make statistically less income than tall men It has also shown that compared with attractive individuals, less attractive people generally receive poorer performance reviews, lower salaries, and smaller damages awards if they win lawsuits Should something be done about this? Can “Lookism” Be Prohibited? Although there is certainly evidence that appearancebased discrimination exists in the workplace and elsewhere, it is not so clear that it can be prohibited In the 1970s, Michigan decided to something about “lookism” and passed a law barring various kinds of appearancebased discrimination.a Whether because of the cost or the difficulty of proving this type of discrimination, however, only a few lawsuits based on the law have been filed each year At least six cities have similar laws, but these laws also have not given rise to many lawsuits Federal and state laws prohibit discrimination against people who are clinically obese, but discrimination against those who are merely overweight is usually not illegal Given that one study found that more than 40 percent of overweight women felt stigmatized by their employers, this remains a serious problem a Michigan Compiled Laws Section 37.2202 management positions at a school district She claimed that the terminations were part of a reorganization plan to cut costs in the department The men sued for (reverse) racial discrimination and won They were awarded nearly $3 million in damages.7  ◀ In 2009, the United States Supreme Court issued a decision that has had a significant impact on disparate-impact and reverse discrimination litiga­ tion ▶ Case in Point 22.6  The fire department in New Haven, Connecticut, administered a test to identify which firefighters were eligible for promotions No African Americans and only two Hispanic firefighters passed the test Fearing that it would be sued for racial discrimination if it used the test results for promotions, the city refused to use the results Johnston v School District of Philadelphia, 2006 WL 999966 (E.D.Pa 2006) The damages awarded by a jury were reduced slighted by the appellate court A Double Standard for Grooming Women sometimes complain that they are held to different grooming standards in the workplace than their male counterparts A female bartender at a casino in Nevada brought a lawsuit after she was fired for not complying with rules that required her to wear makeup and teased hair while male bartenders were just told to “look neat.” The court ruled, however, that these allegations were not enough to outweigh an at-will employment contract.b At the same time, women in senior management positions find that they can look “too sexy.” A few years ago, a Citibank employee made headlines when she claimed that she was fired for her excessive sexiness, which supposedly distracted her male co-workers Legal Critical Thinking Insight into Social Media The majority of workers today post photographs of themselves, their families, and their friends on Facebook and other social media How might this practice affect appearancebased discrimination in the workplace? b Jespersen v Harrah’s Operating Co., 444 F.3d 1104 (9th Cir 2006) The white firefighters (and one Hispanic) who had passed the test then sued the city, claiming reverse discrimination The Supreme Court held that the city’s actions were not justified Mere fear of litigation was not a sufficient reason for the city to discard its test results.8 The city subsequently certified the test results and promoted all the firefighters involved in the lawsuit.  ◀ Potential Section 1981 Claims  Victims of racial or ethnic discrimination may also have a cause of action under 42 U.S.C Section 1981 This section, which was enacted as part of the Civil Rights Act of 1866 to protect the rights of freed slaves, prohibits discrimination on the basis of race or ethnicity in the formation Ricci v DeStefano, 557 U.S 557, 129 S.Ct 2658, 174 L.Ed.2d 490 (2009) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 510  Unit Five  The Employment Environment or enforcement of contracts Because employment is often a contractual relationship, Section 1981 can provide an alternative basis for a plaintiff’s action and is potentially advantageous because it does not place a cap on damages Discrimination Based on Religion Title VII of the Civil Rights Act of 1964 also prohibits government employers, private employers, and unions from discriminating against persons because of their religion Employers cannot treat their employees more or less favorably based on their religious beliefs or practices and cannot require employees to participate in any religious activity (or forbid them from participating in one) ▶  Example 22.7  Jason Sewell claims that his employer, a car dealership, fired him for not attending the weekly prayer meetings of dealership employees If the dealership does require its employees to attend prayer gatherings and fired Sewell for not attending, he has a valid claim of religious discrimination.  ◀ Reasonable Accommodation  An employer must “reasonably accommodate” the religious practices of its employees, unless to so would cause undue hardship to the employer’s business An employee’s religion might prohibit her or him from working on a certain day of the week, for instance, or at a certain type of job The employer must make a reasonable attempt to accommodate the employee’s sincerely held religious belief Reasonable accommodation is required even if the belief is not based on the doctrines of a traditionally recognized religion, such as Christianity or Judaism, or of a denomination, such as Baptist Undue Hardship  A reasonable attempt to accommodate does not necessarily require the employer to make every change an employee requests or to make a permanent change for an employee’s benefit An employer is not required to make an accommodation that would cause the employer undue hardship ▶ Case in Point 22.8  Miguel Sánchez-Rodríguez sold cell phones at kiosks in shopping malls for AT&T in Puerto Rico After six years, Sánchez informed his supervisors that he had become a Seventh Day Adventist and could no longer work on Saturdays for religious reasons AT&T responded that his position required rotating Saturday shifts and that his inability to work on Saturdays would cause it hardship As a reasonable accommodation, the company suggested that Sánchez swap schedules with others and offered him two other positions that would not require work on Saturdays Sánchez was unable to find workers to swap shifts with him, however, and declined the other jobs because they would result in less income (no commissions) He began missing work on Saturdays After a time, AT&T indicated that it would discipline him for any additional Saturdays that he missed Eventually, he was placed on active disciplinary status Sánchez resigned and filed a religious discrimination lawsuit The court found in favor of AT&T, and a federal appellate court affirmed The company had made adequate efforts at accommodation by allowing Sánchez to swap shifts and offering him other positions that did not require work on Saturdays.9  ◀ Discrimination Based on Gender Under Title VII and other federal acts, employers are forbidden from discriminating against employees on the basis of gender Employers are prohibited from classifying or advertising jobs as male or female unless the employer can prove that the gender of the applicant is essential to the job Employers also cannot have separate male and female seniority lists or refuse to promote employees based on their gender Gender Must Be a Determining Factor Generally, to succeed in a suit for gender discrimination, a plaintiff must demonstrate that gender was a determining factor in the employer’s decision to hire, fire, or promote him or her Typically, this involves looking at all of the surrounding circumstances ▶ Case in Point 22.9  Wanda Collier worked for Turner Industries Group, LLC, in the maintenance department She complained to her supervisor that Jack Daniell, the head of the department, treated her unfairly Her supervisor told her that Daniell had a problem with her gender and was harder on women The supervisor talked to Daniell about Collier’s complaint, but did not take any disciplinary action A month later, Daniell confronted Collier, pushing her up against a wall and berating her After this incident, Collier filed a formal complaint and kept a male co-worker with her at all times A month later, she was fired She subsequently filed a lawsuit alleging gender discrimination The court allowed Collier’s clam to go to a jury because there was suf9 Sánchez-Rodríguez v AT&T Mobility Puerto Rico, Inc., 673 F.3d (1st Cir 2012) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 22  Employment Discrimination  ficient evidence that gender was a determining factor in Daniell’s conduct.10  ◀ Pregnancy Discrimination  The Pregnancy Discrimination Act11 amended Title VII and expanded the definition of gender discrimination to include discrimination based on pregnancy Women affected by pregnancy, childbirth, or related medical conditions must be treated—for all employment-related purposes, including the receipt of benefits under employee benefit programs—the same as other persons not so affected but similar in ability to work Wage Discrimination  Several laws prohibit employers from engaging in gender-based wage discrimination The Equal Pay Act12 requires equal pay for male and female employees working at the same establishment doing similar work (a barber and a hair stylist, for example) To determine whether the Equal Pay Act has been violated, a court will look to the primary duties of the two jobs—the job content rather than the job description controls.13 If a court finds that the wage differential is due to “any factor other than gender,” such as a seniority or merit system, then it does not violate the Equal Pay Act In 2009, Congress enacted the Lilly Ledbetter Fair Pay Act, which made discriminatory wages actionable under federal law regardless of when the discrimination began.14 This act countered a previous decision by the United States Supreme Court that had limited the time period in which plaintiffs could file a wagediscrimination complaint to 180 days after the employer’s decision.15 Today, if a plaintiff continues to work for the employer while receiving discriminatory wages, the time period for filing a complaint is practically unlimited Constructive Discharge The majority of Title VII complaints involve unlawful discrimination in decisions to hire or fire employees In some situations, however, employees who 10 Collier v Turner Industries Group, LLC, 797 F.Supp.2d 1029 (D Idaho 2011) 11 42 U.S.C Section 2000e(k) 12 29 U.S.C Section 206(d) 13 For an illustration of the factors courts consider in wage-­ discrimination claims under the Equal Pay Act, see Beck-Wilson v Principi, 441 F.3d 353 (6th Cir 2006) 14 Pub L No 111-2, 123 Stat (January 5, 2009), amending 42 U.S.C Section 2000e-5[e] 15 Ledbetter v Goodyear Tire Co., 550 U.S 618, 127 S.Ct 2162, 167 L.Ed.2d 982 (2007) 511 leave their jobs voluntarily can claim that they were “constructively discharged” by the employer Constructive discharge occurs when the employer causes the employee’s working conditions to be so intolerable that a reasonable person in the employee’s position would feel compelled to quit Proving Constructive Discharge  The employee must present objective proof of intolerable working conditions, which the employer knew or had reason to know about yet failed to correct within a reasonable time period Courts generally also require the employee to show causation—that the employer’s unlawful discrimination caused the working conditions to be intolerable Put a different way, the employee’s resignation must be a foreseeable result of the employer’s discriminatory action Courts weigh the facts on a case-by-case basis Employee demotion is one of the most frequently cited reasons for a finding of constructive discharge, particularly when the employee was subjected to humiliation ▶  Example 22.10  Khalil’s employer humiliates him by informing him in front of his co-workers that he is being demoted to an inferior position Khalil’s coworkers then continually insult him, harass him, and make derogatory remarks to him about his national origin (he is from Iran) The employer is aware of this discriminatory treatment but does nothing to remedy the situation, despite repeated complaints from Khalil After several months, Khalil quits his job and files a Title VII claim In this situation, Khalil would likely have sufficient evidence to maintain an action for constructive discharge in violation of Title VII.  ◀ Applies to All Title VII Discrimination  Plaintiffs can use constructive discharge to establish any type of discrimination claims under Title VII, including race, color, national origin, religion, gender, and pregnancy, but it is most commonly asserted in cases involving sexual harassment Constructive discharge may also be used in cases involving discrimination based on age or disability (discussed later in this chapter) When constructive discharge is claimed, the employee can pursue damages for loss of income, including back pay These damages ordinarily are not available to an employee who left a job voluntarily Sexual Harassment Title VII also protects employees against sexual harassment in the workplace Sexual harassment can take two forms: Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 512  Unit Five  The Employment Environment Quid pro quo harassment occurs when sexual favors are demanded in return for job opportunities, promotions, salary increases, or other benefits Quid pro quo is a Latin phrase that is often translated as “something in exchange for something else.” Hostile-environment harassment occurs when a pattern of sexually offensive conduct runs throughout the workplace and the employer has not taken steps to prevent or discourage it In the words of the United States Supreme Court, hostile-environment harassment exists when “the workplace is permeated with discriminatory intimidation, ridicule, and insult, that is sufficiently severe or pervasive to alter the conditions of the victim’s employment and create an abusive working environment.”16 The courts determine whether the sexually offensive conduct was sufficiently severe or pervasive to create a hostile environment on a case-by-case basis Typically, a single incident of sexually offensive conduct is not enough to permeate the work environment (although there have been exceptions when the conduct was particularly objectionable).17 If the employee who is alleging sexual harassment has signed an employment contract containing an arbitration clause (see Chapter 3), she or he will most likely be required to arbitrate the claim.18 In other words, the dispute will not be litigated in court Harassment by Supervisors For an employer to be held liable for a supervisor’s sexual harassment, the supervisor normally must have taken a tangible employment action against the employee A tangible employment action is a significant change in employment status or benefits, such as when an employee is fired, refused a promotion, demoted, or reassigned to a position with significantly different responsibilities Only a supervisor, or another person acting with the authority of the employer, can cause this sort of harm A constructive discharge also qualifies as a tangible employment action.19 The Ellerth/Faragher Affirmative Defense In 1998, the United States Supreme Court issued several 16 Harris v Forklift Systems, 510 U.S 17, 114 S.Ct 367, 126 L.Ed.2d 295 (1993) See also Baker v Via Christi Regional Medical Center, 491 F.Supp.2d 1040 (D.Kan 2007) 17 See, for example, Pomales v Celulares Telefonica, Inc., 447 F.3d 79 (1st Cir 2006); and Fontanez-Nunez v Janssen Ortho, LLC, 447 F.3d 50 (1st Cir 2006) 18 See, for example, EEOC v Cheesecake Factory, Inc., 2009 WL 1259359 (D.Ariz 2009) 19 See, for example, Pennsylvania State Police v Suders, 542 U.S 129, 124 S.Ct 2342, 159 L.Ed.2d 204 (2004) important rulings that have had a lasting impact on cases involving alleged sexual harassment by supervisors.20 The Court held that an employer (a city) was liable for a supervisor’s harassment of employees even though the employer was unaware of the behavior Although the city had a written policy against sexual harassment, it had not distributed the policy to its employees and had not established any complaint procedures for employees who felt that they had been sexually harassed In another case, the Court held that an employer can be liable for a supervisor’s sexual harassment even though the employee does not suffer adverse job consequences The Court’s decisions in these cases established what has become known as the Ellerth/Faragher affirmative defense to charges of sexual harassment The defense has two elements: The employer must have taken reasonable care to prevent and promptly correct any sexually harassing behavior (by establishing effective harassment policies and complaint procedures, for instance) The plaintiff-employee must have unreasonably failed to take advantage of preventive or corrective opportunities provided by the employer to avoid harm An employer that can prove both elements normally will not be liable for a supervisor’s harassment Retaliation by Employers  Employers sometimes retaliate against employees who complain about sexual harassment or other Title VII violations Retaliation can take many forms An employer might demote or fire the person, or otherwise change the terms, conditions, and benefits of employment Title VII prohibits retaliation, and employees can sue their employers when it occurs In a retaliation claim, an individual asserts that she or he has suffered harm as a result of making a charge, testifying, or participating in a Title VII investigation or proceeding Plaintiffs not have to prove that the challenged action adversely affected their workplace or employment Instead, plaintiffs must show that the action would likely have dissuaded a reasonable worker from making or supporting a charge of discrimination Title VII’s retaliation protection extends to an employee who speaks out about discrimination 20 Burlington Industries, Inc v Ellerth, 524 U.S 742, 118 S.Ct 2257, 141 L.Ed.2d 633 (1998); and Faragher v City of Boca Raton, 524 U.S 775, 118 S.Ct 2275, 141 L.Ed.2d 662 (1998) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 22  Employment Discrimination  against another employee during an employer’s internal investigation.21 The Supreme Court has also held that Title VII protected an employee who was fired after his fiancée filed a gender discrimination claim against their employer.22 513 In the following case, a law professor lost her job after she complained about comments made by her dean and colleagues The court had to decide whether she had been retaliated against for engaging in protected conduct 21 Crawford v Metropolitan Government of Nashville and Davidson County, Tennessee, 555 U.S 271, 129 S.Ct 846, 172 L.Ed.2d 650 (2009) 22 See Thompson v North American Stainless, LP, _ U.S _, 131 S.Ct 863, 178 L.Ed.2d 694 (2011) Case 22.2 Morales-Cruz v University of Puerto Rico United States Court of Appeals, First Circuit, 676 F.3d 220 (2012) BACKGROUND AND FACTS  In 2003, Myrta Morales-Cruz began a tenure-track teaching position at the University of Puerto Rico School of Law During Morales-Cruz’s probationary period, one of her colleagues in a law school clinic had an affair with one of their students that resulted in a pregnancy In 2008, Morales-Cruz wanted the university’s administrative committee to approve a one-year extension for her tenure review The law school’s dean asked Morales-Cruz about her colleague’s affair and criticized her for failing to report it He later recommended granting the extension but called Morales-Cruz “­ insecure,” “immature,” and “fragile.” Similarly, a law school committee recommended granting the extension Nevertheless, a dissenting professor commented that in dealing with her colleague’s affair, Morales-Cruz had shown poor judgment, exhibited “personality flaws,” and demonstrated that she had trouble with “complex and sensitive” situations Morales-Cruz soon learned about the dean’s and the dissenting professor’s comments and complained in writing to the university’s chancellor As a result, the dean then recommended denying the one-year extension, and the administrative committee ultimately did just that When her employment was terminated, Morales-Cruz sued the university under Title VII Among other things, she asserted that the dean had retaliated against her for complaining to the chancellor The district court found that Morales-Cruz had not stated a proper retaliation claim under Title VII IN THE LANGUAGE OF THE COURT SELYA, Circuit Judge * * * * The amended complaint alleges that various officials described the plaintiff as “fragile,” “immature,” “unable to handle complex and sensitive issues,” * * * and exhibiting “lack of judgment.” These descriptors are admittedly unflattering—but they are without exception gender-neutral All of them apply equally to persons of either gender * * *  * * * * * * * Title VII makes it unlawful for an employer to take materially adverse action against an employee “because he has opposed any practice made an unlawful employment practice by this subchapter.” To state a cause of action under this portion of the statute, the pleading must contain plausible allegations indicating that the plaintiff opposed a practice prohibited by Title VII and suffered an adverse employment action as a result of that opposition. [Emphasis added.] The plaintiff alleges that she was retaliated against for writing to the Chancellor to complain about the “discriminatory” comments made in the course of her request for an extension In support of this allegation, she points out that after she sent her letter the Dean reversed his position on her extension This construct suffers from a fatal flaw: her factual allegations not support a reasonable inference that she was engaging in protected conduct when she opposed the remarks made CASE 22.2 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 514  Unit Five  The Employment Environment CASE 22.2 CONTINUEd * * * The facts alleged * * * provide no reasonable basis for inferring that the comments cited reflected gender-based discrimination. Those comments were unarguably gender-neutral and not afford an objectively reasonable foundation for a retaliation action DECISION AND REMEDY  The appellate court held that Morales-Cruz could not bring a retaliation claim under Title VII It therefore affirmed the district court’s judgment for the University of Puerto Rico THE ETHICAL DIMENSION  Could Morales-Cruz’s dean have had legitimate reasons for changing his mind about the one-year extension? If so, what might they have been? THE LEGAL ENVIRONMENT DIMENSION  What steps should employers take to reduce the likelihood that supervisors will retaliate against employees who make or support discrimination claims? Harassment by Co-Workers and Others  When the harassment of co-workers, rather than supervisors, creates a hostile working environment, an employee may still have a cause of action against the employer Normally, though, the employer will be held liable only if it knew or should have known about the harassment and failed to take immediate remedial action Occasionally, a court may also hold an employer liable for harassment by nonemployees if the employer knew about the harassment and failed to take corrective action ▶  Example 22.11  Jordan, who owns and manages a Great Bites restaurant, knows that one of his regular customers, Dean, repeatedly harasses Kaylia, a waitress If Jordan does nothing and permits the harassment to continue, he may be liable under Title VII even though Dean is not an employee of the restaurant.  ◀ Same-Gender Harassment  In Oncale v Sundowner Offshore Services, Inc.,23 the United States Supreme Court held that Title VII protection extends to individuals who are sexually harassed by members of the same gender Proving that the harassment in same-gender cases is “based on sex” can be difficult, though It is easier to establish a case of same-gender harassment when the harasser is homosexual.24 Sexual Orientation Harassment Federal law (Title VII) does not prohibit discrimination or harassment based on a person’s sexual orientation Nonetheless, a growing number of states have enacted laws that prohibit sexual orientation discrimination in 23 523 U.S 75, 118 S.Ct 998, 140 L.Ed.2d 207 (1998) 24 See, for example, Tepperwien v Entergy Nuclear Operations, Inc., 606 F.Supp.2d 427 (S.D.N.Y 2009) private employment.25 Some states, such as Michigan, explicitly prohibit discrimination based on a person’s gender identity or expression Many companies have also voluntarily established nondiscrimination policies that include sexual orientation Online Harassment Employees’ online activities can create a hostile working environment in many ways Racial jokes, ethnic slurs, or other comments contained in e-mail, texts, blogs, and social media can lead to a claim of hostileenvironment harassment or other forms of discrimination A worker who regularly sees sexually explicit images on a co-worker’s computer screen may find the images offensive and claim that they create a hostile working environment Nevertheless, employers may be able to avoid liability for online harassment by taking prompt remedial action Remedies under Title VII Employer liability under Title VII may be extensive If the plaintiff successfully proves that unlawful discrimination occurred, he or she may be awarded reinstatement, back pay, retroactive promotions, and damages Compensatory damages are available only in cases of intentional discrimination Punitive damages may be recovered against a private employer only if the employer acted with malice or reckless indifference to an individual’s rights The statute limits the total amount of compensatory and punitive damages that plaintiffs can recover from specific employers, 25 See, for example, 775 Illinois Compiled Statutes 5/1–103 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 22  Employment Discrimination  depending on the size of the employer For instance, there is a $50,000 cap on damages from employers with one hundred or fewer employees SECTION Discrimination Based on Age Age discrimination is potentially the most widespread form of discrimination because anyone—regardless of race, color, national origin, or gender—could be a victim at some point in life The Age Discrimination in Employment Act26 (ADEA), as amended, prohibits employment discrimination on the basis of age against individuals forty years of age or older The act also prohibits mandatory retirement for nonmanagerial workers The United States Supreme Court has ruled that the ADEA encompasses not only claims of age discrimination, but also claims of retaliation for complaining about age discrimination.27 Thus, the ADEA protects federal and private-sector employees from retaliation based on age-related complaints For the act to apply, an employer must have twenty or more employees, and the employer’s business activities must affect interstate commerce The EEOC administers the ADEA, but the act also permits private causes of action against employers for age discrimination 26 29 U.S.C Sections 621–634 27 Gomez-Perez v Potter, 553 U.S 474, 128 S.Ct 1931, 170 L.Ed.2d 887 (2008) 515 Procedures under the ADEA The burden-shifting procedure under the ADEA differs from the procedure under Title VII as a result of a 2009 United States Supreme Court decision, which dramatically changed the burden of proof in age discrimination cases.28 As explained earlier, if the plaintiff in a Title VII case can show that the employer was motivated, at least in part, by unlawful discrimination, the burden of proof shifts to the employer to articulate a legitimate nondiscriminatory reason for the challenged action Thus, in cases in which the employer has a “mixed motive” for discharging an employee, the employer has the burden of proving its reason was legitimate Under the ADEA, in contrast, a plaintiff must show that the unlawful discrimination was not just a reason but the reason for the adverse employment action In other words, the employee has the burden of establishing but for causation—that is, “but for” the employee’s age, the action would not have been taken Thus, to establish a prima facie case, the plaintiff must show that she or he (1) was a member of the protected age group, (2) was qualified for the position from which she or he was discharged, and (3)  was discharged because of age discrimination Then the burden shifts to the employer If the employer offers a legitimate reason for its action, the plaintiff must show that the stated reason is only a pretext for the employer’s decision The following case illustrates this process 28 Gross v FBL Financial Services, Inc., 557 U.S 167, 129 S.Ct 2343, 174 L.Ed.2d 119 (2009) Case 22.3 Mora v Jackson Memorial Foundation, Inc United States Court of Appeals, Eleventh Circuit, 597 F.3d 1201 (2010) BACKGROUND AND FACTS  Josephine Mora, a fund-raiser for Jackson Memorial Foundation, Inc., was sixty-two years old when the foundation’s chief executive officer (CEO) fired her, citing errors and issues with professionalism Mora filed a suit against the foundation, alleging age discrimination She asserted that when she was fired, the CEO told her, “I need someone younger I can pay less.” She had a witness who heard that statement and also heard the CEO say that Mora was “too old to be working here anyway.”  The foundation moved for summary judgment, arguing that Mora was fired chiefly because she was incompetent The district court granted the motion, and Mora appealed IN THE LANGUAGE OF THE COURT PER CURIAM [By the Whole Court] * * * * CASE 22.3 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 516  Unit Five  The Employment Environment CASE 22.3 CONTINUEd After Plaintiff [Mora] appealed, the Supreme Court, in Gross v FBL Financial Services, Inc.,a clarified the nature of ADEA claims The Supreme Court concluded that ADEA claims are not subject to the burden-shifting protocol set forth for Title VII suits in Price Waterhouse v Hopkins.b The ADEA requires that “age [be] the reason that the employer decided to act.” Because an ADEA plaintiff must establish “but for” causality, no “same decision” affirmative defense [the argument that the same decision—to fire someone, for example—would have been made regardless of the alleged discrimination] can exist: the employer either acted “because of” the plaintiff’s age or it did not [Emphasis added.] Because the Supreme Court has excluded the whole idea of a “mixed motive” ADEA claim—and the corresponding “same decision” defense—we need not consider the district court’s analysis of Defendant’s [the foundation’s] affirmative defense Instead, * * * we look to determine whether a material factual question exists on this record about whether Defendant discriminated against her We say “Yes.” * * * * A plaintiff in an ADEA claim may “establish a claim of illegal age discrimination through either direct evidence or circumstantial evidence.” Plaintiff’s testimony that Rodriguez [the CEO] fired her because she was “too old” was substantiated by the affidavits of two other employees of Defendant Rodriguez and Quevedo [another employee] testified that no such comments were made * * *  The resolution of this case depends on whose account of the pertinent conversations a jury would credit We conclude that a reasonable juror could accept that Rodriguez made the discriminatory-sounding remarks and that the remarks are sufficient evidence of a discriminatory motive which was the “but for” cause of Plaintiff’s dismissal Summary judgment for Defendant was therefore incorrect We have considered cases factually similar to Plaintiff’s In [one case], we concluded that statements from a county official who “didn’t want to hire any old pilots” were direct evidence of discrimination * * *  In [another case], we likewise concluded that an employer’s statement that he wanted “aggressive, young men like himself to be promoted” was circumstantial evidence of discrimination While these cases were litigated under the now-defunct ADEA mixed motive theory, they remain instructive Plaintiff’s situation is similar A reasonable juror could find that Rodriguez’s statements should be taken at face value and that he fired Plaintiff because of her age DECISION AND REMEDY  The U.S Court of Appeals for the Eleventh Circuit vacated (set aside) the decision of the trial court and remanded the case for further proceedings Because there was a “disputed question of material fact” as to whether the plaintiff had been fired because of her age, the defendant was not entitled to summary judgment THE ETHICAL DIMENSION  Is the court’s decision in this case fair to employers? Why or why not? MANAGERIAL IMPLICATIONS  Business owners and supervisory personnel should be careful to avoid statements regarding an employee’s age that may sound discriminatory If the employee later has to be dismissed due to poor performance, comments about his or her age may become the basis for an age discrimination lawsuit a 557 U.S 167, 129 S.Ct 2343, 174 L.Ed.2d 119 (2009) b 490 U.S 228, 109 S.Ct 1775, 104 L.Ed.2d 268 (1989) Replacing Older Workers with Younger Workers Numerous age discrimination cases have been brought against employers who, to cut costs, replaced older, higher-salaried employees with younger, lower- salaried workers Whether a firing is discriminatory or simply part of a rational business decision to prune the company’s ranks is not always clear A plaintiff must prove that the discharge was motivated by age bias The plaintiff does not need to prove that she or he was replaced by a person “outside the Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 22  Employment Discrimination  517 protected class” (under the age of forty years), as long as the replacement worker is younger than the plaintiff Nevertheless, the bigger the age gap, the more likely the plaintiff will succeed in showing age discrimination “reasonably accommodate” the needs of persons with disabilities unless to so would cause the employer to suffer an “undue hardship.” The ADA Amendments Act34 broadened the coverage of the ADA’s protections, as discussed shortly State Employees Not Covered by the ADEA Procedures under the ADA Generally, the states are immune under the Eleventh Amendment from lawsuits brought by private individuals in federal court—unless a state consents to the suit This immunity stems from the United States Supreme Court’s interpretation of the Eleventh Amendment (see Appendix B) State immunity under the Eleventh Amendment is not absolute, however In some situations, such as when fundamental rights are at stake, Congress has the power to abrogate (abolish) state immunity to private suits through legislation that unequivocally shows Congress’s intent to subject states to private suits.29 Generally, though, the Court has found that state employers are immune from private suits brought by employees under the ADEA (for age discrimination), the Americans with Disabilities Act (for disabilitybased discrimination),30 and the Fair Labor Standards Act.31 State employers are not immune from the requirements of the Family and Medical Leave Act, however.32 SECTION Discrimination Based on Disability The Americans with Disabilities Act (ADA) of 199033 prohibits disability-based discrimination in all workplaces with fifteen or more workers An exception is state government employers, who are generally immune under the Eleventh Amendment, as just discussed Basically, the ADA requires that employers 29 Tennessee v Lane, 541 U.S 509, 124 S.Ct 1978, 158 L.Ed.2d 820 (2004) 30 Board of Trustees of the University of Alabama v Garrett, 531 U.S 356, 121 S.Ct 955, 148 L.Ed.2d 866 (2001) 31 Alden v Maine, 527 U.S 706, 119 S.Ct 2240, 144 L.Ed.2d 636 (1999) 32 Nevada Department of Human Resources v Hibbs, 538 U.S 721, 123 S.Ct 1972, 155 L.Ed.2d 953 (2003) 33 42 U.S.C Sections 12103–12118 To prevail on a claim under the ADA, a plaintiff must show that he or she (1) has a disability, (2) is otherwise qualified for the employment in question, and (3) was excluded from the employment solely because of the disability As in Title VII cases, the plaintiff must pursue the claim through the EEOC before filing an action in court for a violation of the ADA The EEOC may decide to investigate and perhaps even sue the employer on behalf of the employee The EEOC can bring a suit on behalf of the employee under the ADA even if the employee signed an arbitration agreement with the employer.35 If the EEOC decides not to sue, then the employee may so Plaintiffs in lawsuits brought under the ADA may seek many of the same remedies that are available under Title VII These include reinstatement, back pay, a limited amount of compensatory and punitive damages (for intentional discrimination), and certain other forms of relief Repeat violators may be ordered to pay fines of up to $100,000 What Is a Disability? The ADA is broadly drafted to cover persons with physical or mental impairments that “substantially limit” their everyday activities Specifically, the ADA defines a disability as including any of the following: A physical or mental impairment that substantially limits one or more of the major life activities of the affected individual A record of having such an impairment Being regarded as having such an impairment Types of Disability  Health conditions that have been considered disabilities under federal law include blindness, alcoholism, heart disease, cancer, muscular dystrophy, cerebral palsy, paraplegia, diabetes, acquired immune deficiency syndrome (AIDS), testing positive for the human immunodeficiency virus 34 42 U.S.C Sections 12103 and 12205a 35 This was the Supreme Court’s ruling in EEOC v Waffle House, Inc., 534 U.S 279, 122 S.Ct 754, 151 L.Ed.2d 755 (2002) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 518  Unit Five  The Employment Environment (HIV, the virus that causes AIDS), and morbid obesity (which exists when an individual’s weight is twice the normal weight for his or her height) The ADA includes a separate provision that prevents employers from taking adverse employment actions based on stereotypes or assumptions about individuals who associate with people who have disabilities.36 An employer cannot, for instance, refuse to hire the parent of a child with a disability based on the assumption that the person will miss work too often or be unreliable.37 Correctable Conditions  At one time, the courts focused on whether a person had a disability after the use of corrective devices or medication A person with severe myopia (nearsightedness), which can be corrected with lenses, for instance, did not qualify as having a disability because that individual’s major life activities were not substantially impaired In 2008, Congress amended the ADA to strengthen its protections and prohibit employers from considering mitigating measures or medications when determining if an individual has a disability Disability is now determined on a case-by-case basis A condition may fit the definition of disability in one set of circumstances, but not in another Reasonable Accommodation The ADA does not require that employers accommodate the needs of job applicants or employees with disabilities who are not otherwise qualified for the work If a job applicant or an employee with a disability, with reasonable accommodation, can perform essential job functions, however, the employer must make the accommodation Required modifications may include installing ramps for a wheelchair, establishing flexible working hours, creating or modifying job assignments, and designing or improving training materials and procedures Generally, employers should give primary consideration to employees’ preferences in deciding what accommodations should be made whether an accommodation constitutes an undue hardship on a case-by-case basis ▶  Example 22.12  Bryan Lockhart, who uses a wheelchair, works for a cell phone company that provides parking for its employees Lockhart informs his supervisor that the parking spaces are so narrow that he is unable to extend the ramp on his van that allows him to get in and out of the vehicle Lockhart therefore requests that the company reasonably accommodate his needs by paying a monthly fee for him to use a larger parking space in an adjacent lot In this situation, a court would likely find that it would not be an undue hardship for the employer to pay for additional parking for Lockhart.  ◀ Job Applications and Physical Exams  Employers must modify their job-application and selection process so that those with disabilities can compete for jobs with those who not have disabilities For instance, a job announcement might be modified to allow applicants to respond by e-mail or letter, as well as by telephone, so that it does not discriminate against potential applicants with hearing impairments Employers are restricted in the kinds of questions they may ask on job-application forms and during preemployment interviews In addition, employers cannot require persons with disabilities to submit to preemployment physicals unless such exams are required of all other applicants An employer can disqualify the applicant only if the medical problems discovered during a preemployment physical would make it impossible for the applicant to perform the job ▶  Example 22.13  Abba Freight Systems runs a trucking operation When filling the position of delivery truck driver, Abba cannot screen out all applicants who are unable to meet the U.S Department of Transportation’s hearing standard Abba would first have to prove that drivers who are deaf are not qualified to perform the essential job function of driving safely and pose a higher risk of accidents than drivers who are not deaf.38  ◀ Undue Hardship  Employers who not accommodate the needs of persons with disabilities must demonstrate that the accommodations would cause undue hardship in terms of being significantly difficult or expensive for the employer Usually, the courts decide Substance Abusers  Drug addiction is considered a disability under the ADA because it is a substantially limiting impairment The act does not protect individuals who are actually using illegal drugs, however Instead, the ADA protects only persons with former drug addictions—those who have completed or are now in a supervised drug-rehabilitation program 36 42 U.S.C Section 12112(b)(4) 37 See, for example, Francin v Mosby, Inc., 248 S.W.3d 619 (Mo 2008) 38 See, for example, Bates v United Parcel Service, Inc., 465 F.3d 1069 (9th Cir 2006) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 22  Employment Discrimination  Individuals who have used drugs casually in the past also are not protected under the act They are not considered addicts and therefore not have a disability (addiction) People suffering from alcoholism are protected by the ADA Employers cannot legally discriminate against employees simply because they suffer from alcoholism Of course, employers can prohibit the use of alcohol in the workplace and require that employees not be under the influence of alcohol while working Employers can also fire or refuse to hire a person who is an alcoholic if (1) he or she poses a substantial risk of harm either to himself or herself or to others, and (2) the risk cannot be reduced by reasonable accommodation Health-Insurance Plans Workers with disabilities must be given equal access to any health insurance provided to other employees An employer can put a limit, or cap, on health-care payments under its group health policy, however, as long as the cap is applied equally to all insured employees and does not discriminate on the basis of disability Whenever a group health-care plan makes a disability-based distinction in its benefits, the plan violates the ADA (An exception exists if the employer can justify its actions under the business necessity defense, as discussed in the next section) SECTION Defenses to Employment Discrimination The first line of defense for an employer charged with employment discrimination is to assert that the plaintiff has failed to meet his or her initial burden of proving that discrimination occurred As noted, plaintiffs bringing age discrimination claims may find it difficult to meet this initial burden because they must prove that age discrimination was the reason for their employer’s decision Once a plaintiff succeeds in proving that discrimination occurred, the burden shifts to the employer to justify the discriminatory practice Possible justifications include that the discrimination was the result of a business necessity, a bona fide occupational qualification, or a seniority system In some situations, as noted earlier, an effective antiharassment policy and prompt remedial action when harassment occurs may shield employers from liability for sexual harassment under Title VII 519 Business Necessity An employer may defend against a claim of disparateimpact (unintentional) discrimination by asserting that a practice that has a discriminatory effect is a business necessity ▶  Example 22.14  Jiffy Mart requires its employees to have a high school diploma If this requirement is shown to have a discriminatory effect, Jiffy might argue that a high school education is necessary for workers to perform the job at a required level of competence If Jiffy can demonstrate to the court’s satisfaction that a definite connection exists between a high school education and job performance, then Jiffy normally will succeed in this business necessity defense.  ◀ Bona Fide Occupational Qualification Another defense applies when discrimination against a protected class is essential to a job—that is, when a particular trait is a bona fide occupational qualification (BFOQ) Race, color, and national origin, however, can never be BFOQs Generally, courts have restricted the BFOQ defense to instances in which the employee’s gender or religion is essential to the job ▶  Example 22.15  Urban Minx, a women’s clothing store, might legitimately hire only female salespersons if part of a salesperson’s job involves assisting clients in the store’s dressing rooms Similarly, the Federal Aviation Administration can legitimately impose age limits for airline pilots— but an airline cannot impose weight limits only on female flight attendants.  ◀ Seniority Systems An employer with a history of discrimination may have no members of protected classes in upper-level positions Even if the employer now seeks to be unbiased, it may face a lawsuit from members of protected classes claiming that they should be promoted ahead of schedule to compensate for past discrimination If no present intent to discriminate is shown, however, and if promotions or other job benefits are distributed according to a fair seniority system (in which workers with more years of service are promoted first or laid off last), the employer normally has a good defense against the suit According to the United States Supreme Court, this defense may also apply to claims of discrimination under the ADA ▶ Case in Point 22.16  A ­baggage Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 520  Unit Five  The Employment Environment ­ andler who had injured his back requested an assignh ment to a mailroom position at U.S Airways, Inc The airline refused to give the employee the position because another employee had seniority The Court sided with U.S Airways If an employee with a disability requests an accommodation that conflicts with an employer’s seniority system, the accommodation generally will not be considered “reasonable” under the ADA.39  ◀ After-Acquired Evidence of Employee Misconduct In some situations, employers have attempted to avoid liability for employment discrimination on the basis of “after-acquired evidence”—that is, evidence that the employer discovers after a lawsuit is filed— of an employee’s misconduct ▶  Example 22.17  An employer fires a worker, Ravi, who then sues the employer for employment discrimination During pretrial investigation, the employer learns that Ravi made material misrepresentations on his employment application—misrepresentations that, had the employer known about them, would have served as a ground to fire the individual.  ◀ According to the United States Supreme Court, after-acquired evidence of wrongdoing cannot be used to shield an employer entirely from liability for employment discrimination It may, however, be used to limit the amount of damages for which the employer is liable.40 and institutions that received federal funding were required to implement affirmative action policies Title VII of the Civil Rights Act of 1964 neither requires nor prohibits affirmative action Thus, most private companies and organizations have not been required to implement affirmative action policies, though many have done so voluntarily Affirmative action programs have been controversial, however, particularly when they result in reverse discrimination against members of a majority group, such as white males Constitutionality of Affirmative Action Programs Because of their inherently discriminatory nature, affirmative action programs may violate the equal protection clause of the Fourteenth Amendment to the U.S Constitution The United States Supreme Court has held that any federal, state, or local government affirmative action program that uses racial or ethnic classifications as the basis for making decisions is subject to strict scrutiny by the courts.41 Recall from Chapter that strict scrutiny is the highest standard, which means that most programs not survive a court’s analysis under this test Today, an affirmative action program normally is constitutional only if it attempts to remedy past discrimination and does not make use of quotas or preferences Furthermore, once such a program has succeeded in the goal of remedying past discrimination, it must be changed or dropped SECTION Affirmative Action Affirmative Action in Schools Most of the affirmative action cases that have reached the United States Supreme Court in the last twenty years have involved university admissions programs and schools, rather than business employers Federal statutes and regulations providing for equal opportunity in the workplace were designed to reduce or eliminate discriminatory practices with respect to hiring, retaining, and promoting employees Affirmative action programs go a step further and attempt to “make up” for past patterns of discrimination by giving members of protected classes preferential treatment in hiring or promotion These programs also promote diversity in schools and workplaces During the 1960s, all federal and state government agencies, private companies that contracted to business with the federal government, Race as a “Plus” Factor  Generally, the Court has found that a school admissions policy that automatically awards minority group applicants a specified number of points violates the equal protection clause.42 A school can, however, “consider race or ethnicity more flexibly as a ‘plus’ factor in the context of individualized consideration of each and every applicant.”43 In other words, it is unconstitutional for schools to 39 U.S Airways, Inc v Barnett, 535 U.S 391, 122 S.Ct 1516, 152 L.Ed.2d 589 (2002) 40 McKennon v Nashville Banner Publishing Co., 513 U.S 352, 115 S.Ct 879, 130 L.Ed.2d 852 (1995) See also EEOC v Dial Corp., 469 F.3d 735 (8th Cir 2006) 41 See the landmark decision in Adarand Constructors, Inc v Peña, 515 U.S 200, 115 S.Ct 2097, 132 L.Ed.2d 158 (1995) 42 Gratz v Bollinger, 539 U.S 244, 123 S.Ct 2411, 156 L.Ed.2d 257 (2003) 43 Grutter v Bollinger, 539 U.S 306, 123 S.Ct 2325, 156 L.Ed.2d 304 (2003) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 22  Employment Discrimination  apply a mechanical formula that gives “diversity bonuses” based on race or ethnicity ▶ Case in Point 22.18  School districts in Seattle, Washington, and Jefferson County, Kentucky, adopted plans that relied on race to assign certain children to schools The Seattle plan classified children as “white” or “nonwhite” and used racial classifications as a “tiebreaker” to determine which school students would attend The school district in Jefferson County classified students as “black” or “other” to assign children to elementary schools Parent groups filed lawsuits claiming that the racial preferences violated the equal protection clause The United States Supreme Court held that the school districts had failed to show that the use of racial classifications in their student assignment plans was necessary to achieve their stated goal of racial diversity Hence, the affirmative action programs of both school districts were unconstitutional.44  ◀ 44 The Court consolidated the two cases and issued one opinion for both See Parents Involved in Community Schools v Seattle School District No 1, 551 U.S 701, 127 S.Ct 2738, 168 L.Ed.2d 508 (2007) 521 A 2013 Challenge to Race-Conscious Policies  In 2013, the Supreme Court issued a ruling in the case of Fisher v University of Texas.45 The case involved Abigail Fisher, a white woman who claimed that her rights to equal protection had been violated when she was denied admission to the University of Texas The university’s affirmative action program followed the guidelines previously set forth by the Court and considered race merely as a plus factor Although many thought that the Supreme Court would use this case to invalidate race-conscious affirmative action programs, that did not occur Instead, the Court held that the lower court had applied the wrong standard when it did not hold the university to the demanding burden of strict scrutiny articulated in the Court’s prior decisions The case was therefore remanded for further proceedings 45 _ U.S _, 133 S.Ct 2411, 186 L.Ed.2d 474 (2013) Reviewing: Employment Discrimination Amaani Lyle, an African American woman, was hired by Warner Brothers Television Productions to be a scriptwriters’ assistant for the writers of Friends, a popular, adult-oriented television series One of her essential job duties was to type detailed notes for the scriptwriters during brainstorming sessions in which they discussed jokes, dialogue, and story lines The writers then combed through Lyle’s notes after the meetings for script material During these meetings, the three male scriptwriters told lewd and vulgar jokes and made sexually explicit comments and gestures They often talked about their personal sexual experiences and fantasies, and some of these conversations were then used in episodes of Friends During the meetings, Lyle never complained that she found the writers’ conduct offensive After four months, Lyle was fired because she could not type fast enough to keep up with the writers’ conversations during the meetings She filed a suit against Warner Brothers, alleging sexual harassment and claiming that her termination was based on racial discrimination Using the information presented in the chapter, answer the following questions Would Lyle’s claim of racial discrimination be for intentional (disparate-treatment) or unintentional (disparate-impact) discrimination? Explain Can Lyle establish a prima facie case of racial discrimination? Why or why not? When Lyle was hired, she was told that typing speed was extremely important to the position At the time, she maintained that she could type eighty words per minute, so she was not given a typing test It later turned out that Lyle could type only fifty words per minute What impact might typing speed have on Lyle’s lawsuit? Lyle’s sexual-harassment claim is based on the hostile working environment created by the writers’ sexually offensive conduct at meetings that she was required to attend The writers, however, argue that their behavior was essential to the “creative process” of writing for Friends, a show that routinely Continued Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 522  Unit Five  The Employment Environment contained sexual innuendos and adult humor Which defense discussed in the chapter might Warner Brothers assert using this argument? Debate This  Members of minority groups and women have made enough economic progress in the last several decades that they no longer need special legislation to protect them Terms and Concepts affirmative action 520 bona fide occupational qualification (BFOQ) 519 business necessity 519 constructive discharge 511 disparate-impact discrimination 508 disparate-treatment discrimination 506 employment discrimination 505 prima facie case 506 protected class 505 seniority system 519 sexual harassment 511 tangible employment action 512 ExamPrep Issue Spotters Ruth is a supervisor for a Subs & Suds restaurant Tim is a Subs & Suds employee The owner announces that some employees will be discharged Ruth tells Tim that if he has sex with her, he can keep his job Is this sexual harassment? Why or why not? (See page 511.) Koko, a person with a disability, applies for a job at Lively Sales Corporation for which she is well qualified, but she is rejected Lively continues to seek applicants and eventually fills the position with a person who does not have a disability Could Koko succeed in a suit against Lively for discrimination? Explain (See page 517.) •  Check your answers to the Issue Spotters against the answers provided in Appendix E at the end of this text Before the Test  Go to www.cengagebrain.com, enter the ISBN 9781285428949, and click on “Find” to locate this textbook’s Web site Then, click on “Access Now” under “Study Tools,” and select Chapter 22 at the top There, you will find an Interactive Quiz that you can take to assess your mastery of the concepts in this chapter, as well as Flashcards and a Glossary of important terms Business Scenarios 22–1. Title VII Violations. Discuss fully whether either of the following actions would constitute a violation of Title VII of the 1964 Civil Rights Act, as amended: (See page 505.) (a) Tennington, Inc., is a consulting firm and has ten employees These employees travel on consulting jobs in seven states Tennington has an employment record of hiring only white males (b) Novo Films is making a movie about Africa and needs to employ approximately one hundred extras for this picture To hire these extras, Novo advertises in all major newspapers in Southern California The ad states that only African Americans need apply 22–2. Religious Discrimination. Gina Gomez, a devout Roman Catholic, worked for Sam’s Department Stores, Inc., in Phoenix, Arizona Sam’s considered Gomez a productive employee because her sales exceeded $200,000 per year At the time, the store gave its managers the discretion to grant unpaid leave to employees but prohibited vacations or leave during the holiday season—October through December Gomez felt that she had a “calling” to go on a “pilgrimage” in October to Bosnia where some persons claimed to have had visions of the Virgin Mary The Catholic Church had not designated the site an official pilgrimage site, the visions were not expected to be stronger in October, and tours were available at other times The store managers denied Gomez’s request for leave, but she had a nonrefundable ticket and left anyway Sam’s terminated her employment, and she could not find another job Can Gomez establish a prima facie case of religious discrimination? Explain (See page 510.) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 22  Employment Discrimination  523 Business Case Problems 22–3. Spotlight on Title VII of the Civil Rights Act of 1964— Discrimination Based on Gender.  Burlington Coat Factory Warehouse, Inc., had a dress code that required male salesclerks to wear business attire consisting of slacks, shirt, and a necktie Female salesclerks, by contrast, were required to wear a smock so that customers could readily identify them Karen O’Donnell and other female employees refused to wear the smock Instead they reported to work in business attire and were suspended After numerous suspensions, the female employees were fired for violating Burlington’s dress code policy All other conditions of employment, including salary, hours, and benefits, were the same for female and male employees Was the dress code policy discriminatory? Why or why not? [O’Donnell v Burlington Coat Factory Warehouse, Inc., 656 F.Supp 263 
(S.D Ohio 1987)] (See page 510.) 22–4. Discrimination Based on Gender. Brenda Lewis had been employed for two years at Heartland Inns of America, LLC, and gradually worked her way up the management ladder Lewis, who described herself as a tomboy, was commended for her good work When she moved to a different Heartland hotel, the director of operations, Barbara Cullinan, told one of the owners that Lewis was not a “good fit” for the front desk because she was not feminine enough Cullinan told various people that the hotel wanted “pretty” girls at the front desk Cullinan then informed Lewis that her hiring had not been done properly and that she would need to undergo another interview Soon after the interview, Cullinan fired Lewis The reason given in a letter was that Lewis was hostile during the interview Lewis sued Heartland for gender discrimination based on unlawful gender stereotyping The district court dismissed the suit Lewis appealed Does her claim fall under Title VII’s prohibition against discrimination based on gender? Why or why not? [Lewis v Heartland Inns of America, LLC, 591 F.3d 1033 (8th Cir 2010)] (See page 510.) 22–5.  Business Case Problem with Sample Answer:  Retaliation by Employers Entek International hired Shane Dawson, a male homosexual Some of Dawson’s co-workers, including his supervisor, made derogatory comments about his sexual orientation Dawson’s work deteriorated He filed a complaint with Entek’s human resources department Two days later, he was fired State law made it unlawful for an employer to discriminate against an individual based on sexual orientation Could Dawson establish a claim for retaliation? Explain [Dawson v Entek International, 630 F.3d 928 (9th Cir 2011)] (See page 512.) •  For a sample answer to Problem 22–5, go to Appendix F at the end of this text 22–6.  Sexual Harassment by Co-Worker.  Billie Bradford worked for the Kentucky Department of Community Based Services (DCBS) One of Bradford’s co-workers, Lisa Stander, routinely engaged in extreme sexual behavior (such as touching herself and making crude comments) in Bradford’s presence Bradford and others regularly complained about Stander’s conduct to their supervisor, Angie Taylor Rather than resolve the problem, Taylor nonchalantly told Stander to stop, encouraged Bradford to talk to Stander, and suggested that Stander was just having fun Assuming that Bradford was subjected to a hostile work environment, could DCBS be liable? Why or why not? [Bradford v Department of Community Based Services, 2012 WL 360032 (E.D.Ky 2012)] (See page 511.) 22–7. Age Discrimination. Beginning in 1986, Paul Rangel was a sales professional for the pharmaceutical company sanofi-aventis U.S LLC (S-A) Rangel had satisfactory performance reviews until 2006, when S-A issued new “Expectations” guidelines with sales call quotas and other standards that he failed to meet After two years of negative performance reviews, Rangel—who was then more than forty years old—was terminated as part of a nationwide reduction in force of all sales professionals who had not met the “Expectations” guidelines, including younger workers Did S-A engage in age discrimination? Discuss [Rangel v sanofi aventis U.S LLC, 2013 WL 142040 (10th Cir 2013)] (See page 515.) 22–8.  Special Case Analysis:  Employment Discrimination Go to Case Analysis Case 22.1, Dees v United Rentals North America, Inc., on pages 506 and 507 Read the excerpt and answer the following questions (a) Issue: What conduct on the part of the plaintiff and what action on the part of the defendant were at the center of the dispute in this case? (b) Rule of Law: Once a prima facie case of employment discrimination has been established, as the case moves forward, who must prove what, and who must respond with evidence of what else? (c) Applying the Rule of Law: What was the court’s evaluation of the parties’ allegations and evidence in this case? (d) Conclusion: In whose favor did the court rule? Why? 22–9.  A Question of Ethics:  Discrimination Based on Disability Titan Distribution, Inc., employed Quintak, Inc., to run its tire mounting and distribution operation in Des Moines, Iowa Robert Chalfant worked for Quintak as a second shift supervisor at Titan He suffered a heart attack in 1992 and underwent heart bypass surgery in 1997 He also had arthritis In July 2002, Titan Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 524  Unit Five  The Employment Environment decided to fire Quintak Chalfant applied to work at Titan On his application, he described himself as disabled After a physical exam, Titan’s physician concluded that Chalfant could work in his current capacity, and he was notified that he would be hired Despite the notice, Nadis Barucic, a Titan employee, wrote “not pass px” at the top of Chalfant’s application, and he was not hired He took a job with AMPCO Systems, a parking ramp management company This work involved walking up to five miles a day and lifting more weight than he had at Titan In September, Titan eliminated its second shift Chalfant filed a suit in a federal district court against Titan, in part, under the Americans with Disabilities Act (ADA) Titan argued that it had not hired Chalfant because he did not pass the physical, but no one—including Barucic—could explain why she had written “not pass px” on his application Later, Titan claimed that Chalfant was not hired because the entire second shift was going to be eliminated [Chalfant v Titan Distribution, Inc., 475 F.3d 982 (8th Cir 2007)] (See page 517.) (a) What must Chalfant establish to make his case under the ADA? Can he meet these requirements? Explain (b) In employment-discrimination cases, punitive damages can be appropriate when an employer acts with malice or reckless indifference toward an employee’s protected rights Would an award of punitive damages to Chalfant be appropriate in this case? Discuss Legal Reasoning Group Activity 22–10. Racial Discrimination. Two African American plaintiffs sued the producers of the reality television series The Bachelor and The Bachelorette for racial discrimination The plaintiffs claimed that the shows have never featured persons of color in the lead roles The plaintiffs also alleged that the producers failed to provide people of color who auditioned for the lead roles with the same opportunities to compete as white people who auditioned (See page 506.) (a) The first group will assess whether the plaintiffs can establish a prima facie case of disparate-treatment (intentional) discrimination (b) The second group will consider whether the plaintiffs can establish disparate-impact discrimination (c) The third group will assume that the plaintiffs established a prima facie case and that the burden has shifted to the employer to articulate a legal reason for not hiring the plaintiffs What legitimate reasons might the employer assert for not hiring the plaintiffs in this situation? Should the law require television producers to hire persons of color for lead roles in reality television shows? Discuss Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 23 Immigration, and Labor Law D uring the nineteenth century, two separate forces began to affect the employment environment in the United States—a rise in immigration and the Industrial Revolution Both led to significant changes in the legal environment of the workplace, which we will examine in this chapter Legislation was enacted to prohibit employers from hiring illegal immigrants Immigration law has evolved over the years into a myriad of complex rules that employers need to follow when hiring foreign-born workers During the Industrial Revolution, ­fewer Americans were self-employed than ever before, and employers generally set the terms of employment Moreover, with increasing industrialization, the size of workplaces and the number of on-the-job hazards increased Workers came to believe that to counter the power and freedom of their employers and to protect themselves, they needed to organize into unions Beginning in 1932, Congress enacted a number of statutes that generally increased employees’ rights At the heart of these rights is the right to join unions and engage in collective bargaining with management to nego- SECTION Immigration Law The United States did not have any laws restricting immigration until the late nineteenth century Today, the most important laws affecting the employment relationship are the Immigration Reform and Control Act (IRCA) of 19861 and the Immigration Act of 1990.2 Immigration law has become increasingly important in recent years An estimated 12 million undocumented immigrants now live in the United States, many of whom came to find jobs Because U.S employers face serious penalties if they hire undocumented workers, it is necessary for businesspersons to have an understanding of immigration laws 29 U.S.C Section 1802 This act amended various provisions of the Immigration and Nationality Act of 1952, U.S.C Sections 1101 et seq tiate working conditions, salaries, and benefits for a group of workers This chapter begins with a discussion of immigration law and its importance to employers in our diverse society We then describe labor laws and examine the process of unionizing a company We also discuss collective bargaining, strikes, lockouts, and the labor practices that are considered unfair under federal law As you will read in this chapter’s Managerial Strategy feature, rules that arise in the context of labor unions sometimes can apply to all employees, not just to union workers The Immigration Reform and Control Act When the IRCA was enacted in 1986, it provided amnesty to certain groups of aliens living illegally in the United States at the time It also established a system that sanctions employers that hire immigrants who lack work authorization The IRCA makes it illegal to hire, recruit, or refer for a fee someone not authorized to work in this country Through Immigration and Customs Enforcement officers, the federal government conducts random compliance audits and engages in enforcement ­ actions against employers who hire undocumented workers I-9 Employment Verification To comply with IRCA requirements, an employer must perform I-9 ­verifications for new hires, including those hired as “contractors” or “day workers” if they work under the employer’s direct supervision The employer 525 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 526  Unit Five  The Employment Environment must complete Form I-9, Employment Eligibility Verification, which is available from U.S Citizenship and Immigration Services,3 for each worker within three days of his or her commencement of employment The three-day period allows the employer to check the form’s accuracy and to review and verify documents establishing the prospective worker’s identity and eligibility for employment in the United States Documentation.  The employer must declare, under penalty of perjury, that an employee produced documents establishing his or her identity and legal employability Acceptable documents include a U.S passport establishing the person’s citizenship or a document authorizing a foreign citizen to work in the United States, such as a permanent resident card or an Alien Registration Receipt (discussed on the next page) Legal Actions.  Most legal actions alleging violations of I-9 rules are brought against employees An employee must state on the I-9 form that she or he is a U.S citizen or otherwise authorized to work in the United States If the employee enters false information on the form or presents false documentation, the employer can fire the worker, who then may be subject to deportation Nevertheless, employers must be honest when verifying an employee’s documentation If an employer “should have known” that the worker was unauthorized, the employer has violated the rules U.S Citizenship and Immigration Services is a federal agency that is part of the U.S Department of Homeland Security Enforcement  U.S Immigration and Customs Enforcement (ICE) is the largest investigative arm of the U.S Department of Homeland Security ICE has a general inspection program that conducts random compliance audits Other audits may occur if the agency receives a written complaint alleging that an employer has committed violations Government inspections include a review of an employer’s file of I-9 forms The government does not need a subpoena or a warrant to conduct such an inspection If an investigation reveals a possible violation, ICE will bring an administrative action and issue a Notice of Intent to Fine, which sets out the charges against the employer The employer has a right to a hearing on the enforcement action if it files a request within thirty days This hearing is conducted before an administrative law judge (ALJ, see Chapter 6), and the employer has a right to counsel and to discovery (see Chapter 2) The typical defense in such actions is good faith or substantial compliance with the documentation provisions Individuals who believe they have suffered as a result of illegal hiring have no direct cause of action to sue an employer under current law They may sue under the Racketeer Influenced and Corrupt Organizations Act (RICO), though, using the violations as a predicate (initial or underlying) illegal act.4 The following case illustrates such an action RICO was discussed in Chapter Case 23.1 Trollinger v Tyson Foods, Inc United States District Court, Eastern District of Tennessee, 2008 WL 1984264 (2008) Background and Facts  Tyson Foods, Inc., is one of the nation’s largest poultry processors, with more than 100,000 employees One of its plants is located in Shelbyville, Tennessee In December 2001, Tyson was indicted for conspiring to smuggle illegal aliens into the country and employ them Soon after the indictment was filed, four former workers at the Shelbyville facility filed this action against Tyson under the Racketeer Influenced and Corrupt Organizations Act (RICO), alleging that Tyson engaged in an illegal scheme to depress wages by hiring illegal immigrants Tyson moved to dismiss the complaint IN THE LANGUAGE OF THE COURT COLLIER, J [Judge] * * * * * * * The Complaint alleges Defendants engaged in a long-term pattern and practice of violating [the Immigration Reform and Control Act] * * * The Complaint states Tyson signs Employment Eligibility Verification Forms (I-9 forms) in mass quantities before any docu- Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 23  Immigration and Labor Law  CASE 23.1 CONTINUEd 527 ments are inspected, more than three days after new hires have been employed, and based on a review of copies of documents rather than reviewing the original documents The Complaint further alleges Tyson prohibits its employees from taking into account obvious facts which indicate that documents not relate to the people tendering them; rehires persons whom it previously hired under different names, usually after a short absence; hires workers who appear decades younger than the pictures on their stolen identity documents; uses temporary employment placement services to hire illegal immigrants and then “loan” them to Tyson for a fee; and gives employees leave to “get good documents” after Tyson learns the initial documents submitted by the illegal alien actually belong to someone else * * * * In the context of the present illegal immigration problem in the United States, it is widely, if not universally, known that illegal immigration from Mexico is done in substantial part through smuggling It is also of note that Tyson’s processing plants are all located in areas where the predominant illegal alien population is from Mexico This knowledge along with the above allegations satisfies the requirement that the Complaint alleges Defendants had a subjective belief that large numbers of its illegal alien employees had been brought into the United States illegally [Emphasis added.] Decision and Remedy  The court denied Tyson’s motion to dismiss the complaint What If the Facts Were Different?  Assume that Tyson’s human resources managers were acting on their own, in clear violation of that company’s written employment policy Would the judge have ruled differently? Why or why not? The Global Dimension  Many businesses in U.S communities near the border with Mexico rely on the purchasing power of immigrants, both legal and illegal What incentives, if any, these businesses have to help enforce U.S immigration laws? Penalties  An employer who violates the law by hiring an unauthorized worker is subject to substantial penalties The employer can be fined up to $2,200 for each unauthorized employee for a first offense, $5,000 per employee for a second offense, and up to $11,000 for subsequent offenses Employers who have engaged in a “pattern or practice of violations” are subject to criminal penalties, which include additional fines and imprisonment for up to ten years A company may also be barred from future government contracts In determining the penalty, ICE considers the seriousness of the violation (such as intentional falsification of documents) and the employer’s past compliance ICE regulations also identify factors that will mitigate or aggravate the penalty under certain circumstances, such as whether the employer cooperated in the investigation or is a small business The Immigration Act Often, U.S businesses find that they cannot hire sufficient domestic workers with specialized skills For this reason, U.S immigration laws have long made provisions for businesses to hire specially qualified foreign workers The Immigration Act of 1990 placed caps on the number of visas (entry permits) that can be issued to immigrants each year Most temporary visas are set aside for workers who can be characterized as “persons of extraordinary ability,” members of the professions holding advanced degrees, or other skilled workers and professionals To hire such an individual, an employer must submit a petition to U.S Citizenship and Immigration Services, which determines whether the job candidate meets the legal standards Each visa is for a specific job, and there are legal limits on the employee’s ability to switch jobs once he or she is in the United States I-551 Alien Registration Receipts A company seeking to hire a noncitizen worker may so if the worker is self-authorized This means that the worker either is a lawful permanent resident or has a valid temporary Employment Authorization Document A lawful permanent resident can prove his or her Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 528  Unit Five  The Employment Environment status to an employer by presenting an I-551 Alien Registration Receipt, known as a green card, or a properly stamped foreign passport Many immigrant workers are not already selfauthorized, and an employer that wishes to hire them can attempt to obtain labor certification, or green cards, for them To gain authorization for hiring a foreign worker, the employer must show that no U.S worker is qualified, willing, and able to take the job Approximately fifty thousand new green cards are issued each year A green card can be obtained only for a person who is being hired for a permanent, full-time position (A separate authorization system provides for the temporary entry and hiring of nonimmigrant visa workers.) The government has detailed regulations governing the advertising of positions as well as the certification process.5 Any U.S applicants who meet the stated job qualifications must be interviewed for the position The employer must also be able to show that the qualifications required for the job are a business necessity The H-1B Visa Program  The most common and controversial visa program today is the H-1B visa system To obtain an H1-B visa, the potential employee must be qualified in a “specialty occupation,” which is defined as involving highly specialized knowledge and the attainment of a bachelor’s or higher degree or its equivalent Individuals with H-1B visas can stay in the United States for three to six years and work only for the sponsoring employer The recipients of these visas include many hightech workers, such as computer programmers and electronics specialists A maximum of sixty-five thousand H-1B visas are set aside each year for new immigrants That limit is typically reached within the first few weeks of the year Consequently, many companies, including Google, HP, and Infosys, continue to lobby Congress to expand the number of H-1B visas available to immigrants These companies contend that the H-1B system is keeping some of the world’s brightest scientific and engineering minds out of the United States In 2013, frustrated by the shortage of visas, several Silicon Valley entrepreneurs started a colony of foreign-­born individuals who live and work on a cruise ship stationed in international waters off the coast of California The ship, called Blueseed, stays The most relevant regulations can be found at 20 C.F.R Section 655 (for temporary employment) and 20 C.F.R Section 656 (for permanent employment) outside U.S jurisdiction so that its residents can start or work for companies near Silicon Valley without having to obtain H-1B visas Labor Certification Before submitting an H-1B application, an employer must file a Labor Certification application on a form known as ETA 9035 The employer must agree to provide a wage level at least equal to the wages offered to other individuals with similar experience and qualifications The employer must also show that the hiring will not adversely affect other workers similarly employed The employer is required to inform U.S workers of the intent to hire a foreign worker by posting the form The U.S Department of Labor reviews the applications and may reject them for omissions or inaccuracies H-2, O, L, and E Visas  Other specialty temporary visas are available for other categories of employees H-2 visas provide for workers performing agricultural labor of a seasonal nature O visas provide entry for persons who have “extraordinary ability in the sciences, arts, education, business or athletics which has been demonstrated by sustained national or international acclaim.” L visas allow a company’s foreign managers or executives to work inside the United States E visas permit the entry of certain foreign investors or entrepreneurs State Immigration Legislation Until 2010, immigration and the treatment of illegal immigrants were governed exclusively by federal laws Then Arizona enacted a law that required Arizona law enforcement officials to identify, charge, and potentially deport immigrants living in Arizona who are there illegally Among other things, that law required immigrants to carry their papers at all times and allowed police to check a person’s immigration status during any law enforcement action Preemption Issues  The federal government, however, insisted that federal immigration laws preempt state legislation The United States Supreme Court ruled on the legality of the Arizona law in 2012 By that time, several other states had passed similar legislation In the Arizona v United States6 case, the Supreme Court upheld the controversial “show-me-your-papers” provision that requires police to check the immigra6 _ U.S _, 132 S.Ct 2492, 183 L.Ed.2d 351 (2012) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 23  Immigration and Labor Law  tion status of persons stopped for another violation All other provisions of Arizona’s law were struck down because they were preempted by federal laws The Future of State Legislation  The Supreme Court’s decision does not prohibit states from enacting laws related to immigration, but it does set some limits States are prohibited from making it a crime for immigrants not to carry their registration documents or for those without work permits to seek employment States also cannot authorize law enforcement to arrest anyone based solely on a reasonable suspicion that the person is in the country illegally States can, however, require individuals to show documentation of their immigration status to law enforcement when requested to so during a lawful stop for other reasons SECTION Federal Labor Laws Federal labor laws governing union-employer relations have developed considerably since the first law was enacted in 1932 Initially, the laws were concerned with protecting the rights and interests of workers Subsequent legislation placed some restraints on unions and granted rights to employers We look here at four major federal statutes regulating unionemployer relations Norris-LaGuardia Act Congress protected peaceful strikes, picketing, and boycotts in 1932 in the Norris-LaGuardia Act.7 The statute restricted the power of federal courts to issue injunctions against unions engaged in peaceful strikes In effect, this act declared a national policy permitting employees to organize National Labor Relations Act One of the foremost statutes regulating labor is the National Labor Relations Act (NLRA) of 1935.8 This act established the rights of employees to engage in collective bargaining and to strike 29 U.S.C Sections 101–110, 113–115 20 U.S.C Sections 151–169 529 The act also specifically defined a number of employer practices as unfair to labor: Interference with the efforts of employees to form, join, or assist labor organizations or to engage in concerted activities for their mutual aid or protection An employer’s domination of a labor organization or contribution of financial or other support to it Discrimination in the hiring of or the awarding of tenure to employees for reason of union affiliation Discrimination against employees for filing charges under the act or giving testimony under the act Refusal to bargain collectively with the duly designated representative of the employees The National Labor Relations Board  The NLRA also created the National Labor Relations Board (NLRB) to oversee union elections and to prevent employers from engaging in unfair and illegal union activities and unfair labor practices (To learn how recent NLRB rulings have affected social media policies, see this chapter’s Managerial Strategy feature on the next page.) The NLRB has the authority to investigate employees’ charges of unfair labor practices and to file complaints against employers in response to these charges When violations are found, the NLRB may issue a cease-and-desist order compelling the employer to stop engaging in the unfair practices Cease-and-desist orders can be enforced by a federal appellate court if necessary After the NLRB rules on claims of unfair labor practices, its decision may be appealed to a federal court ▶ Case in Point 23.1  Roundy’s, Inc., which operates a chain of stores in Wisconsin, became involved in a dispute with a local construction union When union members started distributing “extremely unflattering” flyers outside the stores, Roundy’s ejected them from the property The NLRB filed a complaint against Roundy’s for unfair labor practices An administrative law judge ruled that Roundy’s had violated the law by discriminating against the union, and a federal appellate court affirmed It is an unfair labor practice for an employer to prohibit union members from distributing flyers outside a store when it allows nonunion members to so.9  ◀ Good Faith Bargaining  Under the NLRA, employers and unions have a duty to bargain in good faith Bargaining over certain subjects is mandatory, and a party’s refusal to bargain over these subjects is an Roundy’s, Inc v NLRB, 647 F.3d 638 (7th Cir 2012) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 530  Unit Five  The Employment Environment Managerial Strategy Many Companies Have to Revise Their Social Media Policies Over the past few years, many companies have created social media policies for their employees For example, Costco’s policy used to read as follows: Any communication transmitted, stored or displayed electronically must comply with the policies outlined in the Costco Employee Agreement Employees should be aware that statements posted electronically that damage the company, defame any individual or damage any person’s reputation, or violate the policies outlined in the Costco Employee Agreement, may be subject to discipline up to and including termination of employment Since a ruling by the National Labor Relations Board (NLRB) in 2012, however, many companies have had to revise their policies The NLRB Rules on Protected “Concerted Activities” Section of the National Labor Relations Act states: “Employees shall have the right to self-organization, to form, join, or assist labor organizations and to engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection.” [Emphasis added.] When employees challenged Costco’s social media policy, the NLRB found that the policy violated the National Labor Relations Act because it was overly broad and did not specifically reference Section activity The ruling stated: “The broad prohibition against making statements that ‘damage the company, defame any individual or damage any person’s reputation’ clearly encompasses concerted communications protesting the Respondent’s [Costco’s] treatment of its employees.” a The NLRB Continues to Strike Down Broad Prohibitions in Social Media Policies Since the ruling on Costco’s social media policy, the NLRB has struck down similar policies at several companies, a Costco Wholesale Corporation and United Food and Commercial Workers Union, Local 371, Case 34-CA-01242, September 7, 2012, decision and order from NLRB (available at www.nlrb.gov/case/34–CA-012421) unfair labor practice that can be reported to the NLRB In one case, for example, an employer was required to bargain with the union over the use of hidden video surveillance cameras.10 10 National Steel Corp v NLRB, 324 F.3d 928 (7th Cir 2003) including EchoStar Technologies and Dish Network The NLRB’s general counsel has also issued three reports concluding that many companies’ social media policies illegally restrict workers’ exercise of their rights In one case, Karl Knauz BMW, a car dealership, had told its employees to always be “polite and friendly to our customers, vendors, and suppliers, as well as to your fellow employees.” The NLRB found that this policy, like the one at Costco, was “unlawful because employees would reasonably construe its broad prohibition against disrespectful conduct and language which injures the image or reputation of the dealership” as encompassing Section activity In other words, the policy was overly broad because it could apply to discussions in which employees objected to their working conditions and sought the support of others in improving those conditions—which are protected activities.b Managerial Implications All companies that have social media policies should include a statement that any employee communications protected by Section of the National Labor Relations Act are excluded from those policies Companies can no longer have a policy that states that all social media posts must be “completely accurate and not misleading” because such a policy would be considered overbroad Note also that companies cannot require their employees to report any unusual or inappropriate internal social media activity Business Questions 1. Employees meeting around the water cooler or coffee machine have always had the right to discuss workrelated matters Is a social media outlet simply a digital water cooler? Why or why not? 2. If your company instituted a policy stating that employees should “think carefully about ‘friending’ co-workers,” would that policy be lawful? Why or why not? b www.nlrb.gov/category/case-number/13-CA-046452 Workers Protected by the NLRA  To be protected under the NLRA, an individual must be an employee or a job applicant (otherwise, the NLRA’s ban on discrimination in regard to hiring would mean little) Additionally, the United States Supreme Court has held that individuals who are hired by a union to orga- Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 23  Immigration and Labor Law  531 nize a company (union organizers) are to be considered employees of the company for NLRA purposes.11 cally illegal in the twenty-four states that have rightto-work laws Labor-Management Relations Act Labor-Management Reporting and Disclosure Act The Labor-Management Relations Act (LMRA or TaftHartley Act) of 194712 was passed to proscribe certain unfair union practices, such as the closed shop A closed shop is a firm that requires union membership as a condition of employment Although the act made the closed shop illegal, it preserved the legality of the union shop A union shop is a firm that does not require union membership as a prerequisite for employment but can, and usually does, require that workers join the union after a specified amount of time on the job The LMRA also prohibited unions from refusing to bargain with employers, engaging in certain types of picketing, and featherbedding (causing employers to hire more employees than necessary) In addition, the act allowed individual states to pass their own rightto-work laws—laws making it illegal for union membership to be required for continued employment in any establishment Thus, union shops are techni11 NLRB v Town & Country Electric, Inc., 516 U.S 85, 116 S.Ct 450, 133 L.Ed.2d 371 (1995) 12 29 U.S.C Sections 141 et seq The Labor-Management Reporting and Disclosure Act (LMRDA)13 established an employee bill of rights and reporting requirements for union activities The act regulates unions’ internal business procedures, including elections For instance, the LMRDA requires unions to hold regularly scheduled elections of officers using secret ballots Former convicts are prohibited from holding union office Moreover, union officials are accountable for union property and funds Members have the right to attend and to participate in union meetings, to nominate officers, and to vote in most union proceedings The act also outlawed hot-cargo agreements, in which employers voluntarily agree with unions not to handle, use, or deal in goods of other employers produced by nonunion employees The LMRDA holds union officers to a high standard of responsibility and ethical conduct in administering the affairs of their union This standard was at the core of the dispute in the following case 13 29 U.S.C Sections 401 et seq C AS E ANALY S IS Case 23.2 Services Employees International Union v National Union of Healthcare Workers United States Court of Appeals, Ninth Circuit, 711 F.3d 970 (2013) In the language of the court tallman, Circuit Judge: * * * * The Services Employees International Union (“SEIU”) consists of 2.2 million members who work in healthcare, public services, and property services United Health Workers (“UHW”) is one of many “local” unions affiliated with SEIU [and represents] approximately 150,000 healthcare workers in California * * * The SEIU constitution vests SEIU’s International Executive Board with authority regarding alignment and jurisdiction of local unions like UHW * * * * * * * The international union intended to move 150,000 long-term care workers from three separate unions, including some 65,000 from UHW, into a new local union chartered by SEIU * * * * * * * The SEIU constitution grants SEIU the authority to place a local union into trusteeship “to protect the interests of the membership” from local union malfeasance * * * * The SEIU International Executive Board [gave] UHW until January 27, 2009, to confirm in writing that it would not oppose the creation of the new long-term care workers union The UHW would not so promise, and SEIU placed UHW into trusteeship on January 27, 2009 * * * * * * * UHW officials sought to create an ungovernable situation for trustees appointed to administer UHW by: (1) blocking access to UHW buildings to prevent the SEIU-appointed trustees from entering; (2) removing CASE 23.2 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 532  Unit Five  The Employment Environment CASE 23.2 CONTINUEd UHW property from UHW buildings, including office equipment, computers, and employee grievance files; [and] (3) instructing lower-level UHW officials and rank-and-file members not to recognize the authority of the trustees At the same time, the [UHW officials], while still on the UHW payroll, began to create and promote [a] new union Within a week after the trusteeship was announced, the * * * [UHW officials] had created the National Union of Healthcare Workers (“NUHW”) * * * * [SEIU filed a suit in a federal district court against the NUHW and the UHW officials] for breach of fiduciary duties * * * The jury returned a verdict awarding damages against the individual defendants * * * , and the district court entered judgment against the defendants [The defendants appealed.] * * * * Under Section 501 of the Labor Management Reporting and Disclosure Act (“LMRDA”), officers of labor unions are held to the highest standards of responsibility and ethical conduct in administering the affairs of the union [Emphasis added.] The UHW defendants posit that they owed this duty to only the rankand-file members of their local union Because they subjectively believed their actions assisted those members by establishing a more democratic union with localized control, they maintain they have done no wrong under Section 501 Their argument ignores the fact that they diverted union resources to weaken their own union and form a rival union merely because they did not agree with the constitutionally permissible decision of the international union Because no construction of the LMRDA allows such conduct based merely on the defendants’ subjective motives, we reject the defendants’ argument [Emphasis added.] The SEIU Executive Committee, under the authority given to it by both its constitution and the UHW constitution, carefully considered and adopted a measure it believed would better serve its members The UHW officers disagreed, which they may do, and they voiced their opposition, which they also may What they may not under the law is use their union’s resources to actively obstruct implementation of the final decision * * * * The judgment of liability was properly entered when a correctly instructed jury, on a sufficient factual record, found the defendants in breach of their fiduciary duties under Section 501 of the LMRDA AFFIRMED Legal Reasoning Questions 1.  What standard was at the core of the dispute in this case? 2.  To whom was this standard owed, according to the United Health Workers officials (the defendants)? 3.  Under this standard, what could the defendants and what could they not do, according to the court? 4.  How did the court rule on the dispute in this case? Why? Coverage and Procedures Coverage of federal labor laws is broad and extends to all employers whose business activity either involves or affects interstate commerce Some workers are specifically excluded from these laws Railroads and airlines are not covered by the NLRA but are covered by a separate act, the Railway Labor Act, which closely parallels the NLRA Other types of workers, such as agricultural workers and domestic servants, are excluded from the NLRA and have no coverage under separate legislation When a union or employee believes that an employer has violated federal labor law (or vice versa), a charge is filed with a regional office of the NLRB The form for an employee to use to file an unfair labor practice charge against an employer is shown in Exhibit 23–1 on the facing page The charge is inves- tigated, and if it is found worthy, the regional director files a complaint An ALJ initially hears the complaint and rules on it The board reviews the ALJ’s findings and decision If the NLRB finds a violation, it may issue remedial orders (such as requiring the rehiring of discharged workers) The NLRB decision may be appealed to a U.S court of appeals S ection Union Organization The key starting point for labor relations law is the decision by a company’s employees to form a union, which is usually referred to as their ­bargaining ­representative In workplaces that have no union, workers bargain individually with the employer If the Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 23  Immigration and Labor Law  533 E x hi b i t 23 –1  Unfair Labor Practice Complaint Form Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 534  Unit Five  The Employment Environment workers decide that they want the added power of collective union representation, they must follow certain steps to have the union certified The employer will often resist these efforts to unionize Authorization Cards Typically, the first step in organizing a union at a particular firm is to have the workers sign authorization cards An authorization card usually states that the worker desires to have a certain union, such as the United Auto Workers, represent the workforce If a majority of the workers sign authorization cards, the union organizers (unionizers) present the cards to the employer and ask for formal recognition of the union The employer is not required to recognize the union at this point in the process, but it may so voluntarily on a showing of majority support (Under proposed legislation, the employer would have to recognize the union as soon as a majority of the workers had signed authorization cards—without holding an election, as described next.)14 Union Elections If the employer refuses to voluntarily recognize the union after a majority of the workers sign authorization cards, the union organizers present the cards to the NLRB with a petition for an election If less than 50 percent of the workers sign the cards, the unionizers may still petition for an election For an election to be held, they must demonstrate that at least 30 percent of the workers to be represented support a union or an election on unionization The proposed union must represent an a ­ ppropriate bargaining unit Not every group of workers can form a single union One key requirement to being an appropriate bargaining unit is a mutuality of interest among all the workers to be represented by the union Factors considered in determining whether there is a mutual14 If the proposed Employee Free Choice Act (or Card Check Bill) ever becomes law, some of the information here may change ity of interest include the similarity of the jobs of all the workers to be unionized and their physical location If all of these requirements are met, an election is held The NLRB supervises the election and ensures secret voting and voter eligibility If the proposed union receives majority support in a fair election, the NLRB certifies the union as the bargaining representative for the employees Union Election Campaigns Many disputes between labor and management arise during union election campaigns Generally, the employer has control over unionizing activities that take place on company property and during working hours Thus, the employer may limit the campaign activities of union supporters as long as the employer has a legitimate business reason for doing so The employer may also reasonably limit the times and places that union solicitation occurs, provided that the employer is not discriminating against the union ▶  Example 23.2  A union is seeking to organize clerks at a department store owned by Amanti Enterprises Amanti can prohibit all union solicitation in areas of the store open to the public because the unionizing activities could interfere with the store’s business It can also restrict union-related activities to coffee breaks and lunch hours If Amanti allows solicitation for charitable causes in the workplace, however, it may not prohibit union solicitation.  ◀ An employer may campaign among its workers against the union, but the NLRB carefully monitors and regulates the tactics used by management If the employer issued threats (“If the union wins, you’ll all be fired”) or engaged in other unfair labor practices, the NLRB may certify the union even though it lost the election Alternatively, the NLRB may ask a court to order a new election In the following case, the question was whether managers’ brief interruptions of unionizing activities constituted illegal surveillance in violation of the NLRA Case 23.3 Local Joint Executive Board of Las Vegas v National Labor Relations Board United States Court of Appeals, Ninth Circuit, 515 F.3d 942 (2008) Background and FACTS  Aladdin Gaming, LLC, operates a hotel and casino in Las Vegas, Nevada On May 30, 2003, Local Joint Executive Board of Las Vegas and two other unions (the unions) began an open campaign to organize Aladdin’s housekeeping, food, and beverage departments On two Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 23  Immigration and Labor Law  CASE 23.3 CONTINUEd 535 occasions during this campaign, human resources managers at Aladdin (Tracy Sapien and Stacey Briand) approached union organizers who were discussing unionization with employees in an employee dining room during a lunch break Sapien and Briand interrupted the organizers while they were obtaining signatures on authorization cards and asked whether the employees were fully informed of the facts before signing The unions filed a complaint with the National Labor Relations Board (NLRB) claiming that the managers’ actions were illegal surveillance in violation of the National Labor Relations Act (NLRA) The NLRB ruled in favor of Aladdin, and the unions appealed In the Language of the Court Callahan, Circuit Judge: * * * * Section 8(a)(1) of the NLRA states that “it shall be an unfair labor practice for an employer (1) to interfere with, restrain, or coerce employees in the exercise of the rights guaranteed in section 157 of this title.” The [NLRB] has interpreted Section 8(a)(1) to make observation of union activity unlawful, “if the observation goes beyond casual and becomes unduly intrusive.” * * * “The test for determining whether an employer engages in unlawful surveillance or whether it creates the impression of surveillance is an objective one and involves the determination of whether the employer’s conduct, under the circumstances, was such as would tend to interfere with, restrain or coerce employees in the exercise of the rights guaranteed under Section of the [National Labor Relations] Act.” [Emphasis added.] * * * * There is no evidence that either Ms Sapien or Ms Briand used threats, force, or promises of benefits that would strip their speech of the protections of Section 8(c) Ms Sapien attempted to give the buffet servers additional facts to consider before signing the union cards Ms Briand told Ms Felix [an employee] that Ms Bueno [another employee] should not sign a union card without fully understanding the consequences and provided her opinion that the union may not be able to deliver on its promises Ms Felix voluntarily translated Ms Briand’s comments for Ms Bueno [a Spanish speaker] After Ms Felix explained the translation, Ms Briand left DECISION AND REMEDY  The federal appellate court denied the unions’ petition for review, concluding that the managers’ brief interruptions of organizing activity did not constitute illegal surveillance WHAT IF THE FACTS WERE DIFFERENT?  If management employees had interrupted union-organizing activities twenty-five times rather than just twice, would the outcome of this case have been different? Why or why not? THE LEGAL ENVIRONMENT DIMENSION  An administrative law judge (ALJ) originally ruled that the two brief verbal interruptions by Sapien and Briand violated the NLRA Why might the ALJ have made this ruling? S ection Collective Bargaining If the NLRB certifies the union, the union becomes the exclusive bargaining representative of the workers The central legal right of a union is to engage in collective bargaining on the members’ behalf Collective bargaining is the process by which labor and management negotiate the terms and conditions of employment Negotiating Terms and Conditions Wages, hours of work, and certain other conditions of employment may be discussed during collective bargaining sessions For instance, subjects for negotiation may include workplace safety, employee discounts, health-care plans, pension funds, and apprentice and scholarship programs Management need not bargain over a decision to shut down certain facilities It must bargain, however, over the economic consequences of this decision Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 536  Unit Five  The Employment Environment Thus, issues such as severance pay (pay given to an employee on termination) in the event of plant shutdown or rights of transfer to other plants are considered mandatory subjects of collective bargaining Good Faith Bargaining does not mean that one side must give in to the other or that compromises must be made It does mean that a demand must be taken seriously and considered as part of a package to be negotiated Most important, both sides must bargain in “good faith.” Both the employer and the union must make a reasonable effort to come to an agreement Although good faith is a matter of subjective intent, a party’s actions can be used to evaluate the party’s good or bad faith Excessive delaying tactics may be proof of bad faith, as is insistence on obviously unreasonable contract terms The following actions constitute bad faith in bargaining: Rejecting a proposal without offering a counterproposal Engaging in a campaign among workers to undermine the union Unilaterally changing wages or terms and conditions of employment during the 
bargaining process Constantly shifting positions on disputed contract terms Sending bargainers who lack authority to commit the company to a contract If an employer (or a union) refuses to bargain in good faith without justification, it has committed an unfair labor practice, and the other party may petition the NLRB for an order requiring good faith bargaining S ection Strikes and Lockouts Even when labor and management have bargained in good faith, they may be unable to reach a final agreement When extensive collective bargaining has been conducted and an impasse results, the union may call a strike against the employer to pressure it into making concessions In a strike, the unionized employees leave their jobs and refuse to work The workers also typically picket the workplace, walking or standing outside the facility with signs stating their complaints A strike is an extreme action Striking workers lose their rights to be paid, and management loses production and may lose customers when orders cannot be filled Labor law regulates the circumstances and conduct of strikes Most strikes take the form of “economic strikes,” which are initiated because the union wants a better contract ▶  Example 23.3  The Chicago Teachers Union engaged in an economic strike in 2012 after contract negotiations with the school district failed to bring an agreement on pay and performance Classes were canceled for 350,000 public school students during the strike.  ◀ The Right to Strike The right to strike is guaranteed by the NLRA, within limits Strike activities, such as picketing, are protected by the free speech guarantee of the First Amendment to the U.S Constitution Persons who are not employees have a right to participate in picketing an employer The NLRA also gives workers the right to refuse to cross a picket line of fellow workers who are engaged in a lawful strike Employers are permitted to hire replacement workers to substitute for the striking workers Illegal Strikes In the following situations, the conduct of the strikers may cause the strikes to be illegal: Violent strikes The use of violence (including the threat of violence) against management employees or substitute workers is illegal Massed picketing If the strikers form a barrier and deny management or other nonunion workers access to the plant, the strike is illegal Sit-down strikes Strikes in which employees simply stay in the plant without working are illegal No-strike clause A strike may be illegal if it contravenes a no-strike clause that was in the previous collective bargaining agreement between the employer and the union Secondary boycotts A secondary boycott is an illegal strike that is directed against someone other than the strikers’ employer, such as the companies that sell materials to the employer ▶  Example 23.4  The unionized workers of SemiCo go out on strike To increase their economic leverage, the workers picket the leading suppliers and customers of SemiCo in an attempt to hurt the company’s business SemiCo is considered the primary employer, and its suppliers Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 23  Immigration and Labor Law  and customers are considered secondary employers Picketing of the suppliers or customers is a secondary boycott, which was made illegal by the Labor-Management Relations Act.  ◀ Wildcat strikes A wildcat strike occurs when a small number of workers, perhaps dissatisfied with a union’s representation, call their own strike The union is the exclusive bargaining representative of a group of workers, and only the union can call a strike Therefore, a wildcat strike, unauthorized by the certified union, is illegal Strikers’ Rights after a Strike Ends An important issue concerns the rights of strikers after a strike ends In a typical economic strike, the employer has a right to hire permanent replacements during the strike The employer need not terminate the replacement workers when the strikers seek to return to work In other words, striking workers are not guaranteed the right to return to their jobs after the strike if satisfactory replacement workers have been found If the employer has not hired replacement workers to fill the strikers’ positions, however, then the employer must rehire economic strikers to fill any vacancies Employers may not discriminate against former economic strikers, and those who are rehired retain their seniority rights Different rules apply when a union strikes because the employer has engaged in unfair labor practices In this situation, the employer may still hire replacements but must give the strikers back their jobs once the strike is over Lockouts Lockouts are the employer’s counterpart to the workers’ right to strike A lockout occurs when the employer 537 shuts down to prevent employees from working Lockouts usually are used when the employer believes that a strike is imminent A lockout may be a legal employer response when a union and an employer have reached a stalemate in collective bargaining ▶  Example 23.5  In 2011, the owners of the National Football League (NFL) teams imposed a lockout on the NFL players’ union after negotiations on a new collective bargaining agreement broke down The NFL owners had proposed to reduce players’ salaries and extend the season by two games because of decreased profits due to the struggling economy When the lockout was imposed, the union requested decertification, which cleared the way for a group of players to file an antitrust lawsuit (see Chapter 27) A settlement was reached before the start of the 2011 football season The players accepted percent less of the revenue generated (47 percent rather than 50 percent) in exchange for better working conditions and more retirement benefits The owners agreed to keep the same number of games per season.  ◀ Some lockouts are illegal, however An employer may not use a lockout as a tool to break the union and pressure employees into decertification An employer must be able to show some economic justification SECTION Unfair Labor Practices The preceding sections have discussed unfair labor practices involved in the significant acts of union elections, collective bargaining, and strikes Many unfair labor practices may occur within the normal working relationship as well The most important of these practices are discussed in the following sections and listed in Exhibit 23–2 below E X H I B I T 23 –2  Basic Unfair Labor Practices It is unfair for Employers to It is unfair for Unions to Refuse to recognize a union and refuse to bargain in good faith Refuse to bargain in good faith Interfere with, restrain, or coerce employees in their efforts to form a union and bargain collectively Picket to coerce unionization without the support of a majority of the employees Dominate a union Demand the hiring of unnecessary excess workers Discriminate against union workers Discriminate against nonunion workers Punish employees for engaging in concerted activity Agree to participate in a secondary boycott Engage in an illegal strike Charge excessive membership fees Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 538  Unit Five  The Employment Environment Employer’s Refusal to Recognize the Union and to Negotiate As discussed, once a union has been certified, an employer must recognize and bargain in good faith with the union Failure to so is an unfair labor practice Because the NLRA embraces a policy of majority rule, certification of the union as the bargaining unit’s representative binds all of the employees in that bargaining unit Thus, the union must fairly represent all the members of the bargaining unit Certification does not mean that a union will continue indefinitely as the exclusive representative of the bargaining unit If the union loses the support of a majority of those it represents, an employer is not obligated to continue to recognize, or negotiate with the union As a practical matter, a newly elected representative needs time to establish itself among the workers and to begin to formulate and implement its programs Therefore, a union is immune from attack by employers and from repudiation by the employees for a period of one year after certification Employer’s Interference in Union Activities The NLRA declares it to be an unfair labor practice for an employer to interfere with, restrain, or coerce employees in the exercise of their rights to form a union and bargain collectively Unlawful employer interference may take a variety of forms Courts have found it an unfair labor practice for an employer to make threats that may interfere with an employee’s decision to join a union Even asking employees about their views on the union may be considered coercive Employees responding to such questioning must be able to remain anonymous and must receive assurances against employer reprisals Employers also may not prohibit certain forms of union activity in the workplace If an employee has a grievance with the company, the employer cannot prevent the union’s participation in support of that employee If an employer has unlawfully interfered with the operation of a union, the NLRB or a reviewing court may issue a cease-and-desist order halting the practice The company typically is required to post the order on a bulletin board and renounce its past unlawful conduct Employer’s Domination of a Union In the early days of unionization, employers fought back by forming employer-sponsored unions to rep- resent employees These “company unions” were seldom more than the puppets of management The NLRA outlawed company unions and any other form of employer domination of workers’ unions Under the law against employer domination, an employer can have no say in which employees belong to the union or which employees serve as union officers Nor may supervisors or other management personnel participate in union meetings Company actions that support a union may be considered improper potential domination A company cannot give union workers pay for time spent on union activities, because this is considered undue support for the union A company may not provide financial aid to a union and may not solicit workers to join a union Employer’s Discrimination against Union Employees The NLRA prohibits employers from discriminating against workers because they are union officers or are otherwise associated with a union When workers must be laid off, the company cannot consider union participation as a criterion for deciding whom to fire The provisions prohibiting discrimination also apply to hiring decisions ▶  Example 23.6  Certain employees of SemiCo are represented by a union, but the company is attempting to weaken the union’s strength The company is prohibited from requiring potential new hires to guarantee that they will not join the union.  ◀ Union’s Unfair Labor Practices Certain union activities are declared to be unfair labor practices by the Labor-Management Relations Act Secondary boycotts and illegal strikes, discussed earlier, are examples of such unfair labor practices by unions Coercion  Another significant unfair labor practice by a union is coercion or restraint on an employee’s decision to participate in or refrain from participating in union activities Obviously, it is unlawful for a union to threaten an employee or a family with violence for failure to join the union The law’s prohibition includes economic coercion as well ▶  Example 23.7  A union official declares, “We have a lot of power here You had better join the union, or you may lose your job.” This threat is an unfair labor practice.  ◀ The NLRA provides unions with the authority to regulate their own internal affairs, which includes disciplining union members This discipline cannot Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 23  Immigration and Labor Law  be used in an improperly coercive fashion, however ▶  Example 23.8  Jake Kowalski is a union member who feels that the union is no longer providing proper representation for employees at his workplace He starts a campaign to decertify the union The union may expel Kowalski from membership, but it may not fine or otherwise discipline the worker.  ◀ Discrimination  A union may not discriminate against workers because they refuse to join The Labor-Management Relations Act also prohibits a union from using its influence to cause an employer to discriminate against workers who refuse to join the union A union cannot force an employer to deny promotions to workers who fail to join the union Other Unfair Practices  Other unfair labor practices by unions include demanding the hiring of unnecessary workers, participating in picketing to coerce unionization without majority employee support, and refusing to engage in good faith bargaining with employer representatives 539 Unions are allowed to bargain for certain “union security clauses” in contracts Although closed shops are illegal, a union can bargain for a provision that requires workers to contribute to the union within thirty days after they are hired This is typically called a union shop, or agency shop, clause The union shop clause can compel workers to begin paying dues to the certified union but cannot require the worker to “join” the union Dues payment can be required to prevent workers from taking the benefits of union bargaining without contributing to the union’s efforts The clause cannot require workers to contribute their efforts to the union, however, or to go out on strike Even a requirement of dues payment has its limits Excessive initiation fees or dues may be illegal Unions often use their revenues to contribute to causes or to lobby politicians A nonunion employee subject to a union shop clause who must pay dues cannot be required to contribute to this sort of union expenditure Reviewing: Employment and Labor Law In April 2013, several employees of Javatech, Inc., a computer hardware developer with 250 employees, started organizing the Javatech Employees Union (JEU) When Javatech refused to voluntarily recognize the union, organizers petitioned the National Labor Relations Board (NLRB) for an election In June, the NLRB conducted an election that showed that a majority of Javatech employees supported the union JEU was certified and began bargaining with management over wages and benefits In January 2014, Javatech management offered the JEU a percent annual wage increase to all employees with no other changes in employment benefits The JEU countered by requesting a percent wage increase and an employee health-insurance package Javatech management responded that the percent wage increase was the company’s only offer The JEU petitioned the NLRB for an order requesting good faith bargaining After meeting with an NLRB representative, Javatech management still refused to consider modifying its position JEU leaders then became embroiled in a dispute about whether the JEU should accept this offer or go on strike New union leaders were elected in July 2014, and the employer refused to meet with the new JEU representatives, claiming that the union no longer had majority support from employees In August 2014, a group of seven Javatech engineers began feeling ill while working with a new adhesive used in creating motherboards The seven engineers discussed going on strike without union support Before reaching agreement, one of the engineers, Rosa Molina, became dizzy while working with the adhesive and walked out of the workplace Using the information presented in the chapter, answer the following questions How many of Javatech’s 250 employees must have signed authorization cards to allow the JEU to petition the NLRB for an election? What must Javatech change in its collective bargaining negotiations to demonstrate that it is bargaining in good faith with the JEU, as required by labor law? Could the seven engineers legally call a strike? What would this be called? Would Molina’s safety walkout be protected under the Labor-Management Relations Act? Explain Continued Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 540  Unit Five  The Employment Environment Debate This  To attract the brightest minds to work in the United States, there should be no limit on the number of H-1B visas available to immigrants with highly specialized knowledge Terms and Concepts authorization card 534 cease-and-desist order 529 closed shop 531 collective bargaining 535 hot-cargo agreement 531 I-9 verification 525 I-551 Alien Registration Receipt 528 lockout 537 right-to-work law 531 secondary boycott 536 strike 536 union shop 531 ExamPrep Issue Spotters Aanan Gara is the head of human resources at Skytech, Inc., a firm in Silicon Valley, California Because Skytech cannot find enough domestic workers with specialized skills, Gara wants to recruit qualified employees from other nations What must Gara under the Immigration Act to hire foreign employees for Skytech? (See page 527.) Onyx applies for work with Precision Design Company, which tells her that it requires union membership as a condition of employment She applies for work with Quality Engineering, Inc., which does not require union membership as a condition of employment but requires employees to join a union after six months on the job Are these conditions legal? Why or why not? (See page 531.) •  Check your answers to the Issue Spotters against the answers provided in Appendix E at the end of this text Before the Test  Go to www.cengagebrain.com, enter the ISBN 9781285428949, and click on “Find” to locate this textbook’s Web site Then, click on “Access Now” under “Study Tools,” and select Chapter 23 at the top There, you will find an Interactive Quiz that you can take to assess your mastery of the concepts in this chapter, as well as Flashcards and a Glossary of important terms Business Scenarios 23–1.  Unfair Labor Practices.  Consolidated Stores is undergoing a unionization campaign Prior to the union election, management states that the union is unnecessary to protect workers Management also provides bonuses and wage increases to the workers during this period The employees reject the union Union organizers protest that the wage increases during the election campaign unfairly prejudiced the vote Should these wage increases be regarded as an unfair labor practice? Discuss (See page 527.) 23–2.  Appropriate Bargaining Unit.  A group of employees at the Briarwood Furniture Co.’s manufacturing plant were interested in joining a union The Briarwood Furniture Co., employs 400 unskilled workers and 100 skilled workers in its plant The unskilled workers operate the industrial machinery used in processing Briarwood’s line of standardized plastic office furniture The skilled workers, who work in an entirely separate part of the plant, are experienced artisans who craft Briarwood’s line of expensive wood furniture products Do you see any problems with a single union’s representing all the workers at the Briarwood plant? Explain (See page 534.) Business Case Problems 23–3. Spotlight on Verizon—Collective Bargaining. Verizon New York, Inc (VNY), provides telecommunications services VNY and the Communications Workers of America (CWA) are parties to collective bargaining agreements covering installa- tion and maintenance employees At one time, VNY supported annual blood drives VNY, the CWA, and charitable organizations jointly set dates, arranged appointments, and adjusted work schedules for the drives For each drive, about a thousand employees, including managers, Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 23  Immigration and Labor Law  spent up to four hours traveling to a donor site, giving blood, recovering, and returning to their jobs Employees received full pay for the time In 2001, VNY told the CWA that it would no longer allow employees to participate “on Company time,” claiming that it had experienced problems meeting customer requests for service during the drives The CWA filed a complaint with the National Labor Relations Board (NLRB), asking that VNY be ordered to bargain over the decision Did VNY commit an unfair labor practice? Should the NLRB grant the CWA’s request? Why or why not? [Verizon New York, Inc v National Labor Relations Board, 360 F.3d 206 (D.C.Cir 2004)] (See page 535.) 23–4.  Business Case Problem with Sample Answer:  Unfair Labor Practices.  The Laborers’ International Union of North America, Local 578, and Shaw Stone & Webster Construction, Inc., agreed on a provision in their collective bargaining agreement that required all employees to pay dues to the union Sebedeo Lopez went to work for Shaw Stone without paying the union dues When the union pressed the company to fire him, Lopez agreed to pay The union continued to demand his discharge, however, and Shaw Stone fired him Was the union guilty of unfair labor practices? Why or why not? [Laborers’ International Union of North America, Local 578 v National Labor Relations Board, 594 F.3d 732 (10th Cir 2010)] (See page 537.) •  For a sample answer to Problem 23–4, go to Appendix F at the end of this text 23–5.  Collective Bargaining.  SDBC Holdings, Inc., acquired Stella D’oro Biscuit Co., a bakery in New York City At the time, a collective bargaining agreement existed between Stella D’oro and Local 50, Bakery, Confectionary, Tobacco Workers and Grain Millers International Union During negotiations to renew the agreement, Stella D’oro refused to give the union a copy of the company’s financial statement Stella D’oro did allow Local 50 to examine and take notes on the financial statement and offered the union an 541 opportunity to make its own copy Did Stella D’oro engage in an unfair labor practice? Discuss [SDBC Holdings, Inc v National Labor Relations Board, 711 F.3d 281 (2d Cir 2013)] (See page 535.) 23–6.  A Question of Ethics:  Immigration Work Status Mohammad Hashmi, a citizen of Pakistan, entered the United States in 2002 on a student visa Two years later, when he applied for a job at CompuCredit, he completed an I-9 form and checked the box to indicate that he was “a citizen or national of the United States.” Soon after submitting that form, he married a U.S citizen Several months later, the federal immigration services claimed that Hashmi had misrepresented himself as a U.S citizen Hashmi contended that he had not misrepresented himself At an administrative hearing, he testified that when he filled out the I-9 form he believed that he was a “national of the United States” because he was legally in the country under a student visa and was going to marry a U.S citizen He requested that his immigration status be adjusted to account for the fact that he was employed and married to an American The immigration judge rejected that request and found that Hashmi had made a false claim on the I-9 form He ruled that Hashmi was “inadmissible” to the United States and that his legal status in the country could not be amended because of his marriage or employment Hashmi appealed [Hashmi v Mukasey, 533 F.3d 700 (8th Cir 2008)] (See page 525.) (a)  Was it reasonable for Hashmi to think that he was a U.S national? What if his misunderstanding was due to the fact that he was not proficient in the English language? (b)  Should Hashmi’s visa status be changed because of his marriage and employment? Why or why not? How should the appellate court rule in this case? (c)  Should the court consider what happens to Hashmi’s wife if he is denied legal status? In general, should the law consider the interests of family members when determining a person’s immigration status? Explain Legal Reasoning Group Activity 23–7. Immigration. Nicole Tipton and Sadik Seferi owned and operated a restaurant in Iowa Acting on a tip from the local police, agents of Immigration and Customs Enforcement executed search warrants at the restaurant and at an apartment where some restaurant workers lived The agents discovered six undocumented aliens working at the restaurant and living together When the I-9 forms for the restaurant’s employees were reviewed, none were found for the six aliens They were paid in cash while other employees were paid by check Tipton and Seferi were charged with hiring and harboring undocumented aliens (See page 525.) (a)  The first group will develop an argument that Tipton and Seferi were guilty of hiring and harboring illegal aliens.
 (b)  The second group will assess whether Tipton and Seferi can assert a defense by claiming that they did not know that the workers were unauthorized aliens Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Unit Five  Focus on Ethics Ethics and the Employment Environment Ethical principles—and challenging ethical issues—pervade the areas of agency and employment As you read in Chapter 20, when one person agrees to act on behalf of another, as an agent does in an agency relationship, both that person and the principal assume certain ethical responsibilities and duties In essence, agency law gives legal force to the ethical duties arising in an agency relationship Although agency law also focuses on the rights of agents and principals, those rights are framed by the concept of duty—that is, an agent’s duty becomes a right for the principal, and vice versa Significantly, many of the duties of the principal and agent are negotiable When they form their contract, the principal and the agent can extend or abridge many of the ordinary duties owed in such a relationship Employees who deal with third parties are also deemed to be agents and thus share the ethical (and legal) duties imposed under agency law It is not always possible for an employee to negotiate favorable employment terms, however Often, a person who is offered a job must either accept the job on the employer’s terms or look elsewhere for a position Although numerous federal and state statutes protect employees, in some situations employees still have little recourse against their employers At the same time, employers complain that statutes regulating employment relationships impose so many requirements that they find it hard to exercise a reasonable amount of control over their workplaces The Agent’s Duty to the Principal The principal-agent relationship is based on trust Because of the nature of this relationship, which we call a fiduciary relationship, an agent is considered to owe certain duties to the principal These duties include being loyal and obedient, informing the principal of important facts concerning the agency, accounting to the principal for property or funds received, and performing with reasonable diligence and skill The ethical conduct expected of an agent has evolved into rules that, if breached, cause the agent to be held legally liable Thus, an agent may not represent two principals in the same transaction, make a secret profit from the agency relationship, or fail to disclose his or her interest in property being purchased by the principal Does an Agent Also Have a Duty to Society?  A question that sometimes arises is whether an agent’s obligation includes a duty to society as well as to the principal Consider, for example, the situation faced by an employee who knows that her employer is engaging in an unethical—or even illegal—practice, such as marketing an unsafe product Does the employee’s duty to the principal include keeping silent about this practice, which may harm users of the product? Does the employee have a duty to protect consumers by disclosing this information to the public, even if she loses her job as a result? Some scholars have argued that many of the greatest evils in the past thirty years were carried out in the name of duty to the principal Legal Reasoning How much obedience and loyalty does an agent-employee owe to an employer? What if the employer engages in an activity—or requests that the employee engage in an activity—that violates the employee’s ethical standards but does not necessarily violate any public policy or law? In this situation, does an employee’s duty to abide by her or his own ethical standards override the employee’s duty of loyalty to the employer? Discuss Does an Agent’s Breach of Loyalty Terminate the Agent’s Authority?  Several cases in recent years have involved employee-agents who breached the duty of loyalty by taking their employer’s trade secrets to a competitor The employees obtained the secrets from computer files that they were authorized to access The question for the courts is whether the act of accessing the trade secrets was unauthorized because of the employees’ breach of loyalty If the accessing was unauthorized, the employees could be subject to severe penalties under statutes prohibiting unauthorized access to computer data To date, most courts have ruled that an agent’s authority continues, even though there was a breach of loyalty In one case, for example, three employees of Lockheed Martin Corporation copied confidential information and trade secrets from Lockheed’s computer network onto compact discs and BlackBerries (personal digital assistants) Lockheed had authorized the employee-agents to access these files but was understandably upset when the three resigned and went to work for a competitor, taking the trade secrets with them Lockheed sued the former employees under the Computer Fraud and Abuse Act (discussed in Chapter 7), arguing that they had accessed the data without authorization The federal district court, however, held that the individuals did not lose their authorization to access the computer network when they breached the duty of loyalty Therefore, the court dismissed the case.1 Legal Reasoning When an agent acts in violation of his or her ethical or legal duty to the principal, should that action terminate the agent’s authority to act on behalf of the principal? Why or why not? Lockheed Martin Corp v Speed, 2006 WL 2683058 (M.D.Fla 2006) See also Clarity Services, Inc v Barney, 698 F.Supp.2d 1309 (M.D.Fla 2010) 542 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Unit Five  Focus on Ethics Ethics and the Employment Environment, Continued The Principal’s Duty to the Agent Just as agents owe certain duties to their principals, so principals owe duties to their agents, such as compensation and reimbursement for job-related expenses Principals also owe their agents a duty of cooperation One might expect principals to cooperate with their agents out of self-interest, but this does not always happen Suppose that a principal hires an agent on commission to sell a building, and the agent puts considerable time and expense into finding a buyer If the principal changes his mind and decides to retain the building, he may try to prevent the agent from completing the sale Is such an action ethical? Does it violate the principal’s duty of cooperation? What alternatives would the principal have? Although a principal is legally obligated to fulfill certain duties to the agent, these duties not include any specific duty of loyalty Some argue that employers’ failure to be loyal to their employees has resulted in a reduction in employee loyalty to employers After all, why should an employee be loyal to an employer’s interests over the years when the employee knows that the employer has no corresponding legal duty to be loyal to the employee’s interests? Employers who show a sense of loyalty toward their employees—for example, by not laying off longtime employees when business is slow or replacing them with younger workers at lower cost—base that loyalty primarily on ethical, not legal, considerations Respondeat Superior Agency relationships have ethical ramifications for third parties as well as for agents and principals A legal concept that addresses the effect of agency relationships on third parties is the doctrine of respondeat superior This doctrine raises a significant ethical question: Why should innocent employers be required to assume responsibility for the tortious, or wrongful, actions of their agent-employees? One reason has to with the courts’ perception that when one of two innocent parties must suffer a loss, the party in the better position to prevent that loss should bear the burden Thus, because the employer has more control over an employee’s behavior than a third party does, the employer should bear the cost of that behavior Another reason is that the employer is assumed to be better able to pay for any damage incurred by a third party One of our society’s shared beliefs is that an injured party should be afforded the most effective relief possible Thus, even though an employer may be entirely innocent, the employer has “deeper pockets” than the employee and will be more likely to have the funds necessary to make the injured party whole The employer may be held liable for the employee’s action even though the employer did not authorize the action and was not even aware of it Is it fair to hold the employer liable in this situation? Would it be more equitable if the employee alone was held liable for his or her tortious actions to third parties, even when the actions were committed within the scope of employment? Why or why not? Immigration Reform Unauthorized workers make up percent of the total U.S workforce and 12 percent of the workers in the construction industry Not long ago, the federal government significantly stepped up enforcement actions (raids) to combat the growing number of unauthorized immigrants The raids targeted workers in many industries, including food-­processing and packaging firms, contractors (landscape, cleaning, and janitorial services), construction firms, temporary employment services, and fast-food restaurants Often, the unauthorized workers were performing jobs that no one else wanted because the jobs paid low wages or involved substandard conditions As a result of these raids, many immigrant workers were detained and deported, their families were torn apart, the businesses for which they worked were disrupted, and some managers faced prison terms The impact of these raids on immigrants—in a nation founded by immigrants—has led many U.S citizens to believe that reforming the immigration laws is a moral imperative Many believe that it is unethical to imprison and deport these impoverished and unrepresented workers—who often were already being exploited by their U.S employers When President Barack Obama took office, he promised to reform immigration law The goal was to decrease bureaucracy, increase efficiency, and boost the number of immigrant workers with legal status in the United States Nevertheless, Congress has not yet reached a consensus on the specific changes necessary The comprehensive immigration reforms suggested by a bipartisan group of senators in early 2013 were quickly rejected.2 Legal Reasoning How should immigration law be reformed? Does the United States have any ethical duties to undocumented aliens who come here to work? How can the law be fair and balance the rights of immigrants, their families, the companies that employ them, and U.S citizens? Legal Reasoning If an agent-employee injures a third party during the course of employment, the doctrine of respondeat superior applies The Border Security, Economic Opportunity, and Immigration Modernization Act of 2013, Senate Bill 744 Focus on Ethics CONTINUES  • 543 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Unit Five  Focus on Ethics Ethics and the Employment Environment, Continued Problems with I-9 Verification Verifying a person’s eligibility to work in the United States can be a complicated and costly process for employers The most recent I-9 form (see Chapter 23) specifies the documents that an employer may accept to verify employment eligibility and identification At the same time, it is illegal for an employer to discriminate against foreign-born workers by requiring them to provide a driver’s license or Social Security card to prove their identity If an employer relies on the documents a worker provides to prove identity and eligibility (such as a school photo identification card) and these documents later prove to be fraudulent or invalid, the employer can be sanctioned for hiring a person that the employer “should have known” was unauthorized Thus, employers are forced to choose between violating antidiscrimination laws and risking sanctions for violating immigration laws It is an ethical dilemma with no easy answer Discrimination against Transgender Persons Although some states have laws that specifically ban discrimination based on gender identity, most courts have held that federal law (Title VII, discussed in Chapter 22) does not protect transgender persons from discrimination The situation may be changing, however, now that one federal court has extended Title VII protection against gender discrimination to transsexuals Diane Schroer (previously David Schroer) was born male but always identified with the female gender Schroer, who has master’s degrees in history and international relations, served twenty-five years in the military and was a commander of special forces After retiring with top-secret clearance, Schroer applied for a terrorism specialist position at the Library of Congress At the job interview, Schroer dressed as a man and received the highest interview score of all eighteen candidates The selection committee unanimously voted to offer the job to Schroer Schroer then met with her future supervisor and explained that she had been diagnosed with gender identity disorder and was planning to have sex reassignment surgery The next day, the Library of Congress withdrew its offer to hire Schroer When Schroer sued alleging gender discrimination, the Library claimed that it had withdrawn its offer because Schroer was untrustworthy and would be unable to receive the needed security clearance The court, however, found that these reasons were pretexts (excuses) and ruled in favor of Schroer The court held that the Library had refused to hire Schroer because her appearance and background did not comport with the selection committee’s stereotypes about how women and men should act and appear The court concluded that the revocation of the job offer violated Title VII and constituted discrimination “because of sex” even though Title VII does not include transsexuals as a protected class Schroer was awarded nearly $500,000 in back pay and damages.3 Legal Reasoning Should the law prohibit discrimination against transgender persons? Why or why not? Schroer v Billington, 577 F.Supp.2d 293 (D.D.C 2008) See also Glenn v Brumby, 724 F.Supp.2d 1284 (N.D.Ga 2010) 544 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Unit Six The Regulatory Environment Contents Chapter 24  Consumer Protection Chapter 25  Environmental Law Chapter 26  Real Property and Land-Use Control Chapter 27  Antitrust Law Chapter 28  Investor Protection and Corporate Governance Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 24 Consumer Protection A ll statutes, agency rules, and common law judicial decisions that serve to protect the interests of consumers are classified as consumer law Traditionally, in disputes involving consumers, it was assumed that the freedom to contract carried with it the obligation to live by the deal made Over time, this attitude has changed considerably Today, countless federal and state laws attempt to protect consumers from unfair trade practices, unsafe products, discriminatory or unreasonable credit requirements, and other problems related to consumer transactions Nearly every agency and department of the federal government has an office of consumer affairs, and most states have one or more such offices to help consumers Also, typically the attorney general’s office assists consumers at the state level In recent years, there has been a renewed interest in attempting to protect consumers in their dealings with credit-card companies, financial institutions, and insurance companies Congress has enacted new credit-card SECTION Deceptive Advertising regulations and financial reforms to regulate the nation’s largest banks Congress has also enacted health-care reforms and revised food safety laws In this chapter, we examine some of the major laws and regulations protecting consumers, focusing primarily on federal legislation Realize, though, that state laws often provide more sweeping and significant protections for the consumer than federal laws Exhibit 24–1 on the next page indicates many of the areas of consumer law that are regulated by federal statutes Claims That Appear to Be Based on Factual Evidence  Advertising that appears to be based on fac- Generally, deceptive advertising occurs if a reasonable consumer would be misled by the advertising claim Vague generalities and obvious exaggerations are permissible These claims are known as puffery When a claim takes on the appearance of literal authenticity, however, it may create problems tual evidence but in fact is not reasonably supported by some evidence will be deemed deceptive ▶  Case in Point 24.1  MedLab, Inc., advertised that its weightloss supplement (“The New Skinny Pill”) would cause users to lose substantial amounts of weight rapidly The ads claimed that “clinical studies prove” that people who take the pill lose “as much as 15 to 18 pounds per week and as much as 50 percent of all excess weight in just 14 days, without dieting or exercising.” The FTC sued MedLab for deceptive advertising An expert hired by the FTC to evaluate the claim testified that to lose this much weight, “a 200-pound individual would need to run between 57 and 68 miles every day”—the equivalent of more than two marathons per day The court concluded that the advertisement was false and misleading, granted the FTC a summary judgment, and issued a permanent injunction to stop MedLab from running the ads.2  ◀ 15 U.S.C Sections 41–58 Federal Trade Commission v MedLab, Inc, 615 F.Supp.2d 1068 (N.D.Cal 2009) The Federal Trade Commission Act1 (mentioned in Chapter 6) created the Federal Trade Commission (FTC) to carry out the broadly stated goal of preventing unfair and deceptive trade practices, including deceptive advertising A Reasonable Consumer Would Be Misled 546 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 24  Consumer Protection  547 E X HI B I T 24 – 1  Selected Areas of Consumer Law Regulated by Statutes Labeling and Packaging Advertising Example—The Federal Trade Commission Act Example—The Fair Packaging and Labeling Act Sales Example—The FTC Mail-Order Rule CONSUMER LAW Food and Drugs Example—The Federal Food, Drug, and Cosmetic Act Credit Protection Product Safety Example—The Consumer Product Safety Act Claims Based on Half-Truths  Some advertisements contain “half-truths,” meaning that the presented information is true but incomplete and therefore leads consumers to a false conclusion ▶  Example 24.2  The maker of Campbell’s soups advertised that “most” Campbell’s soups are low in fat and cholesterol and thus helpful in fighting heart disease What the ad did not say was that many Campbell’s soups are high in sodium and that high-sodium diets may increase the risk of heart disease Hence, the FTC ruled that Campbell’s claims were deceptive.  ◀ Advertising that contains an endorsement by a celebrity may be deemed deceptive if the celebrity does not actually use the product Bait-and-Switch Advertising The FTC has issued rules that govern specific advertising techniques One of the most important rules is contained in the FTC’s “Guides Against Bait Advertising.”3 The rule seeks to prevent bait-andswitch advertising—that is, advertising a very low price for a particular item that will likely be unavailable to the consumer, who will then be encouraged to purchase a more expensive item The low price is the “bait” to lure the consumer into the store The salesperson is instructed to “switch” the consumer to a different, more expensive item Under the 16 C.F.R Part 238 Example—The Consumer Credit Protection Act FTC guidelines, bait-and-switch advertising occurs if the seller refuses to show the advertised item, fails to have a reasonable quantity of the item in stock, fails to promise to deliver the advertised item within a reasonable time, or discourages employees from selling the item Online Deceptive Advertising Deceptive advertising occurs in the online environment as well as offline The FTC actively monitors online advertising and has identified hundreds of Web sites that have made false or deceptive claims for products ranging from medical treatments for various diseases to exercise equipment and weight-loss aids The FTC has issued guidelines to help online businesses comply with existing laws prohibiting deceptive advertising.4 These guidelines include three basic requirements: All ads—both online and offline—must be truthful and not misleading The claims made in an ad must be substantiated— that is, advertisers must have evidence to back up their claims Ads cannot be unfair, which the FTC defines as “likely to cause substantial consumer injury that consumers could not reasonably avoid and that “Advertising and Marketing on the Internet: Rules of the Road,” www.ftc.com, December 2000 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 548  Unit Six  The Regulatory Environment is not outweighed by the benefit to consumers or competition.” Clear and Conspicuous Disclosure  In addition, the guidelines call for “clear and conspicuous” disclosure of any qualifying or limiting information The overall impression of the ad is important in meeting this requirement The FTC suggests that advertisers should assume that consumers will not read an entire Web page Therefore, to satisfy the “clear and conspicuous” requirement, the disclosure should be placed as close as possible to the claim being qualified or be included within the claim itself If such placement is not feasible, the next-best location is on a section of the page to which a consumer can easily scroll Generally, hyperlinks to a disclosure are recommended only for lengthy disclosures or for disclosures that must be repeated in several locations on the Web page SPAM Advertising As discussed in Chapter 15, Congress passed the federal CAN-SPAM Act to combat the problems associated with unsolicited commercial e-mails, commonly referred to as spam Many states have also passed consumer protection laws that regulate deceptive online advertising In the following case, an e-mail service provider claimed that an online marketing company had violated a California statute that prohibited deceptive content in e-mail advertising The court had to decide whether the CAN-SPAM Act preempted the state statute (preemption was discussed in Chapter 5) Case 24.1 Hypertouch, Inc v ValueClick, Inc California Court of Appeal, Second District, 192 Cal.App.4th 805, 123 Cal.Rptr.3d (2011) BACKGROUND AND FACTS  Hypertouch, Inc., provides e-mail service to customers located inside and outside California ValueClick, Inc., and its subsidiaries provide online marketing services to third party advertisers that promote retail products ValueClick contracts with these advertisers to place offers on its Web sites ValueClick also contracts with affiliates that send out commercial e-mail advertisements The advertisements include links redirecting consumers to promotions on ValueClick’s Web sites If a consumer clicks through an e-mail advertisement and participates in a promotional offer, the affiliate that sent the initial e-mail is compensated for generating a customer “lead.”  The affiliate, rather than ValueClick, controls the content and subject lines of the e-mails Hypertouch filed a complaint against ValueClick, its subsidiaries, and others for violating a California state statute that prohibits e-mail advertising that contains deceptive content and headings The trial court held that the federal CAN-SPAM Act preempts the California statute and granted a summary judgment in favor of ValueClick Hypertouch appealed IN THE LANGUAGE OF THE COURT ZELON, J [Judge] * * * * A determination whether Hypertouch’s claims are preempted by federal law requires an analysis of both section 17529.5 [the California statute] and the CAN-SPAM Act * * * * In 2003, the California Legislature passed Senate Bill 186, which imposed broad restrictions on advertising in unsolicited commercial e-mail advertisements sent from or to a computer within California.
* * * The Legislature concluded that, to effectively regulate the abuses associated with spam, it was necessary to target not only the entities that send unsolicited commercial e-mail advertisements, but also the advertisers whose products and services are promoted in those e-mails[.] Like several other California consumer protection statutes targeting deceptive advertising practices, section 17529.5 dispenses with many of the elements associated with common law fraud, which normally requires the plaintiff to prove “(a) [a] misrepresentation  .  ; (b) knowledge of falsity (or ‘scienter’ ); (c) intent to defraud, [that is,] to induce reliance; (d) justifiable reliance; and (e) resulting damage.” Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 24  Consumer Protection  CASE 24.1 CONTINUEd 549 * * * * The CAN-SPAM Act includes a provision that expressly preempts state statutes that regulate the use of commercial e-mail “except to the extent that any such statute  .  prohibits falsity or deception in any portion of a commercial [e-mail].” * * * [The legislative history indicates that the act] was intended “to implement ‘one national standard’ ” regarding the content of commercial e-mail because “the patchwork of state laws had proven ineffective.” The legislative history also makes clear, however, that the Act’s preemption provision was largely intended to target state statutes imposing content requirements on commercial e-mails, while leaving states free to regulate the use of deceptive practices in commercial e-mails in whatever manner they chose * * * * The [preemption] clause does not reference either fraud or the common law, but rather permits any state law that prohibits
“ ‘falsity and deception in any portion of a commercial electronic mail message.’ ” Congress “is certainly familiar with the word ‘fraud’ and choose[es] not to use it; the words ‘falsity or deception’ suggest broader application.” * * * [Furthermore,] at the time the CAN-SPAM Act was passed, Congress was aware that many states imposed liability for deceptive commercial e-mails without requiring reliance or other elements of common law fraud Despite this knowledge, Congress chose not to use the word “fraud” in the savings [preemption] provision, thereby suggesting that it intended the phrase “falsity or deception” to have a broader application * * * * Rather than broadening the scope of prohibited content in commercial e-mail, California’s decision to dispense with the elements of common law fraud was intended to create a more effective mechanism for eradicating the use of deceptive commercial e-mails Section 17529.5 seeks to accomplish this goal in two ways First, the statute permits a recipient of a deceptive commercial e-mail to bring suit regardless of whether they were actually misled or harmed by the deceptive message This ensures that the use of deceptive e-mail will not go unpunished merely because it failed to mislead its targets Second, imposing strict liability on the advertisers who benefit from (and are the ultimate cause of) deceptive e-mails, forces those entities to take a more active role in supervising the complex web of affiliates who are promoting their products [Emphasis added.] * * * * The numerous subject lines at issue in this suit contain a wide variety of different statements Some simply state that the recipient
of the e-mail can get a free gift (“Get a $300 gift card FREE” * * *), others suggest that the recipient can obtain something free for doing a particular task (“Let us know your opinion and win a free gift card”) * * *  [Emphasis added.] [ValueClick has] made no effort to explain why a reasonable trier of fact could not conclude that many of the subject lines at issue here, such as those offering a free gift card with no qualifying language, would be likely to mislead a reasonable person Instead, it targets isolated e-mails in the record, such as one e-mail with the subject
line “GAP Promotion,” and argues that those particular e-mails are, as a matter of law, not deceptive Regardless of whether Respondent [ValueClick] is correct that the isolated e-mails it cites are not likely to mislead the recipient, that alone does not entitle it to summary judgment on [Hypertouch’s claims.] DECISION AND REMEDY  The state appellate court held that California’s antispam statute is not preempted by the federal CAN-SPAM Act, which exempts state laws that prohibit falsity or deception in commercial e-mail The court therefore reversed the lower court’s decision and remanded the case for trial THE E-COMMERCE DIMENSION  Describe some ways in which the subject line of an e-mail advertisement might be deceptive MANAGERIAL IMPLICATIONS  Business owners and managers who engage in e-mail advertising or contract with online marketing companies for that purpose need to be aware of and comply with the applicable state laws The online marketing company in this case claimed that it was not responsible for the CASE 24.1 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 550  Unit Six  The Regulatory Environment CASE 24.1 CONTINUEd deceptive content of the advertising because it did not send or initiate the e-mails—that was done by the affiliates—and it did not know that the e-mails were deceptive The state court rejected this argument, however, finding that California’s law applies more broadly to any entity that advertises in deceptive e-mails This holding will aid plaintiffs who sue under California’s antispam statute It may also persuade courts in other states to apply the same reasoning and broadly interpret their state laws against deceptive online advertising Federal Trade Commission Actions The FTC receives complaints from many sources, including competitors of alleged violators, consumers, trade associations, Better Business Bureaus, and government organizations and officials When the agency receives numerous and widespread complaints about a particular problem, it will investigate Formal Complaint  If the FTC concludes that a given advertisement is unfair or deceptive, it drafts a formal complaint, which is sent to the alleged offender The company may agree to settle the complaint without further proceedings If not, the FTC can conduct a hearing in which the company can present its defense (see Chapter 6) FTC Orders  If the FTC succeeds in proving that an advertisement is unfair or deceptive, it usually issues a cease-and-desist order requiring the company to stop the challenged advertising In some circumstances, it may also impose a sanction known as counteradvertising This requires the company to advertise anew—in print, on the Internet, on radio, and on television—to inform the public about the earlier misinformation The FTC sometimes institutes a multiple product order, which requires a firm to stop false advertising for all of its products, not just the product involved in the original action Restitution Possible  When a company’s deceptive ad leads to wrongful payments by consumers, the FTC may seek other remedies, including restitution ▶  Case in Point 24.3  Verity International, Ltd., billed phone-line subscribers who accessed certain online pornography sites at the rate for international calls to Madagascar When consumers complained about the charges, Verity told them that the charges were valid and had to be paid, or the consumers would face further collection actions A federal appellate court held that this representation of “uncontestability” was deceptive and a violation of the FTC Act The court ordered Verity to pay nearly $18 million in restitution to consumers.5  ◀ Telemarketing and Fax Advertising The Telephone Consumer Protection Act (TCPA)6 prohibits telephone solicitation using an automatic telephone dialing system or a prerecorded voice In addition, most states have statutes regulating telephone solicitation The TCPA also makes it illegal to transmit ads via fax without first obtaining the recipient’s permission (Similar issues have arisen with respect to spam e-mail—see Chapter 15.) Statutory Remedies  The Federal Communications Commission (FCC) enforces the TCPA The FCC imposes substantial fines ($11,000 each day) on companies that violate the junk fax provisions of the act and even fined one company as much as $5.4 million.7 The TCPA also gives consumers a right to sue for either $500 for each violation of the act or for the actual monetary losses resulting from a violation, whichever is greater If a court finds that a defendant willfully or knowingly violated the act, the court has the discretion to treble (triple) the amount of damages awarded Fraudulent Telemarketing The Telemarketing and Consumer Fraud and Abuse Prevention Act8 directed the FTC to establish rules governing telemarketing and to bring actions against fraudulent telemarketers The FTC’s Telemarketing Sales Rule (TSR)9 requires a telemarketer to identify the seller’s name, describe Federal Trade Commission v Verity International, Ltd., 443 F.3d 48 (2d Cir 2006) 47 U.S.C Sections 227 et seq See Missouri ex rel Nixon v American Blast Fax, Inc., 323 F.3d 649 (8th Cir 2003); cert denied, 540 U.S 1104, 124 S.Ct 1043, 157 L.Ed.2d 888 (2004) 15 U.S.C Sections 6101–6108 16 C.F.R Sections 310.1–310.8 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 24  Consumer Protection  the product being sold, and disclose all material facts related to the sale (such as the total cost of the goods being sold) The TSR makes it illegal for telemarketers to misrepresent information or facts about their goods or services A telemarketer must also remove a consumer’s name from its list of potential contacts if the customer so requests An amendment to the TSR established the national Do Not Call Registry Telemarketers must refrain from calling those consumers who have placed their names on the list Significantly, the TSR applies to any offer made to consumers in the United States—even if the offer comes from a foreign firm Thus, the TSR helps to protect consumers from illegal cross-border telemarketing operations S ection Labeling and Packaging Laws A number of federal and state laws deal specifically with the information given on labels and packages In general, labels must be accurate, and they must use SP TLIGHT 551 words that are easily understood by the ordinary consumer In some instances, labels must specify the raw materials used in the product, such as the percentage of cotton, nylon, or other fiber used in a garment In other instances, the products must carry a warning, such as those required on cigarette packages and advertising.10 Fuel Economy Labels on Automobiles The Energy Policy and Conservation Act of 197511 requires automakers to attach an information label to every new car The label must include the Environmental Protection Agency’s fuel economy estimate for the vehicle In the following case, the buyer of a new car complained that the vehicle had failed to achieve the fuel economy estimate advertised in the automaker’s brochure and listed on the label 10 15 U.S.C Sections 1331–1341 11 49 U.S.C Section 32908(b)(1) on Honda Case 24.2 Paduano v American Honda Motor Co California Court of Appeal, Fourth District, 169 Cal.App.4th 1453, 88 Cal.Rptr.3d 90 (2009) background and facts  In 2004, Gaetano Paduano bought a new Honda Civic Hybrid in California The information label on the car stated that the fuel economy estimates from the Environmental Protection Agency (EPA) were forty-seven miles per gallon (mpg) for city driving and forty-eight mpg for highway driving Honda’s sales brochure added, “Just drive the Hybrid like you would a conventional car and save on fuel bills.” Paduano soon became frustrated with the car’s fuel economy, which was less than half of the EPA’s estimate When American Honda Motor Company refused to repurchase the vehicle, Paduano filed a suit in a California state court against the automaker, alleging deceptive advertising in violation of the state’s Consumer Legal Remedies Act and Unfair Competition Law Honda argued that the federal Energy Policy and Conservation Act (EPCA), which prescribed the EPA’s fuel economy estimate, preempted Paduano’s claims (see Chapter 5) The court issued a summary judgment in Honda’s favor Paduano appealed to a state intermediate appellate court in the language of the court aaron, J [Judge] *  *  *  * The basic rules of preemption are not in dispute: Under the supremacy clause of the United States Constitution, Congress has the power to preempt state law concerning matters that lie within the authority of Congress In determining whether federal law preempts state law, a court’s task is CASE 24.2 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 552  Unit Six  The Regulatory Environment CASE 24.2 CONTINUEd to discern congressional intent Congress’s express intent in this regard will be found when Congress explicitly states that it is preempting state authority [Emphasis added.] * * * * Honda * * * argues that [the EPCA] prevents Paduano from pursuing his * * * claims That provision states in pertinent part, When a requirement under [the EPCA] is in effect, a State or a political subdivision of a State may adopt or enforce a law or regulation on disclosure of fuel economy or fuel operating costs for an automobile covered by [the EPCA] only if the law or regulation is identical to that requirement * * * Honda goes on to assert that “Paduano’s deceptive advertising and misrepresentation claims would impose non identical disclosure requirements.” Contrary to Honda’s characterization * * * , Paduano’s claims are based on statements Honda made in its advertising brochure to the effect that one may drive a Civic Hybrid in the same manner as one would a conventional car, and need not anything “special,” in order to achieve the beneficial fuel economy of the EPA estimates * * * Paduano is challenging * * * Honda’s * * * commentary in which it alludes to those estimates in a manner that may give consumers the misimpression that they will be able to achieve mileage close to the EPA estimates while driving a Honda hybrid in the same manner as they would a conventional vehicle Paduano does not seek to require Honda to provide “additional alleged facts” regarding the Civic Hybrid’s fuel economy, as Honda suggests, but rather, seeks to prevent Honda from making misleading claims about how easy it is to achieve better fuel economy Contrary to Honda’s assertions, if Paduano were to prevail on his claims, Honda would not have to anything differently with regard to its disclosure of the EPA mileage estimates * * * * * * * Allowing states to regulate false advertising and unfair business practices may further the goals of the EPCA, and we reject Honda’s claim decision and remedy  The state intermediate appellate court concluded that federal law did not preempt Paduano’s claims concerning Honda’s advertising The court reversed the lower court’s judgment and remanded the case The ethical dimension  Suppose that the defendant automaker had opposed this action solely to avoid paying damages to the purchaser of a car that had proved to be a “lemon.” Would this have been unethical? Explain The legal environment dimension  What does the interpretation of the law in this case suggest to businesspersons who sell products labeled with statements mandated by federal or state law? Food Labeling Because the quality and safety of food are so important to consumers, several statutes deal specifically with food labeling The Fair Packaging and Labeling Act requires that food product labels identify (1) the product, (2) the net quantity of the contents (and, if the number of servings is stated, the size of a serving), (3) the manufacturer, and (4) the packager or distributor The act includes additional requirements concerning descriptions on packages, savings claims, components of nonfood products, and standards for the partial filling of packages Nutritional Content of Food Products Food products must bear labels detailing the nutritional content, including the number of calories and the amounts of various nutrients that the food contains The Nutrition Labeling and Education Act12 requires standard nutrition facts (including the amount and type of fat that the food contains) to be listed on food labels and regulates the use of such terms as fresh and low fat The U.S Food and Drug Administration (FDA) and the U.S Department of Agriculture (USDA) are the 12 21 U.S.C Section 343.1 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 24  Consumer Protection  primary agencies that issue regulations on food labeling These rules are published in the Federal Register and updated annually For instance, labels on fresh meats, vegetables, and fruits must indicate where the food originated so that consumers can know whether their food was imported Caloric Content of Restaurant Foods The health-care reforms enacted by Congress in 2010 included provisions aimed at combating obesity in the United States All restaurant chains with twenty or more locations are required to post the caloric content of the foods on their menus so that customers will know how many calories they are eating.13 Foods offered through vending machines must also be labeled so that their caloric content is visible to would-be purchasers In addition, restaurants must post guidelines on the number of calories that an average person requires daily so that customers can determine what portion of a day’s calories a particular food will provide The hope is that consumers, armed with this information, will consider the number of calories when they make their food choices The federal law on menu labeling supersedes all state and local laws already in existence SECTION Sales A number of statutes protect consumers by requiring the disclosure of certain terms in sales transactions and providing rules governing unsolicited merchandise and home or door-to-door sales, mail-order sales, and referral sales The FTC has regulatory authority in this area, as other federal agencies The Federal Reserve Board of Governors, for instance, has issued a regulation that governs credit provisions associated with sales contracts (Regulation Z14— discussed later in this chapter) Many states and the FTC have “cooling-off” laws that permit the buyers of goods sold door to door to cancel their contracts within three business days The FTC rule further requires that consumers be notified in Spanish of this right if the oral negotiations for the sale were in that language 13 See Section 4205 of the Patient Protection and Affordable Care Act, Pub L No 111-148, 124 Stat 119 (March 23, 2010) 14 12 C.F.R Sections 226.1–226.30 553 Telephone and Mail-Order Sales The FTC Mail or Telephone Order Merchandise Rule amended the FTC Mail-Order Rule.15 The rule provides specific protections for consumers who purchase goods over the phone, through the mail, by fax, or via the Internet Merchants must ship orders within the time promised in their advertisements and notify consumers when orders cannot be shipped on time The rule also requires merchants to issue a refund within a specified period of time when a consumer cancels an order In addition, under the Postal Reorganization Act,16 a consumer who receives unsolicited merchandise sent by U.S mail can keep it, throw it away, or dispose of it in any manner that she or he sees fit The recipient will not be obligated to the sender Online Sales The FTC and other federal agencies have brought numerous enforcement actions against those who perpetrate online fraud (see the discussion of wire fraud in Chapter 7) Nonetheless, protecting consumers from fraudulent and deceptive sales practices conducted via the Internet has proved to be a challenging task Faced with economic recession, job losses, mounting debt, and dwindling savings, many consumers are looking for any source of income The number of consumers who have fallen prey to Internet fraud has grown in recent years Complaints to the FTC about sales of fraudulent business opportunities, such as work-at-home offers and real estate systems, nearly tripled from 2008 to 2013 About 10 percent of U.S adults claim to have been victims of online fraud SECTION Protection of Health and Safety Labeling and packaging laws (discussed earlier) promote consumer health and safety Nevertheless, there is a significant distinction between regulating the information dispensed about a product and regulating the actual content of the product The classic example is tobacco products Tobacco companies must label their products to warn consumers about 15 16 C.F.R Sections 435.1–435.2 16 39 U.S.C Section 3009 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 554  Unit Six  The Regulatory Environment the health hazards associated with their use, but the sale of tobacco products has not been subjected to significant restrictions Here, we examine various laws that regulate the actual products made available to consumers The Federal Food, Drug, and Cosmetic Act The most important federal legislation regulating food and drugs is the Federal Food, Drug, and Cosmetic Act (FDCA).17 The act protects consumers against adulterated (contaminated) and misbranded foods and drugs Food Safety  The FDCA establishes food standards, specifies safe levels of potentially hazardous food additives, and provides classifications of foods and food advertising Most of these statutory requirements are monitored and enforced by the Food and Drug Administration (FDA) Tainted Foods.  In recent years, many people in the United States have contracted food poisoning from eating foods that were contaminated—often with salmonella or E coli bacteria There have been highprofile recalls of peanut products, eggs, and beef Tainted cantaloupes killed thirty-three people Modernization Legislation.  In 2011, Congress enacted the Food Safety Modernization Act (FSMA)18 to provide greater government control over the U.S food safety system The FSMA gives the FDA authority to directly recall any food products that it suspects are tainted (rather than relying on the producers to recall items) The act requires any person who manufactures, processes, packs, distributes, receives, holds, or imports food products to pay a fee and register with the U.S Department of Health and Human Services (There are some exceptions for small farmers.) The act also requires owners and operators of facilities to analyze and identify food safety hazards, implement preventive controls, monitor effectiveness, and take corrective actions The FSMA also places more restrictions on importers of food and requires them to verify that imported foods meet U.S safety standards In 2013, the FDA proposed 17 21 U.S.C Sections 301–393 18 Pub L No 111-353, 124 Stat 3885 (January 4, 2011) This statute affected numerous parts of Title 21 of the U.S.C new rules to implement the FSMA, but these rules have not been finalized Given that some members of the food industry have expressed concerns about aspects of the proposed rules, it may be several years before final rules implementing the FSMA are in place Drugs  The FDA also has the responsibility of ensuring that drugs are safe and effective before they are marketed to the public Because the FDA must ensure the safety of new medications, there is always a delay before drugs are available to the public and this sometimes leads to controversy ▶  Case in Point 24.4  A group of citizens petitioned the FDA to allow everyone access to Plan B—the morning-after birth control pill—without a prescription The FDA denied the petition and continued to require women under the age of seventeen to obtain a prescription The group appealed to a federal district court, claiming that the prescription requirement can delay access to the pill The pill should be taken as soon as possible after sexual intercourse, preferably within twenty-four hours The court ruled in favor of the plaintiffs and ordered the FDA to make the morning-after pill available to people of any age without a prescription Shortly after the decision in 2013, the FDA changed its policy to allow anyone to obtain the morning-after pill without a prescription.19  ◀ The Consumer Product Safety Act In 1972, the Consumer Product Safety Act20 created the first comprehensive scheme of regulation over matters of consumer safety The act also established the Consumer Product Safety Commission (CPSC), which has far-reaching authority over consumer safety The CPSC’s Authority  The CPSC conducts research on the safety of individual consumer products and maintains a clearinghouse on the risks associated with various products The Consumer Product Safety Act authorizes the CPSC to the following: Set safety standards for consumer products Ban the manufacture and sale of any product that the commission believes poses an “unreasonable risk” to consumers (Products banned by the CPSC have included various types of fireworks, cribs, and toys, as well as many products containing asbestos or vinyl chloride.) 19 Tummino v Hamburg, _ F.Supp.2d _, 2013 WL 1348656 (E.D.N.Y 2013) An appeal was filed in this case 20 15 U.S.C Sections 2051–2083 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 24  Consumer Protection  Remove from the market any products it believes to be imminently hazardous The CPSC frequently works in conjunction with manufacturers to voluntarily recall defective products from stores ▶  Example 24.5  In cooperation with the CPSC, Kolcraft Enterprises, Inc., recalled one million infant play yards because of a defective latch that could cause a rail to fall, posing a risk to children.  ◀ Require manufacturers to report on any products already sold or intended for sale if the products have proved to be hazardous Administer other product-safety legislation, including the Child Protection and Toy Safety Act of 196921 and the Federal Hazardous Substances Act of 1960.22 Notification Requirements  The Consumer Product Safety Act requires the distributors of consumer products to notify the CPSC immediately if they receive information that a product “contains a defect which  .  creates a substantial risk to the public” or “an unreasonable risk of serious injury or death.” ▶  Case in Point 24.6  A company that sold juicers received twenty-three letters from customers complaining that during operation the juicer had suddenly exploded, sending pieces of glass and razorsharp metal across the room The government sued the company because it had waited more than six months before notifying the CPSC The court held that the company had violated that law and ordered it to pay damages.23  ◀ Health-Care Reforms In 2010, the health-care reforms enacted by Congress went into effect and gave Americans new rights and benefits with regard to health care.24 By 2014, these laws prohibited certain insurance company practices, such as denying coverage for preexisting conditions Expanded Coverage for Children and Seniors  The reforms expanded access to health care by enabling more children to obtain health-insurance coverage In addition, the reforms allowed young adults (under age 21 15 U.S.C Section 1262(e) 22 15 U.S.C Sections 1261–1273 23 United States v Mirama Enterprises, Inc., 185 F.Supp.2d 1148 (S.D.Cal 2002) 24 Patient Protection and Affordable Health Care Act of 2010, Pub L No 111-148, 124 Stat 119 (March 23, 2010); and the Health Care and Education Reconciliation Act of 2010, Pub L No 111-152, 124 Stat 1029 (March 30, 2010) 555 twenty-six) to remain on their parents’ health insurance The act also ended lifetime and most annual limits on care, and gave patients access to recommended preventive services (such as cancer screening, vaccinations, and well-baby checks) without cost Medicare recipients now receive a 50 percent discount on namebrand drugs, and the gap in Medicare’s prescription drug coverage will be eliminated by 2020 Controlling Costs of Health Insurance  In an attempt to control the rising costs of health insurance, the law places restrictions on insurance companies Insurance companies must spend at least 85 percent of all premium dollars collected from large employers (80 percent of the premiums collected from individuals and small employers) on benefits and quality improvement If insurance companies not meet these goals, they must provide rebates to consumers Additionally, states can require insurance companies to justify their premium increases to be eligible to participate in the new health-insurance exchanges SECTION Credit Protection Credit protection is one of the more important aspects of consumer protection legislation Nearly 80 percent of U.S consumers have credit cards, and most carry a balance on these cards—a total of about $2.5 trillion of debt nationwide As mentioned in Chapter 6, the Consumer Financial Protection Bureau (CFPB) is the agency dedicated to overseeing the practices of banks, mortgage lenders, and credit-card companies.25 The Truth-in-Lending Act A key statute regulating the credit and credit-card industries is the Truth-in-Lending Act (TILA), the name commonly given to Title I of the Consumer Credit Protection Act, as amended.26 The TILA is basically a disclosure law It is administered by the Federal Reserve Board and requires sellers and lenders to disclose credit terms or loan terms so that individuals can shop around for the best financing arrangements 25 Title 10 of the Restoring American Financial Stability Act of 2010, S.B 3217, April 15, 2010 26 15 U.S.C Sections 1601–1693r Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 556  Unit Six  The Regulatory Environment TILA requirements apply only to persons who, in the ordinary course of business, lend funds, sell on credit, or arrange for the extension of credit Thus, sales or loans made between two consumers not come under the protection of the act Additionally, this law protects only debtors who are natural persons (as opposed to the artificial “person” of a corporation) It does not extend to other legal entities Disclosure Requirements  The disclosure require- ments are contained in Regulation Z, issued by the Federal Reserve Board of Governors If the contracting parties are subject to the TILA, the requirements of Regulation Z apply to any transaction involving an installment sales contract that calls for payment to be made in more than four installments Transactions subject to Regulation Z typically include installment loans, retail and installment sales, car loans, home-improvement loans, and certain real estate loans if the amount of financing is less than $25,000 Under the provisions of the TILA, all of the terms of a credit instrument must be clearly and conspicuously disclosed A lender must disclose the annual percentage rate (APR), finance charge, amount financed, and total payments (the sum of the amount loaned, plus any fees, finance charges, and interest at the end of the loan) The TILA provides for contract rescission (cancellation) if a creditor fails to follow the exact procedures required by the act.27 Equal Credit Opportunity  Congress enacted the Equal Credit Opportunity Act (ECOA)28 as an amendment to the TILA The ECOA prohibits the denial of credit solely on the basis of race, religion, national origin, color, gender, marital status, or age The act also prohibits credit discrimination on the basis of whether an individual receives certain forms of income, such as public-assistance benefits Under the ECOA, a creditor may not require a cosigner on a credit instrument if the applicant qualifies under the creditor’s standards of creditworthiness for the amount and terms of the credit request ▶  Case in Point 24.7  Tonja, an African American, applied for financing with a used-car dealer The dealer looked at Tonja’s credit report and, without submitting the application to the lender, decided that she would not qualify 27 Note, however, that amendments to the TILA enacted in 1995 prevent borrowers from rescinding loans because of minor clerical errors in closing documents [15 U.S.C Sections 1605, 1631, 1635, 1640, and 1641] 28 15 U.S.C Sections 1691–1691f Instead of informing Tonja that she did not qualify, the dealer told her that she needed a cosigner on the loan to purchase the car She filed a complaint A federal appellate court ruled that the dealer qualified as a creditor in this situation because the dealer unilaterally denied the credit Thus, the dealer could be held liable under the ECOA.29  ◀ Credit-Card Rules  The TILA also contains provisions regarding credit cards One provision limits the liability of a cardholder to $50 per card for unauthorized charges made before the creditor is notified that the card has been lost If a consumer receives an unsolicited credit card in the mail that is later stolen, the company that issued the card cannot charge the consumer for any unauthorized charges Another provision requires credit-card companies to disclose the balance computation method that is used to determine the outstanding balance and to state when finance charges begin to accrue Other provisions set forth procedures for resolving billing disputes with the credit-card company These procedures are used if, for example, a cardholder thinks that an error has occurred in billing or wishes to withhold payment for a faulty product purchased by credit card Amendments to Credit-Card Rules  Amendments to the TILA’s credit-card rules that became effective in 2010 added the following protections: A company may not retroactively increase the interest rates on existing card balances unless the account is sixty days delinquent A company must provide forty-five days’ advance notice to consumers before changing its creditcard terms Monthly bills must be sent to cardholders twentyone days before the due date The interest rate charged on a customer’s creditcard balance may not be increased except in specific situations, such as when a promotional rate ends A company may not charge fees to a customer for being over his or her credit-card limit except in specified situations When the customer has balances at different interest rates, payments in excess of the minimum amount due must be applied first to the balance with the highest rate (for instance, a higher interest rate is commonly charged for cash advances) 29 Treadway v Gateway Chevrolet Oldsmobile, Inc., 362 F.3d 971 (7th Cir 2004) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 24  Consumer Protection  A company may not compute finance charges based on the previous billing cycle (a practice known as double-cycle billing, which hurts consumers because they are charged interest for the previous cycle even though they have paid the bill in full) The Fair Credit Reporting Act The Fair Credit Reporting Act (FCRA)30 protects consumers against inaccurate credit reporting and requires that lenders and other creditors report correct, relevant, and up-to-date information The act provides that consumer credit reporting agencies may issue credit reports to users only for specified purposes Legitimate purposes include the extension of credit, the issuance of insurance policies, and in response to the consumer’s request Consumer Notification and Inaccurate Information  Any time a consumer is denied credit or insurance on the basis of her or his credit report, the consumer must be notified of that fact The notice must include the name and address of the credit reporting agency that issued the report The same notice must be sent to consumers who are charged more than others ordinarily would be for credit or insurance because of their credit reports Under the FCRA, consumers may request the source of any information used by the credit agency, as well as the identity of anyone who has received an agency’s report Consumers are also permitted to access the information about them contained in a credit reporting agency’s files If a consumer discovers that an agency’s files contain inaccurate information, he or she should report the problem to the agency On the consumer’s written (or electronic) request, the agency must conduct a systematic examination of its records Any unverifiable or erroneous information must be deleted within a reasonable period of time Remedies for Violations A credit reporting agency that fails to comply with the act is liable for actual damages, plus additional damages not to exceed $1,000 and attorneys’ fees.31 Creditors and other companies that use information from credit reporting agencies may also be liable for violations of the FCRA The United States Supreme Court held that 30 15 U.S.C Sections 1681–1681t 31 15 U.S.C Section 1681n 557 an insurance company’s failure to notify new customers that they were paying higher insurance rates as a result of their credit scores was a willful violation of the FCRA.32 ▶ Case in Point 24.8  Branch Banking & Trust Company of Virginia (BB&T) gave Rex Saunders an auto loan but failed to give him a payment coupon book and refused his attempts to make payments on the loan In fact, BB&T told him that it had not extended a loan to him Eventually, BB&T discovered its mistake and demanded full payment, plus interest and penalties When payment was not immediately forthcoming, BB&T declared that Saunders was in default It then repossessed the car and forwarded adverse credit information about Saunders to credit reporting agencies, without noting that Saunders disputed the information Saunders filed a lawsuit alleging violations of the FCRA and was awarded $80,000 in punitive damages An appellate court found that the damages award was reasonable, given BB&T’s willful violation.33  ◀ The Fair and Accurate Credit Transactions Act Congress passed the Fair and Accurate Credit Transactions (FACT) Act in an effort to combat identity theft (discussed in Chapter 7).34 The act established a national fraud alert system Consumers who suspect that they have been or may be victimized by identity theft can place an alert on their credit files When a consumer establishes that identify theft has occurred, the credit reporting agency must stop reporting allegedly fraudulent account information The act also requires the major credit reporting agencies to provide consumers with free copies of their own credit reports every twelve months Another provision requires account numbers on credit-card receipts to be truncated (shortened) Merchants, employees, or others who may have access to the receipts no longer have the consumers’ names and full credit-card numbers Financial institutions must work with the FTC to identify “red flag” indicators of identity theft and to develop rules for the disposal of sensitive credit information 32 Safeco Insurance Co of America v Burr, 551 U.S 47, 127 S.Ct 2201, 167 L.Ed.2d 1045 (2007) 33 Saunders v Branch Banking & Trust Co of Virginia, 526 F.3d 142 (4th Cir 2008) 34 Pub L No 108-159, 117 Stat 1952 (December 4, 2003) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 558  Unit Six  The Regulatory Environment The Fair Debt Collection Practices Act The Fair Debt Collection Practices Act (FDCPA)35 attempts to curb perceived abuses by collection agencies The act applies only to specialized debt-­collection agencies and attorneys who regularly attempt to collect debts on behalf of someone else, usually for a percentage of the amount owed Creditors attempting to collect debts are not covered by the act unless, by misrepresenting themselves, they cause debtors to believe they are collection agencies A debt collector who fails to comply with the act is liable for actual damages, plus additional damages not to exceed $1,00036 and attorneys’ fees Prohibited Debt-Collection Tactics  Under the FDCPA, a collection agency may not any of the following: Contact the debtor at the debtor’s place of employment if the debtor’s employer objects Contact the debtor at inconvenient or unusual times (for example, at three o’clock in the morning) or at any time, if the debtor is being represented by an attorney Contact third parties other than the debtor’s parents, spouse, or financial adviser about pay35 15 U.S.C Section 1692 36 According to the U.S Court of Appeals for the Sixth Circuit, the $1,000 limit on damages applies to each lawsuit, not to each violation See Wright v Finance Service of Norwalk, Inc., 22 F.3d 647 (6th Cir 1994) ment of a debt unless a court authorizes such action Harass or intimidate the debtor (by using abusive language or threatening violence, for example) or make false or misleading statements (such as posing as a police officer) Communicate with the debtor at any time after receiving notice that the debtor is refusing to pay the debt, except to advise the debtor of further action to be taken by the collection agency Notification and Bona Fide Errors  The FDCPA also requires a collection agency to include a validation notice whenever it initially contacts a debtor for payment of a debt or within five days of that initial contact The notice must state that the debtor has thirty days in which to dispute the debt and to request a written verification of the debt from the collection agency Debt collectors who violate the act are exempt from liability if they can show that the violation was not intentional and “resulted from a bona fide error notwithstanding the maintenance of procedures reasonably adapted to avoid any such error.” The “bona fide error” defense typically has been applied to mistakes of fact or clerical errors Should the defense also apply to mistakes of law? In other words, if a debt collector violates the act because of a mistaken interpretation of the legal requirements of the FDCPA, can the debt collector avoid liability under the act? That was the issue in the following case C a s e Analy A naly s is Case 24.3  Jerman v Carlisle, McNellie, Rini, Kramer & Ulrich, LPA Supreme Court of the United States, 559 U.S 573, 130 S.Ct 1605, 176 L.Ed.2d 519 (2010) IN THE LANGUAGE OF THE COURT Justice SOTOMAYOR delivered the opinion of the Court * * * * Respondents in this case are a law firm, Carlisle, McNellie, Rini, Kramer & Ulrich, L.P.A., [Legal Professional Association], and one of its attorneys, Adrienne S Foster (collectively Carlisle) In April 2006, Carlisle filed a complaint in Ohio state court on behalf of a client, Countrywide Home Loans, Inc Carlisle sought foreclosure of a mortgage held by Countrywide in real property owned by petitioner Karen L Jerman The complaint included a “Notice,” later served on Jerman, stating that the mortgage debt would be assumed to be valid unless Jerman disputed it in writing Jerman’s lawyer sent a letter disputing the debt, and Carlisle sought verification from Countrywide When Countrywide acknowledged that Jerman had, in fact, already paid the debt in full, Carlisle withdrew the foreclosure lawsuit Jerman then filed her own lawsuit seeking * * * damages under the FDCPA [Fair Debt Collection Practices Act], contending that Carlisle violated Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 24  Consumer Protection  559 CASE 24.3 CONTINUEd [the act] by stating that her debt would be assumed valid unless she disputed it in writing While acknowledging a division of authority on the question, the District Court held that Carlisle had violated [the act] by requiring Jerman to dispute the debt in writing The court ultimately granted summary judgment to Carlisle, however, concluding that Section 1692k(c) [of the FDCPA] shielded it from liability because the violation was not intentional, resulted from a bona fide error, and occurred despite the maintenance of procedures reasonably adapted to avoid any such error The Court of Appeals for the Sixth Circuit affirmed Acknowledging that the Courts of Appeals are divided regarding the scope of the bona fide error defense, and that the “majority view is that the defense is available for clerical and factual errors only,” the Sixth Circuit nonetheless held that Section 1692k(c) extends to “mistakes of law.” * * * * The parties disagree about whether a “violation” resulting from a debt collector’s misinterpretation of the legal requirements of the FDCPA can ever be “not intentional” under 1692k(c) Jerman contends that when a debt collector intentionally commits the act giving rise to the violation (here, sending a notice that included the “in writing” language), a misunderstanding about what the Act requires cannot render the violation “not intentional,” given the general rule that mistake or ignorance of law is no defense Carlisle and the dissent, in contrast, argue that nothing in the statutory text excludes legal errors from the category of “bona fide error[s]” covered by 1692k(c) and note that the Act refers not to an unintentional “act” but rather an unintentional “violation.” The latter term, they contend, evinces [makes clear] Congress’ intent to impose liability only when a party knows its conduct is unlawful Carlisle urges us, therefore, to read 1692k(c) to encompass “all types of error,” including mistakes of law We decline to adopt the expansive reading of Section 1692k(c) that Carlisle proposes We have long recognized the “common maxim, familiar to all minds, that ignorance of the law will not excuse any person, either civilly or criminally.” Our law is therefore no stranger to the possibility that an act may be “intentional” for purposes of civil liability, even if the actor lacked actual knowledge that her conduct violated the law [Emphasis added.] * * * When Congress has intended to provide a mistake-of-law defense to civil liability, it has often done so more explicitly than here In particular, the FTC [Federal Trade Commission] Act’s administrativepenalty provisions—which * * * Congress expressly incorporated into the FDCPA—apply only when a debt collector acts with “actual knowledge or knowledge fairly implied on the basis of objective circumstances” that its action was “prohibited by [the FDCPA].” Given the absence of similar language in Section 1692k(c), it is a fair inference that Congress chose to permit injured consumers to recover actual damages, costs, fees, and modest statutory damages for “intentional” conduct, including violations resulting from mistaken interpretation of the FDCPA, while reserving the more onerous penalties of the FTC Act for debt collectors whose intentional actions also reflected “knowledge fairly implied on the basis of objective circumstances” that the conduct was prohibited * * * * We draw additional support for the conclusion that bona fide errors in Section 1692k(c) not include mistaken interpretations of the FDCPA from the requirement that a debt collector maintain “procedures reasonably adapted to avoid any such error.” The dictionary defines “procedure” as “a series of steps followed in a regular orderly definite way.” In that light, the statutory phrase is more naturally read to apply to processes that have mechanical or other such “regular orderly” steps to avoid mistakes—for instance, the kind of internal controls a debt collector might adopt to ensure its employees not communicate with consumers at the wrong time of day or make false representations as to the amount of a debt * * * We not dispute that some entities may maintain procedures to avoid legal errors But legal reasoning is not a mechanical or strictly linear process For this reason, we find * * * that the broad statutory requirement of procedures reasonably designed to avoid “any” bona fide error indicates that the relevant procedures are ones that help to avoid errors like clerical or factual mistakes Such procedures are more likely to avoid error than those applicable to legal reasoning, particularly in the context of a comprehensive and complex federal statute such as the FDCPA that imposes open-ended prohibitions on, inter alia [among other things], “false, deceptive,” or “unfair” practices * * * * For the reasons discussed above, the judgment of the United States Court of Appeals for the Sixth Circuit is reversed, and the case is remanded for further proceedings consistent with this opinion LEGAL REASONING QUESTIONS One of the concerns raised by Carlisle was that if attorneys could be held liable for their reasonable misinterpretations of the FDCPA’s requirements, there would be a “flood of lawsuits” against creditors’ attorneys by plaintiffs seeking damages and attorneys’ fees Should this concern have any bearing on the outcome of this case? Why or why not? CASE 24.3 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 560  Unit Six  The Regulatory Environment CASE 24.3 CONTINUEd Jerman’s attorneys contended that if the Court agreed with Carlisle’s argument (that the bona fide error defense included errors in legal interpretation), ethical debt collectors would be placed at a disadvantage Why would this be? Suppose that instead of serving notice to Jerman in writing, Carlisle had simply told her that her debt would be assumed to be valid unless she disputed it in writing Would the result have been different? Explain How might the ruling in this case affect other collection agencies? Reviewing: Consumer Protection Leota Sage saw a local motorcycle dealer’s newspaper advertisement offering a MetroRider EZ electric scooter for $1,699 When she went to the dealership, however, she learned that the EZ model had been sold out The salesperson told Sage that he still had the higher-end MetroRider FX model in stock for $2,199 and would sell her one for $1,999 Sage was disappointed but decided to purchase the FX model When Sage said that she wished to purchase the scooter on credit, she was directed to the dealer’s credit department As she filled out the credit forms, the clerk told Sage, who is an Asian American, that she would need a cosigner to obtain a loan Sage could not understand why she would need a cosigner and asked to speak to the store manager The manager apologized, told her that the clerk was mistaken, and said that he would “speak to” the clerk about that The manager completed Sage’s credit application, and Sage then rode the scooter home Seven months later, Sage received a letter from the manufacturer informing her that a flaw had been discovered in the scooter’s braking system and that the model had been recalled Using the information presented in the chapter, answer the following questions Did the dealer engage in deceptive advertising? Why or why not? Suppose that Sage had ordered the scooter through the dealer’s Web site but the dealer was unable to deliver it by the date promised What would the FTC have required the merchant to in that situation? Assuming that the clerk required a cosigner based on Sage’s race or gender, what act prohibits such credit discrimination? What organization has the authority to ban the sale of scooters based on safety concerns? Debate This  Laws against bait-and-switch advertising should be abolished because no consumer is ever forced to buy anything Terms and Concepts bait-and-switch advertising 547 cease-and-desist order 550 consumer law 546 “cooling-off” laws 553 counteradvertising 550 deceptive advertising 546 multiple product order 550 Regulation Z 556 validation notice 558 ExamPrep Issue Spotters United Pharmaceuticals, Inc., believes that it has developed a new drug that will be effective in the treatment of patients with AIDS The drug has had only limited testing, but United wants to make the drug widely available as soon as possible To market the drug, what must United prove to the U.S Food and Drug Administration? (See page 554.) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 24  Consumer Protection  Gert buys a notebook computer from EZ Electronics She pays for it with her credit card When the computer proves defective, she asks EZ to repair or replace it, but EZ refuses What can Gert do? (See page 556.) •  Check your answers to the Issue Spotters against the answers provided in Appendix E at the end of this text 561 book’s Web site Then, click on “Access Now” under “Study Tools,” and select Chapter 24 at the top There, you will find an Interactive Quiz that you can take to assess your mastery of the concepts in this chapter, as well as Flashcards and a Glossary of important terms Before the Test  Go to www.cengagebrain.com, enter the ISBN 9781285428949, and click on “Find” to locate this text- Business Scenarios 24–1. Unsolicited Merchandise. Andrew, a resident of California, received an advertising circular in the U.S mail announcing a new line of regional cookbooks distributed by the Every-Kind Cookbook Co Andrew didn’t want any books and threw the circular away Two days later, Andrew received in the mail an introductory cookbook entitled Lower Mongolian Regional Cookbook, as announced in the circular, on a “trial basis” from Every-Kind Andrew was not interested but did not go to the trouble to return the cookbook Every-Kind demanded payment of $20.95 for the Lower Mongolian Regional Cookbook Discuss whether Andrew can be required to pay for the book (See page 553.) 24–2. Credit-Card Rules. Maria Ochoa receives two new credit cards on May She has solicited one of them from Midtown Department Store, and the other arrives unsolicited from High-Flying Airlines During the month of May, Ochoa makes numerous credit-card purchases from Midtown Department Store, but she does not use the High-Flying Airlines card On May 31, a burglar breaks into Ochoa’s home and steals both credit cards, along with other items Ochoa notifies the Midtown Department Store of the theft on June 2, but she fails to notify HighFlying Airlines Using the Midtown credit card, the burglar makes a $500 purchase on June and a $200 purchase on June The burglar then charges a vacation flight on the High-Flying Airlines card for $1,000 on June Ochoa receives the bills for these charges and refuses to pay them Discuss Ochoa’s liability for the charges (See page 556.) Business Case Problems 24–3. Spotlight on McDonald’s—Food Labeling. McDonald’s Corp.’s Happy Meal® meal selection consists of an entrée, a small order of french fries, a small drink, and a toy In the early 1990s, McDonald’s began to aim its Happy Meal marketing at children aged one to three In 1995, McDonald’s began making nutritional information for its food products available in documents known as “McDonald’s Nutrition Facts.” Each document lists the food items that the restaurant serves and provides a nutritional breakdown, but the Happy Meal is not included Marc Cohen filed a suit in an Illinois state court, alleging, among other things, that McDonald’s had violated a state law prohibiting consumer fraud and deceptive business practices by failing to adhere to the Nutrition Labeling and Education Act (NLEA) of 1990 The NLEA sets out different requirements for products specifically intended for children under the age of four—generally, the products’ labels cannot declare the percent of daily value of nutritional components Would this requirement be readily understood by a consumer who is not familiar with nutritional standards? Why or why not? Should a state court impose such regulations? Explain [Cohen v McDonald’s Corp., 347 Ill.App.3d 627, 808 N.E.2d 1, 283 Ill.Dec 451 (1 Dist 2004)] (See page 552.) 24–4.  Debt Collection. 55th Management Corp in New York City owns residential property that it leases to various tenants In June 2000, claiming that one of the tenants, Leslie Goldman, owed more than $13,000 in back rent, 55th retained Jeffrey Cohen, an attorney, to initiate nonpayment proceedings Cohen filed a petition in a New York state court against Goldman, seeking recovery of the unpaid rent and at least $3,000 in attorneys’ fees After receiving notice of the petition, Goldman filed a suit in a federal district court against Cohen Goldman contended that the notice of the petition constituted an initial contact that, under the Fair Debt Collection Practices Act (FDCPA), required a validation notice Because Cohen did not give Goldman a validation notice at the time or within five days of the notice of the petition, Goldman argued that Cohen was in violation of the FDCPA Should the filing of a suit in a state court be considered ­“communication,” requiring a debt collector to provide a validation notice under the FDCPA? Why or why not? [Goldman v Cohen, 445 F.3d 152 (2d Cir 2006)] (See page 558.) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 562  Unit Six  The Regulatory Environment 24–5.  Food Labeling.  The Nutrition Labeling and Education Act (NLEA) requires packaged food to have a “Nutrition Facts” panel that sets out “nutrition information,” including “the total number of calories” per serving Before the 2010 health-care reforms enacted provisions on menu labeling (see page 553), restaurants were exempt from this requirement The NLEA also regulated nutritional content claims, such as “low sodium,” that a purveyor might choose to add to a label The NLEA permitted a state or city to require restaurants to disclose nutrition information about the food they serve, but expressly preempted state or local attempts to regulate nutritional content claims New York City Health Code Section 81.50 requires 10 percent of the restaurants in the city, including McDonald’s, Burger King, and KFC, to post calorie content information on their menus The New York State Restaurant Association (NYSRA) filed a suit in a federal district court, contending that the NLEA preempts Section 81.50 (Under the U.S Constitution, state or local laws that conflict with federal laws are preempted.) Was the NYSRA correct? Explain [New York State Restaurant Association v New York City Board of Health, 556 F.3d 114 (2d Cir 2009)] (See page 552.) 24–6.  Deceptive Advertising. Brian Cleary and Rita Burke filed a suit against cigarette maker Philip Morris USA, Inc., seeking class-action status for a claim of deceptive advertising Cleary and Burke claimed that “light” cigarettes, such as Marlboro Lights, were advertised as safer than regular cigarettes, even though the health effects are the same They contended that the tobacco companies concealed the true nature of light cigarettes Philip Morris correctly claimed that it was authorized by the government to advertise cigarettes, including light cigarettes Assuming that is true, should the plaintiffs still be able to bring a deceptive advertising claim against the tobacco company? Why or why not? [Cleary v Philip Morris USA, Inc., 683 F.Supp.2d 730 (N.D.Ill 2010)] (See page 546.) 24–7.  Business Case Problem with Sample Answer:  Fair Debt-Collection Practices Bank of America hired Atlantic Resource Management, LLC, to collect a debt from Michael E Engler Atlantic called Engler’s employer and asked his supervisor about the company’s policy concerning the execution of warrants It then told the supervisor that, to stop the process, Engler needed to call Atlantic about “Case Number 37291 NY0969” during the first three hours of his next shift When Engler’s supervisor told him about the call, Engler feared that he might be arrested, and he experienced discomfort, embarrassment, and emotional distress at work Can Engler recover under the Fair Debt Collection Practices Act? Why or why not? [Engler v Atlantic Resource Management, LLC, 2012 WL 464728 (W.D.N.Y 2012)] (See page 558.) •  For a sample answer to Problem 24–7, go to Appendix F at the end of this text 24–8.  A Question of Ethics:  Fair Debt-Collection Practices Barry Sussman graduated from law school, but also served time in prison for attempting to collect debts by posing as an FBI agent He theorized that if a debt-collection business collected only debts that it owned as a result of buying checks written on accounts with insufficient funds (NSF checks), it would not be subject to the Federal Debt Collection Practices Act (FDCPA) Sussman formed Check Investors, Inc., to act on his theory Check Investors bought more than 2.2 million NSF checks, with an estimated face value of about $348 million, for pennies on the dollar Check Investors added a fee of $125 or $130 (more than the legal limit in most states) to the face amount of each check and aggressively pursued its drawer to collect The firm’s employees were told to accuse drawers of being criminals and to threaten them with arrest and prosecution The threats were false Check Investors never took steps to initiate a prosecution The employees contacted the drawers’ family members and used “saturation phoning”—phoning a drawer numerous times in a short period They used abusive language, referring to drawers as “deadbeats,” “retards,” “thieves,” and “idiots.” Between January 2000 and January 2003, Check Investors netted more than $10.2 million from its efforts [ Federal Trade Commission v Check Investors, Inc., 502 F.3d 159 (3d Cir 2007)] (See page 538.) (a) The Federal Trade Commission filed a suit in a federal district court against Check Investors and others, alleging, in part, violations of the FDCPA Was Check Investors a “debt collector,” collecting “debts,” within the meaning of the FDCPA? If so, did its methods violate the FDCPA? Were its practices unethical? What might Check Investors argue in its defense? Discuss (b) Are “deadbeats” the primary beneficiaries of laws such as the FDCPA? If not, how would you characterize debtors who default on their obligations? Legal Reasoning Group Activity 24–9.  Consumer Protections.  Many states have enacted laws that go even further than federal law to protect consumers These laws vary tremendously from state to state (See page 546.) (a) The first group will decide whether having different laws is fair to sellers who may be prohibited from engaging in a practice in one state that is legal in another (b) The second group will consider how these different laws might affect a business (c) A third group will determine whether is it fair that residents of one state have more protection than residents of another Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 25 Environmental Law C oncern over the degradation of the environment has increased over time in response to the environmental effects of population growth, urbanization, and industrialization Environmental protection is not without a price, however For many businesses, the costs of complying with environmental regulations are high, and for some they may seem too high A constant tension exists between the desire to increase profits and productivity and the need to protect the environment In this chapter, we discuss environmental law, which consists of all laws and regulations designed to protect and preserve our environmental SECTION Common Law Actions Common law remedies against environmental pollution originated centuries ago in England Those responsible for operations that created dirt, smoke, noxious odors, noise, or toxic substances were sometimes held liable under common law theories of nuisance or negligence Today, injured individuals continue to rely on the common law to obtain damages and injunctions against business polluters Nuisance Under the common law doctrine of nuisance, persons may be held liable if they use their property in a manner that unreasonably interferes with others’ rights to use or enjoy their own property Courts typically balance the harm caused by the pollution against the costs of stopping it Courts have often denied injunctive relief on the ground that the hardships that would be imposed on the polluter and on the community are greater than the hardships suffered by the plaintiff ▶  Example 25.1  Hewitt’s factory causes neighboring landowners to suffer from smoke, soot, and vibrations If the factory is the core of the local economy, a court may leave it in operation and award mone- resources To a great extent, environmental law consists of statutes passed by federal, state, or local governments and regulations issued by administrative agencies Before examining statutory and regulatory environmental laws, however, we look at the remedies against environmental pollution that are available under the common law tary damages to the injured parties Damages can include compensation for the decline in the value of their property caused by Hewitt’s operation.  ◀ To obtain relief from pollution under the nuisance doctrine, a property owner may have to identify a distinct harm separate from that affecting the general public This harm is referred to as a “private” nuisance Under the common law, individuals were denied standing (access to the courts—see Chapter 2) unless they suffered a harm distinct from that suffered by the public at large Some states still require this A public authority (such as a state’s attorney general), however, can sue to stop a “public” nuisance Negligence and Strict Liability An injured party may sue a business polluter in tort under the negligence and strict liability theories discussed in Chapters 12 and 13 A negligence action is based on a business’s alleged failure to use reasonable care toward a party whose injury was foreseeable and was caused by the lack of reasonable care For instance, employees might sue an employer whose failure to use proper pollution controls contaminated the air, causing the employees to suffer respiratory illnesses Lawsuits for personal injuries caused by exposure to a toxic substance, such as asbestos, radiation, or hazardous waste, have given rise to a growing body of tort law known as toxic torts 563 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 564  Unit Six  The Regulatory Environment Businesses that engage in ultrahazardous activities— such as the transportation of radioactive materials—are strictly liable for any injuries the activities cause In a strict liability action, the injured party does not have to prove that the business failed to exercise reasonable care SECTION Federal, State, and Local Regulations All levels of government in the United States regulate some aspect of the environment In this section, we look at some of the ways in which the federal, state, and local governments control business activities and land use in the interests of environmental preservation and protection State and Local Regulations In addition to the federal regulations to be discussed shortly, many states have enacted laws to protect the environment State laws may restrict a business’s discharge of chemicals into the air or water or regulate its disposal of toxic wastes States may also regulate the disposal or recycling of other wastes, including glass, metal, plastic containers, and paper Additionally, states may restrict emissions from motor vehicles City, county, and other local governments also regulate some aspects of the environment For instance, local zoning laws may be designed to inhibit or regulate the growth of cities and suburbs or to protect the natural environment In the interest of safeguarding the environment, such laws may prohibit certain land uses Even when zoning laws permit a business’s proposed development, the plans may have to be altered to lessen the development’s impact on the environment In addition, cities and counties may impose rules regulating methods of waste removal, the appearance of buildings, the maximum noise level, and other aspects of the local environment State and local regulatory agencies also play a significant role in implementing federal environmental legislation Typically, the federal government relies on state and local governments to enforce federal environmental statutes and regulations such as those regulating air quality Exhibit 25–1 on the next page lists and summarizes the major federal environmental statutes discussed in this chapter Most of these statutes are designed to address pollution in the air, water, or land Some specifically regulate toxic chemicals, including pesticides, herbicides, and hazardous wastes Environmental Regulatory Agencies  The primary federal agency regulating environmental law is the Environmental Protection Agency (EPA), which was created in 1970 to coordinate federal environmental responsibilities Other federal agencies with authority for regulating specific environmental matters include the Department of the Interior, the Department of Defense, the Department of Labor, the Food and Drug Administration, and the Nuclear Regulatory Commission All federal agencies must take environmental factors into consideration when making significant decisions In addition, as mentioned, state and local agencies play an important role in enforcing federal environmental legislation Most federal environmental laws provide that citizens can sue to enforce environmental regulations if government agencies fail to so—or to limit enforcement actions if agencies go too far in their actions Typically, a threshold hurdle in such suits is meeting the requirements for standing to sue (see Chapter 2) Environmental Impact Statements  The National Environmental Policy Act of 19691 requires that an environmental impact statement (EIS) be prepared for every major federal action that significantly affects the quality of the environment An EIS must analyze the following: The impact on the environment that the action will have Any adverse effects on the environment and alternative actions that might be taken Any irreversible effects the action might generate Federal Regulations An action qualifies as “major” if it involves a substantial commitment of resources (monetary or otherwise) An action is “federal” if a federal agency has the power to control it ▶  Example 25.2  Development of a ski resort by a private developer on federal land may require an EIS Construction or operation of a nuclear plant, which requires a federal permit, or creation of a dam as part of a federal project requires an EIS.  ◀ If an agency decides that an EIS is unnecessary, it must issue a statement supporting this conclusion Congress has passed a number of statutes to control the impact of human activities on the environment 42 U.S.C Sections 4321–4370d Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 25  Environmental Law  565 E X H I B IT 25 – 1  Major Federal Environmental Statutes Popular Name Purpose Statute Reference Rivers and Harbors Appropriations Act (1899) To prohibit ships and manufacturers from discharging and depositing refuse in navigable waterways 33 U.S.C Sections 401–418 Federal Insecticide, Fungicide, and Rodenticide Act (1947) To control the use of pesticides and herbicides U.S.C Sections 136–136y Federal Water Pollution Control Act (1948) To eliminate the discharge of pollutants from major sources into navigable waters 33 U.S.C Sections 1251–1387 Clean Air Act (1963, 1970) To control air pollution from mobile and stationary sources 42 U.S.C Sections 7401–7671q National Environmental Policy Act (1969) To limit environmental harm from federal government activities 42 U.S.C Sections 4321–4370d Ocean Dumping Act (1972) To prohibit the dumping of radiological, chemical, and biological warfare agents and high-level radioactive waste into the ocean 16 U.S.C Sections 1401–1445 Endangered Species Act (1973) To protect species that are threatened with extinction 16 U.S.C Sections 1531–1544 Safe Drinking Water Act (1974) To regulate pollutants in public drinking water systems 42 U.S.C Sections 300f–300j-25 Resource Conservation and Recovery Act (1976) To establish standards for hazardous waste disposal 42 U.S.C Sections 6901–6986 Toxic Substances Control Act (1976) To regulate toxic chemicals and chemical compounds 15 U.S.C Sections 2601–2692 Comprehensive Environmental Response, Compensation, and Liability Act (1980) To regulate the clean-up of hazardous waste–disposal sites 42 U.S.C Sections 9601–9675 Oil Pollution Act (1990) To establish liability for the clean-up of navigable waters after oil spills 33 U.S.C Sections 2701–2761 Small Business Liability Relief and Brownfields Revitalization Act (2002) To allow developers who comply with state voluntary clean-up programs to avoid federal liability for the properties that they decontaminate and develop 42 U.S.C Section 9628 Private individuals, consumer interest groups, businesses, and others who believe that a federal agency’s activities threaten the environment often use EISs as a means to challenge those activities SECTION Air Pollution Federal involvement with air pollution goes back to the 1950s and 1960s, when Congress authorized funds for air-pollution research and enacted the Clean Air Act.2 The Clean Air Act, as amended, provides the 42 U.S.C Sections 7401–7671q basis for issuing regulations to control multistate air pollution It covers both mobile sources (such as automobiles and other vehicles) and stationary sources (such as electric utilities and industrial plants) of pollution Mobile Sources Regulations governing air pollution from automobiles and other mobile sources specify pollution standards and establish time schedules for meeting the standards The EPA periodically updates the pollution standards in light of new developments and data, usually reducing the amount of emissions allowed Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 566  Unit Six  The Regulatory Environment Reducing Emissions The Obama administration has announced a long-term goal of reducing emissions, including those from cars and sport utility vehicles, by 80 percent by 2050 In 2010, the administration ordered the EPA to develop national standards regulating fuel economy and emissions for mediumand heavy-duty trucks starting with 2014 models Greenhouse Gases A growing concern among many scientists and others around the world is that greenhouse gases, such as carbon dioxide (CO2), are contributing to global warming and climate change The Clean Air Act, as amended, however, does not specifically mention CO2 emissions Therefore, until 2009, the EPA did not regulate CO2 emissions from motor vehicles ▶ Case in Point 25.3  Environmental groups and several states, including Massachusetts, sued the EPA in an effort to force the agency to regulate CO2 emissions When the case reached the United States Supreme Court, the EPA argued that the plaintiffs lacked standing because global warming has widespread effects and thus an individual plaintiff could not show the particularized harm required for standing Furthermore, the agency maintained that it did not have authority under the Clean Air Act to address global climate change and regulate CO2 The Court, however, ruled that Massachusetts had standing because its coastline, including state-owned lands, faced an imminent threat from rising sea levels purportedly caused by global warming The Court also held that the Clean Air Act’s broad definition of “air pollutant” gives the EPA authority to regulate CO2 and requires the EPA to regulate any air pollutants that might “endanger public health or welfare.” Accordingly, the Court ordered the EPA to determine whether CO2 was a pollutant that endangered public health.3  ◀ The EPA later concluded that greenhouse gases, including CO2 emissions, constitute a public danger Stationary Sources The Clean Air Act also authorizes the EPA to establish air-quality standards for stationary sources (such as manufacturing plants) but recognizes that the primary responsibility for implementing these standards rests with state and local governments The standards are aimed at controlling hazardous air pollutants— Massachusetts v Environmental Protection Agency, 549 U.S 497, 127 S.Ct 1438, 167 L.Ed.2d 248 (2007) those likely to cause death or a serious, irreversible, or incapacitating condition, such as cancer or neurological or reproductive damage The EPA sets primary and secondary levels of ambient standards—that is, maximum permissible levels of certain pollutants—and the states formulate plans to achieve those standards Different standards apply depending on whether the sources of pollution are located in clean areas or polluted areas and whether they are existing sources or major new sources Hazardous Air Pollutants  The Clean Air Act requires the EPA to list all hazardous air pollutants (HAPs) on a prioritized schedule In all, nearly two hundred substances—including asbestos, benzene, beryllium, cadmium, mercury, and vinyl chloride— have been classified as hazardous They are emitted from stationary sources by a variety of business activities, including smelting (melting ore to produce metal), dry cleaning, house painting, and commercial baking Maximum Achievable Control Technology  Instead of establishing specific emissions standards for each hazardous air pollutant, the Clean Air Act requires major new sources4 to use pollution-control equipment that represents the maximum achievable control technology, or MACT, to reduce emissions The EPA issues guidelines as to what equipment meets this standard.5 Violations of the Clean Air Act For violations of emission limits under the Clean Air Act, the EPA can assess civil penalties of up to $25,000 per day Additional fines of up to $5,000 per day can be assessed for other violations, such as failure to maintain the required records To penalize those who find it more cost-effective to violate the act than to comply with it, the EPA is authorized to impose a penalty equal to the violator’s economic benefits from noncompliance Persons who provide information about violators may be paid up to $10,000 Private citizens can also sue violators Those who knowingly violate the act may be subject to criminal penalties, including fines of up to The term major new sources is defined to include existing sources modified by a change in a method of operation that increases emissions The EPA has also issued rules to regulate hazardous air pollutants emitted by landfills See 40 C.F.R Sections 60.750–60.759 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 25  Environmental Law  $1 million and imprisonment for up to two years (for false statements or failure to report violations) Corporate officers are among those who may be subject to these penalties SECTION Water Pollution Water pollution stems mostly from industrial, municipal, and agricultural sources Pollutants entering streams, lakes, and oceans include organic wastes, heated water, sediments from soil runoff, nutrients (including fertilizers and human and animal wastes), and toxic chemicals and other hazardous substances Federal regulations governing water pollution can be traced back to the Rivers and Harbors Appropriations Act of 1899.6 These regulations prohibited ships and manufacturers from discharging or depositing refuse in navigable waterways without a permit.7 In 1948, Congress passed the Federal Water Pollution Control Act (FWPCA),8 but its regulatory system and enforcement powers proved to be inadequate The Clean Water Act In 1972, amendments to the FWPCA—known as the Clean Water Act (CWA)—established the following goals: (1) make waters safe for swimming, (2) protect fish and wildlife, and (3) eliminate the discharge of pollutants into the water The CWA also set specific schedules, which were extended by amendment in 1977 and by the Water Quality Act of 1987.9 Under these schedules, the EPA limits the discharge of various types of pollutants based on the technology available for controlling them Focus on Point-Source Emissions The CWA established a permit system, called the National Pollutant Discharge Elimination System (NPDES), for regulating discharges from “point sources” of pollution, which include industrial, municipal (such as pipes and sewage treatment plants), and agricul6 33 U.S.C Sections 401–418 The term navigable waters is interpreted today as including intrastate lakes and streams used by interstate travelers and industries, as well as coastal and freshwater wetlands 33 U.S.C Sections 1251–1387 This act amended 33 U.S.C Section 1251 567 tural facilities.10 Under this system, any point source emitting pollutants into water must have a permit Pollution not from point sources, such as runoff from small farms, is not subject to much regulation NPDES permits can be issued by the EPA and authorized state agencies and Indian tribes, but only if the discharge will not violate water-quality standards NPDES permits must be reissued every five years Although initially the NPDES system focused mainly on industrial wastewater, it was later expanded to cover stormwater discharges In practice, the permit system under the CWA includes the following elements: National effluent (pollution) standards set by the EPA for each industry Water-quality standards set by the states under EPA supervision A discharge permit program that sets water-quality standards to limit pollution Special provisions for toxic chemicals and for oil spills Construction grants and loans from the federal government for publicly owned treatment works, primarily sewage treatment plants Standards for Equipment Regulations generally specify that the best available control technology, or BACT, be installed The EPA issues guidelines as to what equipment meets this standard Essentially, the guidelines require the most effective pollution-­ control equipment available New sources must install BACT equipment before beginning operations Existing sources are subject to timetables for the installation of BACT equipment and must immediately install equipment that utilizes the best practical control technology, or BPCT The EPA also issues guidelines as to what equipment meets this standard The EPA must take into account many factors when issuing and updating its rules Some provisions of the CWA instruct the EPA to weigh the cost of the technology required relative to the benefits achieved The provision that covers power plants, however, neither requires nor prohibits a cost-­ benefit analysis The question in the following case was whether the EPA could base its decision on such an analysis anyway 10 33 U.S.C Section 1342 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 568  Unit Six  The Regulatory Environment Case 25.1 Entergy Corp v Riverkeeper, Inc Supreme Court of the United States, 556 U.S 208, 129 S.Ct 1498, 173 L.Ed.2d 369 (2009) background and facts  As part of its implementation of the Clean Water Act, the Environmental Protection Agency (EPA) has developed two sets of rules that apply to the cooling systems of power plants Phase I rules require new power plants to restrict their inflow of water “to a level commensurate with that which can be attained by a closed-cycle recirculating cooling water system.” Phase II rules apply “national performance standards” to more than five hundred existing plants but not require closedcycle cooling systems The EPA found that converting these facilities to closed-cycle operations would cost $3.5 billion per year The facilities would then produce less power while burning the same amount of coal Moreover, other technologies can attain nearly the same results as closed-cycle systems Phase II rules also allow a variance from the national performance standards if a facility’s cost of compliance “would be significantly greater than the benefits.” Environmental organizations, including Riverkeeper, Inc., challenged the Phase II regulations, arguing that existing plants should be required to convert to closed-cycle systems The U.S Court of Appeals for the Second Circuit issued a ruling in the plaintiffs’ favor Power-generating companies, including Entergy Corporation, appealed to the United States Supreme Court in the language of the court Justice SCALIA delivered the opinion of the Court * * * * In setting the Phase II national performance standards and providing for site-specific costbenefit variances, the EPA relied on its view that [the] “best technology available” standard permits consideration of the technology’s costs and of the relationship between those costs and the environmental benefits produced * * * The “best” technology—that which is “most advantageous”—may well be the one that produces the most of some good, here a reduction in adverse environmental impact But “best technology” may also describe the technology that most efficiently produces some good In common parlance one could certainly use the phrase “best technology” to refer to that which produces a good at the lowest per-unit cost, even if it produces a lesser quantity of that good than other available technologies [Emphasis added.] * * * This latter reading is [not] precluded by the statute’s use of the phrase “for minimizing adverse environmental impact.” Minimizing * * * is a term that admits of degree and is not necessarily used to refer exclusively to the “greatest possible reduction.” [Emphasis added.] Other provisions in the Clean Water Act also suggest the agency’s interpretation When Congress wished to mandate the greatest feasible reduction in water pollution, it did so in plain language: The provision governing the discharge of toxic pollutants into the Nation’s waters requires the EPA to set “effluent limitations which shall require the elimination of discharges of all pollutants * * * .” The less ambitious goal of “minimizing adverse environmental impact” suggests, we think, that the agency retains some discretion to determine the extent of reduction that is warranted under the circumstances That determination could plausibly involve a consideration of the benefits derived from reductions and the costs of achieving them * * * [Under other Clean Water Act provisions that impose standards on sources of pollution,] the EPA is instructed to consider, among other factors, “the total cost of application of technology in relation to the * * * benefits to be achieved.” * * * * This * * * comparison of * * * statutory factors * * * leads us to the conclusion that it was well within the bounds of reasonable interpretation for the EPA to conclude that cost-benefit analysis is not categorically forbidden * * * * While not conclusive, it surely tends to show that the EPA’s current practice is a reasonable and hence legitimate exercise of its discretion to weigh benefits against costs that the agency has been proceeding in essentially this fashion for over 30 years Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 25  Environmental Law  CASE 25.1 CONTINUEd 569 decision and remedy  The United States Supreme Court concluded that the EPA permissibly relied on a cost-benefit analysis to set national performance standards and to allow for variances from those standards as part of the Phase II regulations The Court reversed the lower court’s judgment and remanded the case The ethical dimension  In this case, aquatic organisms were most directly at risk Is it acceptable to apply cost-benefit analyses to situations in which the lives of people are directly affected? Explain The global dimension  In analyzing the costs and benefits of an action that affects the environment, should a line be drawn at a nation’s borders? Why or why not? Wetlands  The CWA prohibits the filling or dredging of wetlands unless a permit is obtained from the Army Corps of Engineers The EPA defines wetlands as “those areas that are inundated or saturated by surface or ground water at a frequency and duration sufficient to support vegetation typically adapted for life in saturated soil conditions.” Wetlands are thought to be vital to the ecosystem because they filter streams and rivers and provide habitat for wildlife In the past, the EPA’s broad interpretation of what constituted a wetland generated substantial controversy In recent years, the courts have considerably scaled back the CWA’s protection of wetlands.11 In the following case, the court had to deal with the meaning of wetlands and whether the term included saturated land adjacent to navigable-in-fact waters—that is, waters that are navigable in their natural or unimproved condition and used as highways of commerce 11 See, for example, Rapanos v United States, 547 U.S 715, 126 S.Ct 2208, 165 L.Ed.2d 159 (2006) C as e Analy A naly s is Case 25.2 United States v Lucas United States Court of Appeals, Fifth District, 516 F.3d 316 (2008) IN THE LANGUAGE OF THE COURT Patrick E HIGGINBOTHAM, Circuit Judge * * * * Robert J Lucas owned Big Hill Acres, Inc (BHA, Inc.) and Consolidated Investments, Inc Through these companies, he acquired Big Hill Acres (BHA), a large parcel of land in Jackson County, Mississippi, approximately eight miles from the Gulf of Mexico He subdivided the property and sold mobile home lots under long-term installment plans The property was not connected to a central municipal waste system, and County law required Lucas to certify and install individual septic systems on each lot before they could establish electric hook-ups or sell the lots In Jackson County, septic systems must be approved by an engineer with the Mississippi Department of Health (MDH) or by an independent licensed engineer Lucas initially hired an MDH engineer to approve septic systems, but MDH withdrew many of its initial approvals when it found that the lots were on saturated soils Lucas then hired a private licensed engineer, M E Thompson, Jr., to approve and certify the septic systems Robbie Lucas Wrigley, Lucas’s daughter, advertised the lots, showed them to prospective buyers, and leased them The [U.S.] Army Corps of Engineers, the EPA [Environmental Protection Agency], the MDH, and the Mississippi Department of Environmental Quality (DEQ) became concerned that Defendants were selling house lots and installing septic systems on wetlands These agencies issued several cease and desist orders against Lucas and Thompson, and the EPA sent letters to residents and organized a meeting of the residents to warn them of lot conditions and to tell them where wetlands were located on the property It also met with BHA’s counsel to attempt to designate the areas where they would allow development These efforts were not fully successful The Government filed a fortyone–count indictment against Defendants * * * , charging filling of wetlands without a Section 404 CASE 25.2 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 570  Unit Six  The Regulatory Environment CASE 25.2 CONTINUEd permit from the [U.S Army] Corps [of Engineers], failing to obtain Section 402 National Pollutant Discharge Elimination System (NPDES) Permits for the septic tanks, mail fraud, and conspiracy to commit mail fraud and to violate Sections 402 and 404 of the CWA [Clean Water Act] * * * A jury convicted Defendants on all counts, and the court * * * sentenced Lucas, Wrigley, and Thompson to prison terms; placed BHA, Inc., and Consolidated Investments on probation; and ordered all Defendants to pay restitution, special assessments, and fines The first and overarching [dominant] question is jurisdiction—whether the jury was properly required to find that the property at issue was subject to the CWA * * * The instructions stated in relevant part, * * * * The term wetlands means those areas that are inundated or saturated by surface or groundwater at a frequency and duration sufficient to support, and that under normal circumstances support, a prevalence of vegetation typically adapted for life in saturated soil conditions * * * . * * * Wetlands that are waters of the United States are protected by the Clean Water Act Wetlands are considered waters of the United States if they are adjacent to a navigable body of open water Wetlands are adjacent to a navigable body of water if there is a significant nexus ­[connection] between the wetlands in question and a navigable-in-fact waterway Some of the factors which you may wish to consider in determining whether there is a significant nexus include, but are not limited to: * * * flow rate of surface waters from the wetlands into a navigable body of water * * * when, or to what extent, contaminants from the wetlands have or will affect a navigable body of water * * * [Emphasis added.] Defendants argue that the court erred in not including their requested language that: * * * adjacency implicates a “significant nexus” between the water in question and the navigable-in-fact waterway If the government fails to prove beyond a reasonable doubt that the wetlands at issue in this case are in fact navigable or truly adjacent to [that is,] lying near, close, contiguous, or adjoining a navigable waterway, you must find the defendants not guilty * * * * * * * * * * A district court abuses its discretion in omitting a requested jury instruction only if the requested language “(1) is substantively correct; (2) is not substan- tially covered in the charge given to the jury; and (3) concerns an important point in the trial * * *.” [Emphasis added.] The court’s instructions were not in error, nor was the court’s omission of Defendants’ requested instructions * * * The instructions substantially covered Defendants’ requested instructions by requiring adjacency as defined by a significant nexus * * * * The government has shown that there is a significant nexus between the wetlands on Big Hill Acres and navigable-in-fact waters * * * The surface from the Big Hill Acres site drains in three directions The western portions of the site drain into Bayou Costapia Bayou Costapia empties into the Tchoutacabouffa River, which then empties into the Gulf of Mexico The central portions of the Big Hill Acres development drained through tributaries into Old Fort Bayou Creek And Old Fort Bayou Creek connects to Old Fort Bayou, which is a protected coastal preserve emptying into the Gulf of Mexico And the eastern portions drain into the headwaters of Little Bluff Creek, which then connects to Bluff Creek, which flows into the Pascagoula River and on to the Gulf of Mexico The court did not abuse its discretion in giving the CWA instructions LEGAL REASONING QUESTIONS Suppose that during most of the year, there was a solid strip of land around the property in question that was never under water or saturated Would the outcome of this case have been the same? Why or why not? According to the judge, what three characteristics of jury instructions does a federal appellate court examine to determine whether a district court has abused its discretion in omitting a requested jury instruction? Which of these three characteristics was at issue in this case? Would the court have ruled differently if the water from the wetlands had drained or flowed directly into international or foreign waters rather than into the waters of the United States? Discuss Does it seem appropriate to sentence businesspersons to prison for violations of the Clean Water Act? Violations of the Clean Water Act Because point-source water pollution control is based on a permit system, the permits are the key to enforcement States have primary responsibility for enforcing the permit system, subject to EPA monitoring Discharging emissions into navigable waters without a permit, or in violation of pollution limits under a permit, violates the CWA Violators are subject to a variety of civil and criminal penalties Depending on the violation, civil penalties range from $10,000 to $25,000 per day, but not more than $25,000 per violation Lying about a violation is more serious than admitting the truth about improper discharges Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 25  Environmental Law  Criminal penalties, which apply only if a violation was intentional, range from a fine of $2,500 per day and imprisonment for up to one year to a fine of $1 million and fifteen years’ imprisonment Injunctive relief and damages can also be imposed The polluting party can be required to clean up the pollution or pay for the cost of doing so 571 In the following case, landowners filed a lawsuit challenging an EPA order finding that they had violated the CWA The United States Supreme Court had to decide whether the federal courts could review the EPA’s decision Case 25.3 Sackett v Environmental Protection Agency Supreme Court of the United States, _ U.S _, 132 S.Ct 1367, 182 L.Ed.2d 367 (2012) BACKGROUND AND FACTS  To build a home in Idaho, Michael and Chantell Sackett filled part of their residential lot with
dirt and rock A few months later, they received a compliance order from the Environmental Protection Agency (EPA) The order asserted that, because their property was near a major lake, the Sacketts had polluted wetlands in violation of the Clean Water Act The order required the Sacketts to restore their property immediately, and they faced heavy fines of $75,000 a day The Sacketts requested a hearing with the EPA When a hearing was denied, they sued the EPA in federal district court, asserting, among other things, that the compliance order was “arbitrary and capricious” under the Administrative Procedure Act (APA) The district court found that it could not review the EPA’s compliance order On appeal, a federal appellate court affirmed, concluding that the Sacketts had to wait for the EPA to bring an enforcement action against them The United States Supreme Court granted certiorari to resolve the matter IN THE LANGUAGE OF THE COURT Justice SCALIA delivered the opinion of the Court * * * * * * * The APA * * * provides for judicial review of “final agency action for which there is no other adequate remedy in a court.” We consider first whether the compliance order is final agency action There is no doubt it is agency action, which the APA defines as including even a “failure to act.” But is it final? It has all of the hallmarks of
APA finality that our opinions establish Through the order, the EPA
“ ‘determined’ ” “ ‘rights or obligations.’ ” By reason of the order, the Sacketts have the legal obligation to “restore” their property according to an agency-approved Restoration Work Plan, and must give the EPA access to their property and to “records and documentation related to the conditions at the Site.” Also, “ ‘legal consequences flow’ ” from issuance of the order * * * The order exposes the Sacketts to double penalties in a future enforcement proceeding [Emphasis in original.] The issuance of the compliance order also marks the
“ ‘consummation’ ” of the agency’s decision-making process As the Sacketts learned when they unsuccessfully sought a hearing, * * * [the] compliance order * * * [was] not subject to further agency review The APA’s judicial review provision also requires that the person seeking APA review of final agency action have “no other adequate remedy in a court[.]” In Clean Water Act enforcement cases, judicial review ordinarily comes by way of a civil action brought by the EPA * * *  But the Sacketts cannot initiate that process, and each day they wait for the agency to drop the hammer, they accrue * * * an additional $75,000 in potential liability * * * * * * * Compliance orders * * * can obtain quick remediation through voluntary compliance The Government warns that the EPA is less
likely to use the orders if they are subject to judicial review That may be true—but it will be true for all agency actions subjected to judicial review * * * There is no reason to think that the Clean Water Act was uniquely designed to enable the strong-arming of regulated parties into “voluntary compliance” without the opportunity for judicial review * * *  Compliance orders will remain an effective means of securing prompt voluntary CASE 25.3 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 572  Unit Six  The Regulatory Environment CASE 25.3 CONTINUEd compliance in those many cases where there is no substantial basis to question their validity [Emphasis added.] DECISION AND REMEDY  The United States Supreme Court held that the Sacketts could challenge the EPA’s compliance order in federal court The Court reversed the judgment of the federal appellate court THE LEGAL ENVIRONMENT DIMENSION  What does the Court’s decision in this case mean for people and businesses that face compliance orders? Are they more or less likely to acquiesce to orders they find objectionable? Why? THE ENVIRONMENTAL DIMENSION  Is it appropriate to impose significant fines on citizens when they violate environmental laws? Discuss Drinking Water Oil Pollution The Safe Drinking Water Act requires the EPA to set maximum levels for pollutants in public water systems Public water systems operators must come as close as possible to meeting the EPA’s standards by using the best available technology that is economically and technologically feasible The act, as amended, also requires each supplier of drinking water to send every household it supplies with water an annual statement describing the source of its water The statement must also disclose the level of any contaminants contained in the water, and any possible health concerns associated with the contaminants 12 Ocean Dumping The Marine Protection, Research, and Sanctuaries Act of 197213 (popularly known as the Ocean Dumping Act) regulates the transportation and dumping of material (pollutants) into ocean waters It prohibits the ocean dumping of any radiological, chemical, and biological warfare agents and high-level radioactive waste The act also established a permit program for transporting and dumping other materials, and designated certain areas as marine sanctuaries Each violation of any provision or permit requirement in the Ocean Dumping Act may result in a civil penalty of up to $50,000 A knowing violation is a criminal offense that may result in a $50,000 fine, imprisonment for not more than a year, or both A court may also grant an injunction to prevent an imminent or continuing violation 12 42 U.S.C Sections 300f to 300j-25 13 16 U.S.C Sections 1401–1445 When more than 10 million gallons of oil leaked into Alaska’s Prince William Sound from the Exxon Valdez supertanker in 1989, Congress responded and passed the Oil Pollution Act.14 (At that time, the Exxon Valdez disaster was the worst oil spill in U.S history, but the BP oil spill in the Gulf of Mexico in 2010 surpassed it.) Under this act, any oil facility, oil shipper, vessel owner, or vessel operator that discharges oil into navigable waters or onto an adjoining shore may be liable for clean-up costs, as well as damages In addition, the polluter can be ordered to pay for damage to natural resources, private property, and the local economy, including the increased cost of providing public services The party held responsible for the clean-up costs can bring a civil suit for contribution from other potentially liable parties SECTION Toxic Chemicals Originally, most environmental clean-up efforts were directed toward reducing smog and making water safe for fishing and swimming Today, control of toxic chemicals used in agriculture and in industry has become increasingly important Pesticides and Herbicides The Federal Insecticide, Fungicide, and Rodenticide Act (FIFRA) of 194715 regulates pesticides and herbicides Pesticides and herbicides must be (1) registered 14 33 U.S.C Sections 2701–2761 15 U.S.C Sections 136–136y Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 25  Environmental Law  before they can be sold, (2) certified and used only for approved applications, and (3) used in limited quantities when applied to food crops EPA Actions  The EPA can cancel or suspend registration of substances that are identified as harmful The EPA can also inspect factories where the chemicals are made A substance is deemed harmful if human exposure to the substance, including exposure through eating food, results in a risk of one in a million (or higher) of developing cancer.16 Violations and Penalties  It is a violation of FIFRA to sell a pesticide or herbicide that is either unregistered or has had its registration canceled or suspended It is also a violation to sell a pesticide or herbicide with a false or misleading label, or to destroy or deface any labeling required under the act For instance, it is an offense to sell a substance that has a chemical strength different from the concentration declared on the label Penalties for commercial dealers include imprisonment for up to one year and a fine of up to $25,000 (producers can be fined up to $50,000) Farmers and other private users of pesticides or herbicides who violate the act are subject to a $1,000 fine and incarceration for up to thirty days Note that a state can also regulate the sale and use of federally registered pesticides ▶ Case in Point 25.4  The EPA conditionally registered Strongarm, a weed-killing pesticide Dow Agrosciences, LLC, sold Strongarm to Texas peanut farmers When the farmers applied it, however, Strongarm damaged their crops and failed to control the growth of weeds The farmers sued Dow for violations of Texas law, but the lower courts ruled that FIFRA preempted their claims The farmers appealed to the United States Supreme Court The Court held that under a specific provision of FIFRA, a state can regulate the sale and use of federally registered pesticides so long as the regulation does not permit anything that FIFRA prohibits.17  ◀ Toxic Substances The Toxic Substances Control Act18 regulates chemicals and chemical compounds that are known to be toxic—such as asbestos and polychlorinated biphe16 21 U.S.C Section 346a 17 Bates v Dow Agrosciences, LLC, 544 U.S 431, 125 S.Ct 1788, 161 L.Ed.2d 687 (2005) 18 15 U.S.C Sections 2601–2692 573 nyls, popularly known as PCBs The act also controls the introduction of new chemical compounds by requiring investigation of any possible harmful effects from these substances The regulations authorize the EPA to require that manufacturers, processors, and other entities planning to use chemicals first determine their effects on human health and the environment The EPA can regulate substances that may pose an imminent hazard or an unreasonable risk of injury to health or the environment The EPA may require special labeling, limit the use of a substance, set production quotas, or prohibit the use of a substance altogether SECTION Hazardous Wastes Some industrial, agricultural, and household wastes pose more serious threats than others If not properly disposed of, these toxic chemicals may present a substantial danger to human health and the environment If released into the environment, they may contaminate public drinking water resources Resource Conservation and Recovery Act The Resource Conservation and Recovery Act (RCRA)19 was passed in response to growing concern about the effects of hazardous waste materials on the environment The RCRA required the EPA to establish regulations to determine which forms of solid waste should be considered hazardous and to establish regulations to monitor and control hazardous waste disposal The act also requires all producers of hazardous waste materials to label and package properly any hazardous waste to be transported The RCRA was amended in 1984 and 1986 to decrease the use of land containment in the disposal of hazardous waste and to require smaller generators of hazardous waste to comply with the act Under the RCRA, a company may be assessed a civil penalty of up to $25,000 for each violation.20 The penalty is based on the seriousness of the violation, the probability of harm, and the extent to which the violation deviates from RCRA requirements Criminal penalties include fines of up to $50,000 for each day 19 42 U.S.C Sections 6901–6986 20 42 U.S.C Section 6928(a) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 574  Unit Six  The Regulatory Environment of violation, imprisonment for up to two years (in most instances), or both Criminal fines and the time of imprisonment can be doubled for certain repeat offenders Superfund In 1980, Congress passed the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA),21 commonly known as Superfund The basic purpose of Superfund is to regulate the clean-up of disposal sites in which hazardous waste is leaking into the environment CERCLA, as amended, has four primary elements: It established an information-gathering and analysis system that enables the government to identify chemical dump sites and determine the appropriate action It authorized the EPA to respond to hazardous substance emergencies and to arrange for the clean-up of a leaking site directly if the persons responsible for the problem fail to clean up the site It created a Hazardous Substance Response Trust Fund (also called Superfund) to pay for the clean-up of hazardous sites using funds obtained through taxes on certain businesses It allowed the government to recover the cost of clean-up from the persons who were (even remotely) responsible for hazardous substance releases Potentially Responsible Parties  Superfund provides that when a release or a threatened release of hazardous chemicals from a site occurs, the following persons may be held responsible for cleaning up the site: The person who generated the wastes disposed of at the site The person who transported the waste to the site The person who owned or operated the site at the time of the disposal The current owner or operator A person falling within one of these categories is referred to as a potentially responsible party (PRP) If the PRPs not clean up the site, the EPA can clean up the site and recover the clean-up costs from the PRPs 21 42 U.S.C Sections 9601–9675 Strict Liability of PRPs.  Superfund imposes strict liability on PRPs, and that liability cannot be avoided through transfer of ownership Thus, selling a site where hazardous wastes were disposed of does not relieve the seller of liability, and the buyer also becomes liable for the clean-up Liability also extends to businesses that merge with or buy corporations that have violated CERCLA Although a parent corporation is not automatically liable for the violations of its subsidiary, it can be held liable if the subsidiary was merely a shell company or if the parent corporation participated in or controlled the facility.22 Joint and Several Liability.  Liability under Superfund is usually joint and several In other words, a PRP who generated only a fraction of the hazardous waste disposed of at a site may nevertheless be liable for all of the clean-up costs CERCLA authorizes a party who has incurred clean-up costs to bring a “contribution action” against any other person who is liable or potentially liable for a percentage of the costs Minimizing Liability  One way for a business to minimize its potential liability under Superfund is to conduct environmental compliance audits of its own operations regularly A business can perform internal investigations of its own operations and property to determine whether any environmental hazards exist The EPA encourages companies to conduct self-audits and promptly detect, disclose, and correct wrongdoing Companies that so are subject to lighter penalties (fines may be reduced as much as 75 percent) for violations of environmental laws Under EPA guidelines, the EPA will waive all fines if a small company corrects environmental violations within 180 days after being notified of the violations (or 360 days if pollutionprevention techniques are involved) The policy does not apply to criminal violations of environmental laws, though, or to violations that pose a significant threat to public health, safety, or the environment Defenses  There are a few defenses to liability under CERCLA The most important is the innocent landowner defense.23 Under this defense, an innocent property owner may be able to avoid liability by showing that he or she had no contractual or employment relationship with the person who released the haz22 The landmark case establishing the liability of a parent corporation under CERCLA is United States v Bestfoods, 524 U.S 51, 118 S.Ct 1876, 141 L.Ed.2d 43 (1998) 23 42 U.S.C Section 9601(35)(B) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 25  Environmental Law  ardous substance on the land Thus, if the party who disposed of the substances transferred the property by contract to the current owner, the defense normally will not be available To assert the defense, the landowner must be able to show that at the time the property was acquired, she or he had no reason to know that hazardous substances had been disposed of on it The landowner 575 must also show that at the time of the purchase, she or he undertook all appropriate investigation into the previous ownership and uses of the property to determine whether there was reason to be concerned about hazardous substances In effect, this defense protects only property owners who took precautions and investigated the possibility of environmental hazards at the time they bought the property Reviewing: Environmental Law Residents of Lake Caliopa, Minnesota, began noticing an unusually high number of lung ailments among their population A group of concerned local citizens pooled their resources and commissioned a study of the frequency of these health conditions per capita in Lake Caliopa as compared with national averages The study concluded that asthma, bronchitis, and emphysema occurred four to seven times more frequently among residents of Lake Caliopa than in the population nationwide During the study period, citizens began expressing concerns about the large volumes of smog emitted by the Cotton Design apparel manufacturing plant on the outskirts of town The plant had opened its production facility two miles east of town beside the Tawakoni River in 1999 and employed seventy full-time workers Just downstream on the Tawakoni River, the city of Lake Caliopa operated a public water works facility, which supplied all city residents with water The Minnesota Pollution Control Agency required Cotton Design to install new equipment to control air and water pollution Later, citizens sued Cotton Design for various respiratory ailments allegedly caused or compounded by smog from Cotton Design’s factory Using the information presented in the chapter, answer the following questions Under the common law, what would each plaintiff be required to identify in order to be given relief by the court? Are air-quality regulations typically overseen by federal, state, or local governments? What standard for limiting emissions into the air does Cotton Design’s pollution-control equipment have to meet? What information must the city send to every household that it supplies with water? Debate This  The courts should reject all cases in which the wetlands in question not consist of actual bodies of water that exist during the entire year Terms and Concepts environmental impact statement (EIS) 564 environmental law 563 nuisance 563 potentially responsible party (PRP) 574 toxic tort 563 wetlands 569 ExamPrep Issue Spotters Resource Refining Company’s plant emits smoke and fumes Resource’s operation includes a short railway system, and trucks enter and exit the grounds continuously Constant vibrations from the trains and trucks rattle nearby residential neighborhoods The residents Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 576  Unit Six  The Regulatory Environment sue Resource Are there any reasons why the court might refuse to issue an injunction against Resource’s operation? Explain (See page 563.) ChemCorp generates hazardous wastes from its operations Disposal Trucking Company transports those wastes to Eliminators, Inc., which owns a site for hazardous waste disposal Eliminators sells the property on which the disposal site is located to Fluid Properties, Inc If the Environmental Protection Agency cleans up the site, from whom can it recover the cost? (See page 574.) •  Check your answers to the Issue Spotters against the answers provided in Appendix E at the end of this text Before the Test  Go to www.cengagebrain.com, enter the ISBN 9781285428949, and click on “Find” to locate this textbook’s Web site Then, click on “Access Now” under “Study Tools,” and select Chapter 25 at the top There, you will find an Interactive Quiz that you can take to assess your mastery of the concepts in this chapter, as well as Flashcards and a Glossary of important terms Business Scenarios 25–1. Clean Air Act. Current scientific knowledge indicates that there is no safe level of exposure to a cancercausing agent In theory, even one molecule of such a substance has the potential for causing cancer Section 112 of the Clean Air Act requires that all cancer-causing substances be regulated to ensure a margin of safety Some environmental groups have argued that all emissions of such substances must be eliminated if a margin of safety is to be reached Such a total elimination would likely shut down many major U.S industries Should the Environmental Protection Agency totally eliminate all emissions of cancer-­causing chemicals? Discuss (See page 565.) 25–2. Environmental Laws. Fruitade, Inc., is a processor of a soft drink called Freshen Up Fruitade uses returnable bottles, which it cleans with a special acid to allow for further beverage processing The acid is diluted with water and then allowed to pass into a navigable stream Fruitade crushes its broken bottles and throws the crushed glass into the stream Discuss fully any environmental laws that Fruitade has violated (See page 567.) 25–3. Environmental Laws. Moonbay is a home-building corporation that primarily develops retirement communities Farmtex owns a number of feedlots in Sunny Valley Moonbay purchased 20,000 acres of farmland in the same area and began building and selling homes on this acreage In the meantime, Farmtex continued to expand its feedlot business, and eventually only 500 feet separated the two operations Because of the odor and flies from the feedlots, Moonbay found it difficult to sell the homes in its development Moonbay wants to enjoin (prevent) Farmtex from operating its feedlot in the vicinity of the retirement home development Under what common law theory would Moonbay file this action? Has Farmtex violated any federal environmental laws? Discuss (See page 563.) Business Case Problems 25–4. Environmental Impact Statement. The fourth largest crop in the United States is alfalfa, of which percent is exported to Japan RoundUp Ready alfalfa is genetically engineered to resist glyphosate, the active ingredient in the herbicide RoundUp The U.S Department of Agriculture (USDA) regulates genetically engineered agricultural products through the Animal and Plant Health Inspection Service (APHIS) APHIS concluded that RoundUp Ready alfalfa does not have any harmful health effects on humans or livestock and deregulated it Geertson Seed Farms and others filed a suit in a federal district court against Mike Johanns (then the secretary of the USDA) and others, asserting that APHIS’s decision required the preparation of an environmental impact statement (EIS) The plaintiffs argued, among other things, that the introduction of RoundUp Ready alfalfa might significantly decrease the availability of or even eliminate, all nongenetically engineered varieties The plaintiffs were concerned that the RoundUp Ready alfalfa might contaminate standard alfalfa because alfalfa is pollinated by bees, which can travel as far as two miles from a pollen source If contamination occurred, farmers would not be able to market “contaminated” varieties as “organic,” which would affect the sales of “organic” livestock and exports to Japan, which does not allow the import of glyphosateresistant alfalfa Should an EIS be prepared in this case? Why or why not? [Geertson Seed Farms v Johanns, F.Supp.2d (N.D.Cal 2007)] (See page 564.) 25–5.  Business Case Problem with Sample Answer:  Environmental Impact Statement The U.S National Park Service (NPS) manages the Grand Canyon National Park in Arizona under a management plan that is subject to periodic review In 2006, after nine years of background work Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 25  Environmental Law  and the completion of a comprehensive environmental impact statement, the NPS issued a new management plan for the park The plan allowed for the continued use of rafts on the Colorado River, which runs through the Grand Canyon The number of rafts was limited, however Several environmental groups criticized the plan because they felt that it still allowed too many rafts on the river The groups asked a federal appellate court to overturn the plan, claiming that it violated the wilderness status of the national park When can a federal court overturn a determination by an agency such as the NPS? Explain [River Runners for Wilderness v Martin, 593 F.3d 1064 (9th Cir 2010)] (See page 564.) •  For a sample answer to Problem 25–5, go to Appendix F at the end of this text 25–6. Superfund. A by-product of phosphate fertilizer production is pyrite waste, which contains arsenic and lead From 1884 to 1906, seven phosphate fertilizer plants operated on a forty-three-acre site in Charleston, South Carolina Planters Fertilizer & Phosphate Co bought the site in 1906 and continued to make fertilizer In 1966, Planters sold the site to Columbia Nitrogen Corp (CNC), which also operated the fertilizer plants In 1985, CNC sold the site to James Holcombe and J Henry Fair Holcombe and Fair subdivided and sold the site to Allwaste Tank Cleaning Inc., Robin Hood Container Express, the city of Charleston, and Ashley II of Charleston, Inc Ashley spent almost $200,000 cleaning up the contaminated soil Who can be held liable for the cost? Why? [PCS Nitrogen Inc v Ashley II of Charleston LLC, 714 F.3d 161 (4th Cir 2013)] (See page 574.) 25–7.  A Question of Ethics:  Clean Air Act In the Clean Air Act, Congress allowed California, which has particular problems with clean air, to adopt its own standard for emissions from cars and trucks California’s standard is subject to the ap- 577 proval of the Environmental Protection Agency (EPA) based on certain criteria Congress also allowed other states to adopt California’s standard after the EPA’s approval In 2004, in an effort to address global warming, the California Air Resources Board amended the state’s standard to attain “the maximum feasible and cost-effective reduction of GHG [greenhouse gas] emissions from motor vehicles.” The regulation, which applies to new passenger vehicles and light-duty trucks for 2009 and later, imposes decreasing limits on emissions of carbon dioxide through 2016 While EPA approval was pending, Vermont and other states adopted similar standards Green Mountain Chrysler Plymouth Dodge Jeep and other auto dealers, automakers, and associations of automakers filed a suit in a federal district court against George Crombie (then the secretary of the Vermont Agency of Natural Resources) and others, seeking relief from the state regulations [Green Mountain Chrysler Plymouth Dodge Jeep v Crombie, 508 F.Supp.2d 295 (D.Vt 2007)] (See page 565.) (a) Under the Environmental Policy and Conservation Act (EPCA) of 1975, the National Highway Traffic Safety Administration sets fuel economy standards for new cars The plaintiffs argued, among other things, that the EPCA, which prohibits states from adopting separate fuel economy standards, preempts Vermont’s GHG regulation Do the GHG rules equate to the fuel economy standards? Discuss (b) Do Vermont’s rules tread on the efforts of the federal government to address global warming internationally? Who should regulate GHG emissions? The federal government? The state governments? Both? Neither? Why? (c) The plaintiffs claimed that they would go bankrupt if they were forced to adhere to the state’s GHG standards Should they be granted relief on this basis? Does history support their claim? Explain Legal Reasoning Group Activity 25–8.  Clean-Up Costs.  It has been estimated that for every dollar spent cleaning up hazardous waste sites, administrative agencies spend seven dollars in overhead (See page 574.) (a) The first group will list and explain possible ways to trim these administrative costs (b) The second group will evaluate whether the laws pertaining to hazardous waste clean-up can or should be changed to reduce the costs to government Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 578  Unit Six  The Regulatory Environment Chapter 26 Real Property and Land-Use Control F rom the earliest times, property has provided a means for survival Primitive peoples lived off the fruits of the land, eating the vegetation and wildlife Later, as the wildlife was domesticated and the vegetation cultivated, property provided pastures and farmland Throughout history, property has continued to be an indicator of family wealth and social position In the Western world, the protection of an individual’s right to his or her property has become one of our more important rights In this chapter, we look at the nature of real property and the ways in which it can be owned We examine the legal requirements involved in the transfer of real property We even consider whether the buyer of a haunted house can rescind the sale in this chapter’s Spotlight Case SECTION The Nature of Real Property Real property (or realty) consists of land and everything permanently attached to it, including structures and other fixtures Real property includes airspace and subsurface rights, as well as rights to plants and vegetation In essence, real property is immovable Land and Structures Land includes the soil on the surface of the earth and the natural products or artificial structures that are attached to it Land further includes all the waters contained on or under its surface and much, but not necessarily all, of the airspace above it The exterior boundaries of land extend down to the center of the earth and up to the farthest reaches of the atmosphere (subject to certain qualifications) Airspace and Subsurface Rights The owner of real property has relatively exclusive rights to both the airspace above the land and the soil Realize that real property rights are never absolute There is a higher right—that of the government to take, for compensation, private land for public use This chapter discusses this right, as well as other restrictions on the ownership or use of property We conclude the chapter with a discussion of land-use control and zoning laws and minerals underneath it Any limitations on either airspace rights or subsurface rights, called encumbrances, normally must be indicated on the document that transfers title at the time of purchase The ways in which ownership rights in real property can be limited will be examined later in this chapter Airspace Rights Disputes concerning airspace rights may involve the right of commercial and private planes to fly over property and the right of individuals and governments to seed clouds and produce artificial rain Flights over private land normally not violate property rights unless the flights are so low and so frequent that they directly interfere with the owner’s enjoyment and use of the land Leaning walls or projecting eave spouts or roofs may also violate the airspace rights of an adjoining property owner Subsurface Rights  In many states, ownership of land can be separated from ownership of its subsurface In other words, the owner of the surface may sell subsurface rights to another person Subsurface rights can be extremely valuable, as these rights include the ownership of minerals, oil, or natural gas But a subsurface owner’s rights would be of little value if he or she could not use the surface to exercise those rights 578 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 26  Real Property and Land-Use Control  Hence, a subsurface owner has a right, called a profit (see page 582), to go onto the surface of the land to, for example, find and remove minerals When ownership is separated into surface and subsurface rights, each owner can pass title to what she or he owns without the consent of the other owner Of course, conflicts can arise between the surface owner’s use of the property and the subsurface owner’s need to extract minerals, oil, or natural gas In that situation, one party’s interest may become subservient (secondary) to the other party’s interest either by statute or by case law If the owners of the subsurface rights excavate, they are absolutely liable if their excavation causes the surface to collapse Many states have statutes that also make the excavators liable for any damage to structures on the land Typically, these statutes set out precise requirements for excavations of various depths Plant Life and Vegetation Plant life, both natural and cultivated, is also considered to be real property In many instances, the natural vegetation, such as trees, adds greatly to the value of realty When a parcel of land is sold and the land has growing crops on it, the sale includes the crops, unless otherwise specified in the sales contract When crops are sold by themselves, however, they are considered to be personal property or goods Consequently, the sale of crops is a sale of goods and is governed by the Uniform Commercial Code (UCC, discussed in Chapter 11) rather than by real property law SECTION Ownership and Other Interests in Real Property Ownership of property is an abstract concept that cannot exist independently of the legal system No one can actually possess, or hold, a piece of land, the air above, the earth below, and all the water contained on it One can only possess rights in real property Numerous rights are involved in real property ownership, which is why property ownership is often viewed as a bundle of rights One who possesses the entire bundle of rights is said to hold the property in fee simple, which is the most complete form of ownership When only some of the rights in the bundle are transferred to another person, the effect is to limit the ownership rights of both the transferor of the rights and the recipient 579 Traditionally, ownership interests in real property were referred to as estates in land, which include fee simple estates, life estates, and leasehold estates We examine these estates in land, forms of concurrent ownership, and certain other interests in real property that is owned by others in the following subsections Ownership in Fee Simple In a fee simple absolute, the owner has the greatest aggregation of rights, privileges, and power possible The owner can give the property away or dispose of the property by deed (see page 586) or by will When there is no will, the fee simple passes to the owner’s legal heirs on her or his death A fee simple absolute is potentially infinite in duration and is assigned forever to a person and her or his heirs without limitation or condition.1 The owner has the rights of exclusive possession and use of the property The rights that accompany a fee simple absolute include the right to use the land for whatever purpose the owner sees fit Of course, other laws, including applicable zoning, noise, and environmental laws, may limit the owner’s ability to use the property in certain ways A person who uses his or her property in a manner that unreasonably interferes with others’ right to use or enjoy their own property can be liable for the tort of nuisance (discussed in Chapter 25) ▶ Case in Point 26.1  Nancy and James Biglane owned and lived in a building next door to a popular bar called the Under the Hill Saloon that featured live music During the summer, the Saloon, which had no air-conditioning, opened its windows and doors, and live music echoed up and down the street The Biglanes installed extra insulation, thicker windows, and air-conditioning units in their building Nevertheless, the noise from the Saloon kept the Biglanes awake at night Eventually, they sued the owners of the Saloon for nuisance The court held that the noise from the bar unreasonably interfered with the Biglanes’ right to enjoy their property and enjoined (prevented) the Saloon from opening its windows and doors while playing music.2  ◀ In another type of estate, the fee simple defeasible, ownership in fee simple automatically terminates if a stated event occurs For example, property might be conveyed (transferred) to a school only as long as it is used for school purposes In addition, the fee simple may be subject to a condition subsequent This means that if a stated event occurs, the prior owner of the property can bring an action to regain possession of the property Biglane v Under the Hill Corp., 949 So.2d (Miss.Sup 2007) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 580  Unit Six  The Regulatory Environment Life Estates A life estate is an estate that lasts for the life of some specified individual A conveyance, or transfer of real property, “to A for his life” creates a life estate.3 In a life estate, the life tenant’s ownership rights cease to exist on the life tenant’s death The life tenant has the right to use the land, provided that he or she commits no waste (injury to the land) In other words, the life tenant cannot use the land in a manner that would adversely affect its value The life tenant can use the land to harvest crops or, if mines and oil wells are already on the land, can extract minerals and oil from it, but the life tenant cannot exploit the land by creating new wells or mines The life tenant can create liens, easements (see page 582), and leases None can extend beyond the life of the tenant, however In addition, with few exceptions, the owner of a life estate has an exclusive right to possession during his or her lifetime Along with these rights, the life tenant also has some duties—to keep the property in repair and to pay property taxes In short, the owner of the life estate has the same rights as a fee simple owner except that she or he must maintain the value of the property during her or his tenancy Concurrent Ownership Persons who share ownership rights simultaneously in particular property (including real property and personal property) are said to have concurrent ownership There are two principal types of concurrent ownership: tenancy in common and joint tenancy Concurrent ownership rights can also be held in a tenancy by the entirety or as community property, although these types of concurrent ownership are less common interest (one-fourth) in the whole If one of the four owners dies a year after the purchase, his ownership interest passes to his heirs (his wife and children, for example) rather than to the other tenants in common.  ◀ Unless the co-tenants have agreed otherwise, a tenant in common can transfer her or his interest in the property to another without the consent of the remaining co-owners In most states, it is presumed that a co-tenancy is a tenancy in common unless there is specific language indicating the intent to establish a joint tenancy (discussed next) Joint Tenancy  In a joint tenancy, each of two or more persons owns an undivided interest in the property, but a deceased joint tenant’s interest passes to the surviving joint tenant or tenants Right of Survivorship.  The right of a surviving joint tenant to inherit a deceased joint tenant’s ownership interest—referred to as a right of survivorship—distinguishes a joint tenancy from a tenancy in common ▶  Example 26.3  Jerrold and Eva are married and purchase a house as joint tenants The title to the house clearly expresses the intent to create a joint tenancy because it says “to Jerrold and Eva as joint tenants with right of survivorship.” Jerrold has three children from a prior marriage If Jerrold dies, his interest in the house automatically passes to Eva rather than to his children from the prior marriage.  ◀ Tenancy in Common  The term tenancy in common refers to a form of co-ownership in which each of two or more persons owns an undivided interest in the property The interest is undivided because each tenant shares rights in the whole property On the death of a tenant in common, that tenant’s interest in the property passes to her or his heirs ▶  Example 26.2  Four friends purchase a condominium unit in Hawaii together as tenants in common This means that each of them has an ownership Termination of a Joint Tenancy.  Although a joint tenant can transfer her or his rights by sale or gift to another without the consent of the other joint tenants, doing so terminates the joint tenancy The person who purchases the property or receives it as a gift becomes a tenant in common, not a joint tenant ▶  Example 26.4  Three brothers, Brody, Saul, and Jacob, own a parcel as joint tenants Brody is experiencing financial difficulties and sells his interest in the property to Beth The sale terminates the joint tenancy, and now Beth, Saul, and Jacob hold the property as tenants in common.  ◀ A joint tenant’s interest can also be levied against— that is seized by court order—to satisfy the tenant’s judgment creditors If this occurs, the joint tenancy terminates, and the remaining owners hold the property as tenants in common (Judgment creditors can also seize the interests of tenants in a tenancy in common.) A less common type of life estate is created by the conveyance “to A for the life of B.” This is known as an estate pur autre vie—that is, an estate for the duration of the life of another Tenancy by the Entirety  A less common form of shared ownership of real property by husband and Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 26  Real Property and Land-Use Control  wife is a tenancy by the entirety It differs from a joint tenancy in that neither spouse may separately transfer his or her interest during his or her lifetime unless the other spouse consents In some states in which statutes give the wife the right to convey her property, this form of concurrent ownership has effectively been abolished A divorce, either spouse’s death, or mutual agreement will terminate a tenancy by the entirety Community Property  A limited number of states4 allow property to be owned by a married couple as community property If property is held as community property, each spouse technically owns an undivided one-half interest in the property This type of ownership applies to most property acquired by the husband or the wife during the course of the marriage It generally does not apply to property acquired prior to the marriage or to property acquired by gift or inheritance as separate property during the marriage After a divorce, community property is divided equally in some states and according to the discretion of the court in other states Leasehold Estates A leasehold estate is created when a real property owner or lessor (landlord) agrees to convey the right to possess and use the property to a lessee (tenant) for a certain period of time In every leasehold estate, the tenant has a qualified right to exclusive, though temporary, possession (The tenant’s rights are qualified by the landlord’s right to enter onto the premises to ensure that the tenant is not causing damage to the property.) The tenant can use the land—for instance, by harvesting crops—but cannot injure it by such activities as cutting down timber to sell or by extracting oil Here, we look at the types of leasehold estates, or tenancies, that can be created when real property is leased Fixed-Term Tenancy  A fixed-term tenancy, also called a tenancy for years, is created by an express contract stating that the property is leased for a specified period of time, such as a month, a year, or a period of years Signing a one-year lease to occupy an apartment, for instance, creates a tenancy for years These states include Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin Puerto Rico allows property to be owned as community property as well 581 Note that the term need not be specified by date and can be conditioned on the occurrence of an event, such as leasing a cabin for the summer or an apartment during Mardi Gras At the end of the period specified in the lease, the lease ends (without notice), and possession of the property returns to the lessor If the tenant dies during the period of the lease, the lease interest passes to the tenant’s heirs as personal property Often, leases include renewal or extension provisions Periodic Tenancy  With a periodic tenancy, the lease does not specify how long it is to last but does specify that rent is to be paid at certain intervals This type of tenancy is automatically renewed for another rental period unless properly terminated ▶  Example 26.5  Jewel, LLC, enters into a lease with Capital Properties The lease states, “Rent is due on the tenth day of every month.” This provision creates a periodic tenancy from month to month.  ◀ This type of tenancy can also extend from week to week or from year to year A periodic tenancy sometimes arises after the lease term ends when the landlord allows the tenant to retain possession and continue paying monthly or weekly rent Under the common law, the landlord or tenant must give at least one period’s notice to the other party before terminating a periodic tenancy If the tenancy is month to month, for instance, one month’s notice must be given Today, however, state statutes often require a different period of notice before the termination of a tenancy Tenancy at Will  With a tenancy at will, either party can terminate the tenancy without notice This type of tenancy can arise if a landlord rents property to a tenant “for as long as both agree” or allows a person to live on the premises without paying rent Tenancy at will is rare today because, as mentioned, most state statutes require a landlord to provide some period of notice to terminate a tenancy States may also require a landowner to have sufficient cause (reason) to end a residential tenancy Tenancy at Sufferance  The mere possession of land without right is called a tenancy at sufferance A tenancy at sufferance is not a true tenancy because it is created when a tenant wrongfully retains possession of property Whenever a tenancy for years or a periodic tenancy ends and the tenant continues Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 582  Unit Six  The Regulatory Environment to retain possession of the premises without the owner’s permission, a tenancy at sufferance is created Nonpossessory Interests In contrast to the types of property interests just described, some interests in land not include any rights to possess the property These interests, known as nonpossessory interests, include easements, profits, and licenses Nonpossessory interests are basically interests in real property owned by others An easement is the right of a person to make limited use of another person’s real property without taking anything from the property The right to walk across another’s property, for example, is an easement In contrast, a profit is the right to go onto land owned by another and take away some part of the land itself or some product of the land ▶  Example 26.6  Akmed owns real property known as the Dunes Akmed gives Carmen the right to go there and remove all of the sand and gravel that she needs for her cement business Carmen has a profit.  ◀ Easements and profits can be classified as either appurtenant or in gross Because easements and profits are similar and the same rules apply to both, we discuss them together Easement or Profit Appurtenant  An easement (or profit) appurtenant arises when the owner of one piece of land has a right to go onto (or remove something from) an adjacent piece of land owned by another The land that is benefited by the easement is called the dominant estate, and the land that is burdened is called the servient estate Because easements appurtenant are intended to benefit the land, they run (are conveyed) with the land when it is transferred ▶  Example 26.7  Owen has a right to drive his car across Green’s land, which is adjacent to Owen’s property This right-of-way over Green’s property is an easement appurtenant to Owen’s land If Owen sells his land, the easement runs with the land to benefit the new owner.  ◀ Easement or Profit in Gross  In an easement or profit in gross, the right to use or take things from another’s land is given to one who does not own an adjacent tract of land These easements are intended to benefit a particular person or business, not a particular piece of land, and cannot be transferred ▶  Example 26.8  Avery owns a parcel of land with a marble quarry Avery conveys to Classic Stone Corporation the right to come onto her land and remove up to five hundred pounds of marble per day Classic Stone owns a profit in gross and cannot transfer this right to another Similarly, when a utility company is granted an easement to run its power lines across another’s property, it obtains an easement in gross.  ◀ Creation of an Easement or Profit  Most easements and profits are created by an express grant in a contract, deed, or will This allows the parties to include terms defining the extent and length of time of use In some situations, an easement or profit can also be created without an express agreement An easement or profit may arise by implication when the circumstances surrounding the division of a parcel of property imply its creation ▶  Example 26.9  Barrow divides a parcel of land that has only one well for drinking water If Barrow conveys the half without a well to Dean, a profit by implication arises because Dean needs drinking water.  ◀ An easement may also be created by necessity An easement by necessity does not require division of property for its existence A person who rents an apartment, for instance, has an easement by necessity in the private road leading up to it An easement arises by prescription when one person exercises an easement, such as a right-of-way, on another person’s land without the landowner’s consent The use must be apparent and continue for the length of time required by the applicable statute of limitations (In much the same way, title to property may be obtained by adverse possession, as will be discussed later in this chapter.) Termination of an Easement or Profit  An easement or profit can be terminated or extinguished in several ways The simplest way is to deed it back to the owner of the land that is burdened by it Another way is to abandon it and provide evidence of the intent to relinquish the right to use it Mere nonuse will not extinguish an easement or profit, however, unless the nonuse is accompanied by an overt act showing the intent to abandon An overt act might be, for instance, installing and using a different access road to one’s property and discontinuing using an easement across the neighboring property A court must be convinced that there was an intent to abandon the easement or profit, though Also, if the owner of an easement or profit acquires the property burdened by it, then it is merged into the property Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 26  Real Property and Land-Use Control  License  In the context of real property, a license is the revocable right of a person to come onto another person’s land It is a personal privilege that arises from the consent of the owner of the land and can be revoked by the owner A ticket to attend a movie at a theater or a concert is an example of a license In essence, a license grants a person the authority to enter the land of another and perform a specified act or series of acts without obtaining any permanent interest in the land When a person with a license exceeds the authority granted and undertakes some action on the property that is not permitted, the property owner can sue that person for trespass (discussed in Chapter 12) ▶ Case in Point 26.10  A Catholic church granted Prince Realty Management, LLC, a three-month license to use a three-foot strip of its property adja- 583 cent to Prince’s property The license authorized Prince to “put up plywood panels,” creating a temporary fence to protect Prince’s property during the construction of a new building During the license’s term, Prince installed steel piles and beams on the licensed property When Prince ignored the church’s demands that these structures be removed, the church sued Prince for trespass The court concluded that the license allowed only temporary structures and that Prince had exceeded its authority by installing steel piles and beams Therefore, the church was entitled to damages.5  ◀ See Concept Summary 26.1 below for a review of the interests that can exist in real property Roman Catholic Church of Our Lady of Sorrows v Prince Realty Management, LLC, 47 A.D.3d 909, 850 N.Y.S.2d 569 (2008) Concept Summary Summary26.1 8.1 Concept Interests in Real Property Type of Interest Description Ownership Interests Fee simple absolute—The most complete form of ownership Life estate—An estate that lasts for the life of a specified individual Concurrent interests—When two or more persons hold title to property together, concurrent ownership exists a A tenancy in common exists when two or more persons own an undivided interest in property On a tenant’s death, that tenant’s property interest passes to his or her heirs b A joint tenancy exists when two or more persons own an undivided interest in property, with a right of survivorship On the death of a joint tenant, that tenant’s property interest transfers to the remaining tenant(s), not to the heirs of the deceased c A tenancy by the entirety is a form of co-ownership between a husband and wife that is similar to a joint tenancy, except that a spouse cannot separately transfer her or his interest during her or his lifetime d Community property is a form of co-ownership between a husband and wife in which each spouse technically owns an undivided one-half interest in property acquired during the marriage This type of ownership occurs in only a few states Leasehold Estates A leasehold estate is an interest in real property that is held for only a limited period of time, as specified in the lease agreement Types of tenancies relating to leased property include the following: Fixed-term tenancy (tenancy for years)—Tenancy for a period of time stated by express contract Periodic tenancy—Tenancy for a period determined by the frequency of rent payments It is automatically renewed unless proper notice is given Tenancy at will—Tenancy for as long as both parties agree No notice of termination is required Tenancy at sufferance—Possession of land without legal right Nonpossessory Interests Interests that involve the right to use real property but not to possess it Easements, profits, and licenses are nonpossessory interests Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 584  Unit Six  The Regulatory Environment SECTION Transfer of Ownership Ownership interests in real property are frequently transferred by sale, and the terms of the transfer are specified in a real estate sales contract Often, real estate brokers or agents (see Chapter 20) who are licensed by the state assist the buyers and sellers during the sales transaction Real property ownership can also be transferred by gift, by will or inheritance, by possession, or by eminent domain In the subsections that follow, we focus primarily on voluntary sales of real property We then consider adverse possession, which is an involuntary method of transferring title to real property Eminent domain will be discussed later in this chapter Real Estate Sales Contracts In some ways, a sale of real estate is similar to a sale of goods because it involves a transfer of ownership, often with specific warranties A sale of real estate, however, is a more complicated transaction that involves certain formalities that are not required in a sale of goods Usually, after substantial negotiation (offers, counteroffers, responses), the parties enter into a detailed contract setting forth their agreement A contract for a sale of land includes such terms as the purchase price, the type of deed the buyer will receive, the condition of the premises, and any items that will be included Unless the buyer pays cash for the property, the buyer must obtain financing through a mortgage loan (see Chapter 16) Real estate sales contracts are often made contingent on the buyer’s ability to obtain financing at or below a specified rate of interest The contract may also be contingent on the buyer selling other real property, the seller obtaining a survey and title insurance, and the property passing one or more inspections Normally, the buyer is responsible for having the premises inspected for physical or mechanical defects and for insect infestation Closing Date and Escrow  The contract usually fixes a date for performance, or closing, that frequently is four to twelve weeks after the contract is signed On this day, the seller conveys the property to the buyer by delivering the deed to the buyer in exchange for payment of the purchase price Deposits toward the purchase price normally are held in a special account, called an escrow account, until all of the conditions of sale have been met Once the closing takes place, the funds in the escrow account are transferred to the seller The escrow agent may be a title company, bank, or special escrow company that acts as a neutral party in the sales transaction to facilitate the sale and exchange of documents Marketable  Title  The question of title to a particular parcel of property is especially important to the buyer A grantor (seller) is obligated to transfer marketable title, or good title, to the grantee (buyer) Marketable title means that the grantor’s ownership is free from encumbrances (except those disclosed by the grantor) and free of defects If the buyer signs a purchase contract and then discovers that the seller does not have a marketable title, the buyer can withdraw from the contract ▶  Example 26.11  Chan enters into an agreement to buy Fortuna Ranch from Hal Chan then discovers that Hal has previously given Pearl an unexpired option to purchase the ranch In this situation, the title is not marketable because Pearl could exercise the option and Hal would be compelled to sell the ranch to her Therefore, Chan can withdraw from the contract to buy the property.  ◀ The most common way of ensuring title is through title insurance, which insures the buyer against loss from defects in title to real property When financing the purchase of real property, almost all lenders require title insurance to protect their interests in the collateral for the loan Implied Warranties in the Sale of New Homes  The common law rule of caveat emptor (“let the buyer beware”) held that the seller of a home made no warranty as to its soundness or fitness (unless the contract or deed stated otherwise) Today, however, most states imply a warranty—the implied warranty of habitability—in the sale of new homes The seller of a new house warrants that it will be fit for human habitation even if the deed or contract of sale does not include such a warranty Essentially, the seller is warranting that the house is in reasonable working order and is of reasonably sound construction Under this theory, the seller of a new home can be liable if the home is defective In some states, the warranty protects not only the first purchaser but any subsequent purchaser as well Seller’s Duty to Disclose Hidden Defects In most jurisdictions, courts impose on sellers a duty Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 26  Real Property and Land-Use Control  to disclose any known defect that materially affects the value of the property and that the buyer could not reasonably discover Failure to disclose such a material defect gives the buyer a right to rescind the contract and to sue for damages based on fraud or misrepresentation A dispute may arise over whether the seller knew of the defect before the sale, and there is normally a limit to the time within which the buyer can bring a suit against the seller based on the defect For instance, in Louisiana, the prescribed limit for a suit against a seller who knew, or can be presumed to have known, of the defect is one year from the day that the buyer discovered it If the seller did not know of the defect, the limit is one year from the date of the sale ▶ Case in Point 26.12  Matthew Humphrey partially renovated a house in Louisiana and sold it to Terry and Tabitha Whitehead for $67,000 A few months after the Whiteheads moved in, they discovered rotten wood behind the tile in the bathroom and experienced problems with the fireplace and the plumbing SP TLIGHT 585 Two years later, the Whiteheads filed a suit against Humphrey seeking to rescind the sale They argued that the plumbing problems were a latent defect that the seller had failed to disclose Evidence revealed that prior to the sale, the parties were made aware of issues regarding the sewer system and that corrective actions were taken At the time of the sale, the toilets flushed, and neither side realized that the latent defects had not been resolved The court ruled that rescission was not warranted for the sewer problems because the Whiteheads had waited too long after their discovery to file a claim against Humphrey The court did order Humphrey to pay damages for the repairs to the fireplace and for replacing some of the rotten wood, however, because Humphrey knew about these defects at the time of the sale.6  ◀ In the following Spotlight Case, the court had to decide whether the buyer of a house had the right to rescind the sales contract because he was not told that the house was allegedly haunted Whitehead v Humphrey, 954 So.2d 859 (La.App 2007) on Sales of Haunted Houses Case 26.1  Stambovsky v Ackley Supreme Court, Appellate Division, New York, 572 N.Y.S.2d 672, 169 A.D.2d 254 (1991) BACKGROUND AND FACTS  Jeffrey Stambovsky signed a contract to buy Helen Ackley’s home in Nyack, New York. After the contract was signed, Stambovsky discovered that the house was widely reputed to be haunted. The Ackley family claimed to have seen poltergeists on numerous occasions over the prior nine years The Ackleys had been interviewed and quoted in both a national publication (Reader’s Digest) and the local newspaper. The house was described as “a riverfront Victorian (with ghost)” when it was part of a walking tour of Nyack, New York. When Stambovsky discovered the house’s reputation, he sued to rescind the contract and recover his down payment He alleged that Ackley and her real estate agent made material misrepresentations when they failed to disclose Ackley’s belief that the home was haunted Ackley argued that, under the doctrine of caveat emptor, she was under no duty to disclose to the buyer the home’s haunted reputation The trial court dismissed Stambovsky’s case Stambovsky appealed IN THE LANGUAGE OF THE COURT Justice RUBIN delivered the opinion of the court * * * * While I agree with [the trial court] that the real estate broker, as agent for the seller, is under no duty to disclose to a potential buyer the phantasmal [haunted] reputation of the premises and that, in his pursuit of a legal remedy for fraudulent misrepresentation against the seller, plaintiff hasn’t a ghost of a chance, I am nevertheless moved by the spirit of equity to allow the buyer to seek rescission of the contract of sale and recovery of his down payment New York law fails to recognize any remedy for damages incurred as a result of the seller’s mere silence, applying instead the strict rule of caveat emptor Therefore, the theoretical basis CASE 26.1 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 586  Unit Six  The Regulatory Environment CASE 26.1 CONTINUEd for granting relief, even under the extraordinary facts of this case, is elusive if not ephemeral [short-lived] * * * * The doctrine of caveat emptor requires that a buyer act prudently to assess the fitness and value of his purchase and operates to bar the purchaser who fails to exercise due care from seeking the equitable remedy of rescission * * * Applying the strict rule of caveat emptor to a contract involving a house possessed by poltergeists conjures up visions of a psychic or medium routinely accompanying the structural engineer and Terminix man on an inspection of every home subject to a contract of sale It portends [warns] that the prudent attorney will establish an escrow account lest the subject of the transaction come back to haunt him and his client—or pray that his malpractice insurance coverage extends to supernatural disasters In the interest of avoiding such untenable [unsound] consequences, the notion that a haunting is a condition which can and should be ascertained upon reasonable inspection of the premises is a hobgoblin which should be exorcised from the body of legal precedent and laid quietly to rest [Emphasis added.] * * * * In the case at bar [under consideration], defendant seller deliberately fostered the public belief that her home was possessed Having undertaken to inform the public at large, to whom she has no legal relationship, about the supernatural occurrences on her property, she may be said to owe no less a duty to her contract vendee It has been remarked that the occasional modern cases, which permit a seller to take unfair advantage of a buyer’s ignorance so long as he is not actively misled are “singularly unappetizing” [unfounded] Where, as here, the seller not only takes unfair advantage of the buyer’s ignorance but has created and perpetuated a condition about which he is unlikely to even inquire, enforcement of the contract (in whole or in part) is offensive to the court’s sense of equity Application of the remedy of rescission, within the bounds of the narrow exception to the doctrine of caveat emptor set forth herein, is entirely appropriate to relieve the unwitting purchaser from the consequences of a most unnatural bargain DECISION AND REMEDY  The New York appellate court found that the doctrine of caveat emptor did not apply in this case The court allowed Stambovsky to rescind the purchase contract and recover the down payment THE ETHICAL DIMENSION  In not disclosing the house’s reputation to Stambovsky, was Ackley’s behavior unethical? If so, was it unethical because she knew something he did not, or was it unethical because of the nature of the information she omitted? What if Ackley had failed to mention that the roof leaked or that the well was dry—conditions that a buyer would normally investigate? Explain your answer THE LEGAL ENVIRONMENT DIMENSION  Why did the court decide that applying the strict rule of caveat emptor was inappropriate in this case? How would applying this doctrine increase costs for the purchaser? Deeds Possession and title to land are passed from person to person by means of a deed—the instrument used to transfer real property Deeds must meet certain requirements, but unlike a contract, a deed does not have to be supported by legally sufficient consideration Gifts of real property are common, and they require deeds even though there is no consideration for the gift To be valid, a deed must include the following: The names of the grantor (the giver or seller) and the grantee (the donee or buyer) Words evidencing the intent to convey (for instance, “I hereby bargain, sell, grant, or give”) No specific words are necessary, and if the deed does not specify the type of estate being transferred, it presumptively transfers the property in fee simple absolute A legally sufficient description of the land The description must include enough detail to distinguish the Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 26  Real Property and Land-Use Control  property being conveyed from every other parcel of land The property can be identified by reference to an official survey or recorded plat map, or each boundary can be described by metes and bounds Metes and bounds is a system of measuring boundary lines by the distance between two points, often using physical features of the local geography—for example, “beginning at the southwesterly intersection of Court and Main Streets, then West 40 feet to the fence, then South 100 feet, then Northeast approximately 120 feet back to the beginning.” The grantor’s (and usually his or her spouse’s) signature Delivery of the deed Warranty Deeds  Different types of deeds provide different degrees of protection against defects of title A warranty deed makes the greatest number of warranties and thus provides the most extensive protection against defects of title In most states, special language is required to create a warranty deed Warranty deeds include a number of covenants, or promises, that the grantor makes to the grantee These covenants include a covenant that the grantor has the title to, and the power to convey, the property; a covenant of quiet enjoyment (a warranty that the buyer will not be disturbed in her or his possession of the land); and a covenant that transfer of the property is made without knowledge of adverse claims of third parties Generally, the warranty deed makes the grantor liable for all defects of title by the grantor and previous titleholders ▶  Example 26.13  Julio sells a two-acre lot and office building by warranty deed Subsequently, a third person appears, shows that she has better title than Julio had, and forces the buyer off the property Here, the covenant of quiet enjoyment has been breached Thus, the buyer can sue Julio to recover the purchase price of the land, plus any other damages incurred as a result.  ◀ Special Warranty Deed  In contrast to a warranty deed, a special warranty deed, which is also referred to as a limited warranty deed, warrants only that the grantor or seller held good title during his or her ownership of the property In other words, the grantor does not warrant that there were no defects of title when the property was held by previous owners If the special warranty deed discloses all liens or other encumbrances, the seller will not be liable to the 587 buyer if a third person subsequently interferes with the buyer’s ownership If the third person’s claim arises out of, or is related to, some act of the seller, however, the seller will be liable to the buyer for damages Quitclaim Deed  A quitclaim deed offers the least protection against defects in the title Basically, a quitclaim deed conveys to the grantee whatever interest the grantor had So, if the grantor had no interest, then the grantee receives no interest Naturally, if the grantor had a defective title or no title at all, a conveyance by warranty deed or special warranty deed would not cure the defects Such deeds, however, will give the buyer a cause of action to sue the seller A quitclaim deed can and often does serve as a release of the grantor’s interest in a particular parcel of property ▶  Example 26.14  Sanchez owns a strip of waterfront property on which he wants to build condominiums Lanz has an easement on a portion of the property, which might interfere with Sanchez’s plans for the development Sanchez can negotiate with Lanz to deed the easement back to Sanchez A quitclaim deed from Lanz would constitute such a transfer.  ◀ Grant Deed  With a grant deed, the grantor simply states, “I grant the property to you” or “I convey, or bargain and sell, the property to you.” By state statute, grant deeds carry with them an implied warranty that the grantor owns the property and has not previously transferred it to someone else or encumbered it, except as set out in the deed Recording Statutes Once the seller delivers the deed to the buyer (at closing), legal title to the property is conveyed Nevertheless, the buyer should promptly record the deed with the state records office to establish superior ownership rights against any third parties who might make a claim to the property Every state has a recording statute, which allows deeds to be recorded in the public record Deeds generally are recorded in the county in which the property is located The buyer typically pays the required fee because he or she is the one who will be protected by recording the deed Recording a deed gives notice to the public that a certain person is now the owner of a particular parcel of real estate By putting everyone on notice as to the true owner, recording a deed prevents the previous owners from fraudulently conveying the land to other purchasers Many state statutes require that the Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 588  Unit Six  The Regulatory Environment grantor sign the deed in the presence of two witnesses before it can be recorded Adverse Possession A person who wrongfully possesses (by occupying or using) the real property of another may eventually acquire title to it through adverse possession Adverse possession is a means of obtaining title to land without delivery of a deed and without the consent of—or payment to—the true owner Thus, adverse possession is a method of involuntarily transferring title to the property from the true owner to the adverse possessor Essentially, when one person possesses the real property of another for a certain statutory period of time (three to thirty years, depending on the state, with ten years being most common), that person acquires title to the land Elements of Adverse Possession  For property to be held adversely, four elements must be satisfied: Possession must be actual and exclusive This means that the possessor must physically occupy the property This requirement is clearly met if the possessor lives on the property, but it may also be met if the possessor builds fences, erects structures, plants crops, or even grazes animals on the land The possession must be open, visible, and notorious, not secret or clandestine The possessor must occupy the land for all the world to see This requirement of obviousness ensures that the true owner is on notice that someone is possessing the owner’s property wrongfully Possession must be continuous and peaceable for the required period of time This requirement means that the possessor must not be interrupted in the occupancy by the true owner or by the courts Continuous does not mean constant—it simply means that the possessor has continuously occupied the property in some fashion for the statutory time Peaceable means that no force was used to possess the land Possession must be hostile and adverse In other words, the possessor cannot be living on the property with the owner’s permission and must claim the property as against the whole world Purpose of the Doctrine  There are a number of public-policy reasons for the adverse possession doctrine These include society’s interest in resolving boundary disputes, in determining title when title to property is in question, and in assuring that real property remains in the stream of commerce More fundamentally, the doctrine punishes owners who not take action when they see adverse possession and rewards possessors for putting land to productive use In the following case, the question before the court was whether a landowner had obtained title to a portion of adjacent land by adverse possession Case 26.2 Scarborough v Rollins Court of Appeals of Mississippi, 44 So.3d 381 (2010) BACKGROUND AND FACTS  Charles T Scarborough and Mildred T Rollins were adjoining landowners, sharing one common boundary Based on her survey of the property, Rollins believed that she owned a portion of a gravel road located to the south of the apartment buildings she owned On the contrary, Scarborough believed that the gravel road was located totally on his property and that he owned some property north of the gravel road toward Rollins’s apartment buildings In July 2006, Scarborough filed a complaint seeking to quiet and confirm his title to the property Rollins filed a counterclaim seeking to quiet and confirm her title The court entered judgment for Rollins Scarborough appealed IN THE LANGUAGE OF THE COURT ISHEE, J [Judge] * * * * Scarborough asserts that the trial court erred in finding that Rollins proved that she owned the property in dispute by adverse possession Scarborough claims that Rollins failed to prove Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 26  Real Property and Land-Use Control  CASE 26.2 CONTINUEd 589 by clear and convincing evidence that her possession of the disputed grassy area down to the northern edge of the gravel road has been hostile, open, notorious, visible, continuing, exclusive, and peaceful Scarborough also claims that Rollins’s paying taxes and mowing the grass north of the gravel road by her and her predecessors in title, as well as [a prior owner’s] installation of a gas line are not such adverse actions that gave him sufficient notice that he would know that Rollins was claiming the disputed area and that she was attempting to deny him ownership thereof and exclude him therefrom Scarborough asserts that both he and Rollins used the disputed land, thus exercising joint use of the land; therefore, a claim of adverse possession is not supported Scarborough also asserts that Rollins paid taxes only on the land situated north of her monumented south boundary line while he paid taxes on all of the land called for in his deed, including the gravel road and the land north of the gravel road up to Rollins’s south boundary To succeed on a claim of adverse possession, the claimant has the burden to prove each element by clear and convincing evidence * * * Adverse possession requires the claimant to prove that her possession or occupancy was: (1) under claim of ownership; (2) actual or hostile; (3) open, notorious, and visible; (4) continuous and uninterrupted for a period of ten years; (5) exclusive; and (6) peaceful [Emphasis added.] 1.  Under Claim of Ownership The deed to Rollins’s property presented to the chancery court indicated that she owned the property at or near the disputed property Evidence was provided to show that Rollins and her predecessors-in-title paid the taxes on all of the property north of the gravel road However, Scarborough only paid taxes on the property that was south of the gravel road 2.  Actual or Hostile Evidence was provided to the chancery court that for more than thirty-five years, no one other than Rollins and her predecessors-in-title, the Blacks, used this property 3.  Open, Notorious, and Visible [One witness] testified at trial that his family’s ownership of that land was open and obvious He stated that everyone in Starkville, who was around the apartments, knew that the apartment complex owned the yard up to the edge of the gravel road 4.  Continuous and Uninterrupted for a Period of Ten Years Testimony at trial from [three witnesses] all provided that Rollins and her predecessors-intitle used the property for more than thirty-five years 5. Exclusive Testimony at trial * * * indicated that no one, until Scarborough, claimed to have used any part of the property in dispute 6. Peaceful Rollins testified that until September 2007, she and her predecessors-in-title enjoyed peaceful possession of the property We find that Rollins satisfied the elements required for adverse possession * * * * The chancery court properly held that the gravel road which is to the north of Scarborough’s property and to the south of Rollins’s property was the boundary between the parties and that Rollins was entitled to an award of actual and punitive damages and attorney’s fees due to the conversion of her property by Scarborough DECISION AND REMEDY  The Court of Appeals of Mississippi affirmed the lower court’s judgment and assessed all costs of the appeal to Scarborough Rollins had proved title to the land by adverse possession WHAT IF THE FACTS WERE DIFFERENT?  Suppose that Rollins had not paid any taxes on the disputed land and that Scarborough had done so Would the result have been different? Explain THE E-COMMERCE DIMENSION  How might the Internet have facilitated either party’s claim to the disputed property? Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 590  Unit Six  The Regulatory Environment SECTION Limitations on the Rights of Property Owners No ownership rights in real property can ever really be absolute—that is, an owner of real property cannot always whatever she or he wishes on or with the property Nuisance and environmental laws, for example, restrict certain types of activities Holding the property is also conditional on the payment of property taxes Zoning laws and building permits frequently restrict one’s use of realty In addition, if a property owner fails to pay debts, the property may be seized to satisfy judgment creditors In short, the rights of every property owner are subject to certain conditions and limitations We look here at some of the important ways in which owners’ rights in real property can be limited ▶  Example 26.15  When a new public highway is to be built, the government decides where to build it and how much land to condemn After the government determines that a particular parcel of land is necessary for the highway, it will first offer to buy the property If the owner refuses the offer, the government brings a judicial (condemnation) proceeding to obtain title to the land Then, in another proceeding, the court determines the fair value of the land, which usually is approximately equal to its market value.  ◀ When the government uses its power of eminent domain to acquire land owned by a private party, a taking occurs Under the takings clause of the Fifth Amendment to the U.S Constitution (see Appendix B), the government must pay “just compensation” to the owner State constitutions contain similar provisions Even ownership in fee simple absolute is limited by a superior ownership Just as the king was the ultimate landowner in medieval England, today the government has an ultimate ownership right in all land in the United States This right, known as eminent domain, is sometimes referred to as the condemnation power of government to take land for public use It gives the government the right to acquire possession of real property in the manner directed by the U.S Constitution and the laws of the state whenever the public interest requires it Economic Development  In 2005, the United States Supreme Court ruled that the power of eminent domain may be used to further economic development.7 Since that decision, a majority of state legislatures have passed laws limiting the power of state governments to use eminent domain, particularly for urban redevelopment projects that benefit private developers The following case involved a town’s condemnation action to acquire rights-of-way for a natural gas pipeline to be constructed through the town The issue was whether the pipeline was for public use, even though it was not built to furnish natural gas to the residents of that town Public Use Requirement Property may be taken only for public use, not for private benefit Kelo v City of New London, Connecticut, 545 U.S 469, 125 S.Ct 2655, 162 L.Ed.2d 439 (2005) Eminent Domain C a s e Analy A naly s is Case 26.3  Town of Midland v Morris Court of Appeals of North Carolina, 704 S.E.2d 329 (2011) IN THE LANGUAGE OF THE COURT STEPHENS, Judge The Transcontinental Pipeline transports and distributes natural gas from the Gulf of Mexico to the northeastern United States In April 2002, the City of Monroe, North Carolina, decided to supply the citizens of Monroe and the surrounding area with natural gas by a direct connection between its natural gas distribution system and the Transcontinental Pipeline To directly connect to the Transcontinental Pipeline, Monroe needed to acquire the rights to property through which to run a pipeline along the forty-two miles between Monroe and the direct connection on the Transcontinental Pipeline located in Iredell County Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 26  Real Property and Land-Use Control  591 CASE 26.3 CONTINUEd To facilitate the acquisition of land for the construction of the new pipeline (“Pipeline”), Monroe, located in Union County, entered into interlocal agreements with the Town of Mooresville, located in Iredell County, and the Town of Midland, located in Cabarrus County The relevant terms of the interlocal agreement between Midland and Monroe * * * provide as follows: 4.  Midland shall be responsible for obtaining either by acquisition or by the power of eminent domain and holding in its name for the benefit of the parties and this Interlocal Agreement all easements (both permanent and temporary construction), rights of way, and real property required for the project in Cabarrus County * * * * 20.  * * * Midland shall retain a perpetual right to locate and install one (1) tap in the pipeline within the corporate limits of Midland from which to operate and supply its own natural gas distribution utility for the benefit of Midland’s utility customers in Cabarrus County only The one tap for Midland’s use shall be subject to a right of first refusal granted to a private natural gas provider to serve customers that would otherwise be served by Midland * * * * In 2008 Midland began the process of acquiring the property necessary for the construction of the Pipeline When negotiations for voluntary acquisitions for the rights of way failed, Midland exercised its eminent domain authority to condemn the needed property The present controversy stems from fifteen condemnation actions filed by the Town of Midland in Cabarrus County Superior Court In those fifteen actions, the opposing parties (hereinafter “Property Owners”) filed defenses and counterclaims, challenging Midland’s power to condemn the properties in question * * *  * * * * Property Owners first argue that because Midland neither currently provides natural gas services to its citizens, nor currently has any plans to provide natural gas to its citizens in the future, the condemnations were undertaken in violation of the statutes governing eminent domain We disagree * * * * * * * We find it manifest [obvious] that Midland may acquire property by condemnation to establish a gas transmission and distribution system, even in the absence of a concrete, immediate plan to furnish gas services to its citizens [Emphasis added.] While we acknowledge the existence of the requirement that the public enterprise be established and conducted for the city and its citizens, we conclude that this requirement is satisfied by Midland’s placement of a tap on the Pipeline and by Midland’s acquisition of the right to low-cost natural gas Further, * * * there is nothing in the record to indicate that Midland will never offer natural gas services to its citizens In fact, Midland’s contracted-for right to install a tap on the Pipeline “from which to operate and supply its own natural gas distribution utility for the benefit of Midland’s utility customers” indicates just the opposite: that Midland will, eventually, furnish natural gas services to its citizens [Emphasis added.] * * * * Property Owners further argue that Midland’s condemnations violate [the state’s statute] because the condemnations are not “for the public use or benefit.” * * * * It is clear from the statutory language that establishing a gas transmission and distribution system is an appropriate purpose for the condemnation of property under [the relevant provisions] Despite the disjunctive language of this statutory requirement, our courts have determined the propriety of a condemnation under [the statute] based on the condemnation’s satisfaction of both a “public use test” and a “public benefit test.” The first approach—the public use test—asks whether the public has a right to a definite use of the condemned property The second approach—the public benefit test— asks whether some benefit accrues to the public as a result of the desired condemnation Under the public use test, “the principal and dispositive determination is whether the general public has a right to a definite use of the property sought to be condemned.” * * * Applying this test to the present case in the appropriate context, there is nothing to indicate that gas services—were they to be provided by Midland—would be available to anything less than the entire population Accordingly, there can be no doubt that the Midland condemnations would pass the public use test * * *  * * * * Under the public benefit test, “a given condemnor’s desired use of the condemned property in question is for ‘the public use or benefit’ if that use would contribute to the general welfare and prosperity of the public at large.” In this case, we must take care in defining Midland’s “desired use” of the property Midland is condemning the property to run the Pipeline and to control a tap on the Pipeline, not to immediately provide gas to the citizens of Midland Accordingly, it is the availability of natural gas that must contribute to the general welfare and prosperity of the public at large [Emphasis added.] As noted by our Courts, the construction and extension of public utilities, and especially the concomitant commercial and residential growth, provide a clear public benefit to local citizens * * * Midland’s tap on the Pipeline, and its potential to provide natural gas service, likely CASE 26.3 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 592  Unit Six  The Regulatory Environment CASE 26.3 CONTINUEd will spur growth, as well as provide Midland with an advantage in industrial recruitment These opportunities must be seen as public benefits accruing to the citizens of Midland, such that Midland’s condemnations are for the public benefit * * * * Accordingly, we conclude that the Midland condemnations were not undertaken to provide a solely private benefit * * * * We hold that Midland lawfully exercised its eminent domain power LEGAL REASONING QUESTIONS Was Midland’s condemnation of property in this case for a public benefit? Explain Is it fair that a city can exercise its eminent domain power to take property even though the property will not be used immediately to benefit the city’s residents? Why or why not? The town of Midland—and its taxpaying citizens—had to pay fair value to fifteen property owners for property it acquired through eminent domain Is it right to make the citizens of one town pay for a pipeline constructed primarily to benefit another town? Explain Suppose that Midland had used its eminent domain authority to acquire property for the town to lease to a private resort that would provide a large number of jobs and bring tourist dollars into the community What are the arguments for and against this use of the power of eminent domain? Inverse Condemnation Typically, a government agency exercises the power of eminent domain through litigation or negotiation and pays compensation to the landowner whose property is seized Inverse condemnation, in contrast, occurs when a government simply takes private property from a landowner without paying any compensation, thereby forcing the landowner to sue the government for compensation The taking can be physical, as when a government agency uses or occupies the land, or it may be constructive, as when an agency regulation results in loss of property value The United States Supreme Court has held that even temporary flooding of land by the government may result in liability under the takings clause.8 ▶ Case in Point 26.16  In Walton County, Florida, water flows through a ditch from Oyster Lake to the Gulf of Mexico When Hurricane Opal caused the water to rise in Oyster Lake, Walton County reconfigured the drainage to divert the overflow onto the nearby property of William and Patricia Hemby The flow was eventually restored to pre-Opal conditions, but during a later emergency, water was diverted onto the Hembys’ property again This diversion was not restored Arkansas Game and Fish Commission v United States, _ U.S _, 133 S.Ct 511, 184 L.Ed.2d 417 (2012) The Hembys filed a suit against the county After their deaths, their daughter Cozette Drake pursued the claim The court found that by allowing the water diversion, created during emergency conditions, to remain on Drake’s property long after the emergency had passed, the county had engaged in a permanent or continuous physical invasion This invasion rendered Drake’s property useless and deprived her of its beneficial enjoyment Drake was therefore entitled to receive compensation from the county.9  ◀ Restrictive Covenants A private restriction on the use of land is known as a restrictive covenant If the restriction is binding on the party who purchases the property originally and on subsequent purchasers as well, it is said to “run with the land.” A covenant running with the land must be in writing (usually it is in the deed), and subsequent purchasers must have reason to know about it ▶  Example 26.17  In the course of developing a fifty-lot suburban subdivision, Levitt records a declaration of restrictions that effectively limits construction on each lot to one single-family house Each lot’s deed includes a reference to the declaration with a provision that the purchaser and her or his successors are bound to those restrictions Thus, each purchaser assumes ownership with notice of the restrictions If Drake v Walton County, So.3d 717 (Fla.App 2009) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 26  Real Property and Land-Use Control  an owner attempts to build a duplex (or any structure that does not comply with the restrictions) on a lot, the other owners may obtain a court order enjoining the construction Alternatively, Levitt might simply have included the restrictions on the subdivision’s map, filed the map in the appropriate public office, and included a reference to the map in each deed In this way, each owner would also have been held to have constructive notice of the restrictions.  ◀ SECTION Land-Use Control and Zoning The rules and regulations that collectively manage the development and use of land are known as zoning laws Zoning laws were first used in the United States to segregate slaughterhouses, distilleries, kilns, and other businesses that might pose a nuisance to nearby residences The growth of modern urban areas has led to an increased need to organize uses of land Today, zoning laws enable the government of a municipality —a town, city, or county—to control the speed and type of development within its borders by creating different zones and regulating the use of property allowed in each zone The United States Supreme Court has held that zoning is a constitutional exercise of a government’s police powers.10 Therefore, as long as its zoning ordinances are rationally related to the health, safety, or welfare of the community, a municipal government has broad discretion to carry out zoning as it sees fit Purpose and Scope of Zoning Laws The purpose of zoning laws is to manage the land within a community in a way that encourages sustainable and organized development while controlling growth in a manner that serves the interests of the community One of the basic elements of zoning is the classification of land by permissible use as part of a comprehensive municipal plan, but zoning extends to other aspects of land use as well Permissible Uses of Land  Municipalities generally divide their available land into districts according to 10 Village of Euclid v Ambler Realty Co., 272 U.S 365, 47 S.Ct 114, 71 L.Ed 303 (1926) 593 the land’s present and potential future uses Typically, land is classified into the following types of permissible uses: Residential In areas dedicated for residential use, landowners can construct buildings for human habitation Commercial Land assigned for business activities is designated as being for commercial use, sometimes called business use An area with a number of retail stores, offices, supermarkets, and hotels might be designated as a commercial or business district Land used for entertainment purposes, such as movie theaters and sports stadiums, also falls into this category, as does land used for government activities Industrial Areas designated for industrial use typically encompass light and heavy manufacturing, shipping, and heavy transportation For instance, undeveloped land with easy access to highways and railroads might be classified as suitable for future use by industry Although industrial uses can be profitable for a city seeking to raise tax revenue, such uses can also result in noise, smoke, or vibrations that interfere with others’ enjoyment of their property Consequently, areas zoned for industrial use generally are kept as far as possible from residential districts and some commercial districts Conservation districts Some municipalities also establish certain areas that are dedicated to carrying out local soil and water conservation efforts— for instance, wetlands (see Chapter 25) might be designated as a conservation district A city’s residential, commercial, and industrial districts may be divided, in turn, into subdistricts For instance, zoning ordinances regulate the type, density, size, and approved uses of structures within a given district Thus, a residential district may be divided into low-density (single-family homes with large lots), high-density (single- and multiple-family homes with small lots), and planned-unit (condominiums or apartments) subdistricts Other Zoning Restrictions  Zoning rules extend to much more than the permissible use of land In residential districts, for instance, an ordinance may require a house or garage to be set back a specific number of feet from a neighbor’s property line In commercial districts, zoning rules may attempt to maintain a certain visual aesthetic Therefore, businesses may be required to construct buildings of a Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 594  Unit Six  The Regulatory Environment certain height and width so that they conform to the style of other commercial buildings in the area Businesses may also be required to provide parking for patrons or take other measures to manage traffic Sometimes, municipalities limit construction of new businesses to prevent traffic congestion Zoning laws may even attempt to regulate the public morals of the community For instance, cities commonly impose severe restrictions on the location and operation of adult businesses Exceptions to Zoning Laws Zoning restrictions are not absolute It is impossible for zoning laws to account for every contingency The purpose of zoning is to enable the municipality to control development but not to prevent it altogether or limit the government’s ability to adapt to changing circumstances or unforeseen needs Hence, legal processes have been developed to allow for exceptions to zoning laws Here, we look at these exceptions, known as variances and special-use permits, as well as at the special incentives that governments may offer to encourage certain kinds of development Variances  When a property owner wants to use his or her land in a manner not permitted by zoning rules, she or he can request a variance, which allows an exception to the rules The property owner requesting the variance must demonstrate that the requested variance: Is necessary for reasonable development Is the least intrusive solution to the problem Will not alter the essential character of the neighborhood Hardship Situations.  Property owners normally request variances in hardship situations (when complying with the zoning rules would be too difficult or costly due to existing property conditions) ▶  Example 26.18  Lin Wang, a homeowner, wants to replace her single-car garage with a two-car garage, but if she does so, the garage will be closer to her neighbor’s property than is permitted by the zoning rules In this situation, she may ask for a variance She can claim that the configuration of her property (where the current garage is located) makes it difficult and costly to comply with the zoning code, so compliance would create a hardship for her.  ◀ Similarly, a church might request a variance from height restrictions in order to erect a new steeple Or a furniture store might ask for a variance from footprint limitations so that it can expand its showroom (a building’s footprint is the area of ground that it covers) Note that the hardship may not be self-created In other words, a person usually cannot buy property with zoning regulations in effect and then argue that a variance is needed for the property to be used for the owner’s intended purpose Public Hearing.  In almost all instances, before a variance is granted, there must be a public hearing with adequate notice to neighbors who may object to the exception After the public hearing, a hearing examiner appointed by the municipality (or the local zoning board or commission) determines whether to grant the exception When a variance is granted, it applies only to the specific parcel of land for which it was requested and does not create a regulation-free zone Special-Use Permits  Sometimes, zoning laws permit a use, but only if the property owner complies with specific requirements to ensure that the proposed use does not harm the immediate neighborhood In such instances, the zoning board will issue specialuse permits, also called conditional-use permits ▶  Example 26.19  An area is designated as a residential district, but small businesses are permitted to operate there so long as they not affect the characteristics of the neighborhood A bank asks the zoning board for a special-use permit to open a branch in the area At the public hearing, the bank’s managers demonstrate that the branch will be housed in a building that conforms to the style of other structures in the area The bank also shows that adequate parking will be available and that landscaping will shield the parking lot from public view Unless there are strong objections from the branch’s prospective neighbors, the board will likely grant the permit.  ◀ Special Incentives  In addition to granting exceptions to zoning regulations, municipalities may also wish to encourage certain kinds of development To so, they offer incentives, often in the form of lower tax rates or tax credits For instance, to attract new businesses that will provide jobs for local citizens and increase the tax base, a city may offer incentives in the form of lower property tax rates for a period of years Similarly, homeowners may receive tax credits for historical preservation if they renovate and maintain older homes Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 26  Real Property and Land-Use Control  Tax credits provided by cities and towns may encourage construction firms to utilize “green” construction techniques that are more sustainable ▶  Example 26.20  Ryan Orley, of Orley Construction, LLC, knows that a building’s thermal load (the amount of heat that must be removed over a given time period) depends, in part, on its orientation to the sun A change in the building’s orientation 595 may entail a higher cost initially but save on airconditioning expenses later Ryan convinces his client that it is worth the extra cost to have the building redesigned to minimize the long-term cost of airconditioning Ryan also conducts research and discovers that the tax credit available from the city will help cover the additional construction costs.  ◀ Reviewing: Real Property and Land-Use Control Vern Shoepke purchased a two-story home from Walter and Eliza Bruster in the town of Roche, Maine The warranty deed did not specify what covenants would be included in the conveyance The property was adjacent to a public park that included a popular Frisbee golf course (Frisbee golf is a sport similar to golf but using Frisbees.) Wayakichi Creek ran along the north end of the park and along Shoepke’s property The deed allowed Roche citizens the right to walk across a five-foot-wide section of the lot beside Wayakichi Creek as part of a two-mile public trail system Teenagers regularly threw Frisbee golf discs from the walking path behind Shoepke’s property over his yard to the adjacent park Shoepke habitually shouted and cursed at the teenagers, demanding that they not throw objects over his yard Using the information presented in the chapter, answer the following questions What is the term for the right of Roche citizens to walk across Shoepke’s land on the trail? What covenants would most courts infer were included in the warranty deed that was used in the property transfer from the Brusters to Shoepke? Suppose that Shoepke wants to file a trespass lawsuit against some teenagers who continually throw Frisbees over his land Shoepke discovers, however, that when the city put in the Frisbee golf course, the neighborhood homeowners signed an agreement that limited their right to complain about errant Frisbees What is this type of promise or agreement called in real property law? Debate This  Under no circumstances should a local government be able to condemn property in order to sell it later to real estate developers for private use Terms and Concepts adverse possession 588 closing 584 commercial use 593 community property 581 concurrent ownership 580 condemnation 590 conveyance 580 deed 586 easement 582 eminent domain 590 escrow account 584 fee simple absolute 579 fixed-term tenancy 581 grant deed 587 implication 582 implied warranty of habitability 584 industrial use 593 inverse condemnation 592 joint tenancy 580 lease 580 leasehold estate 581 license 583 life estate 580 marketable title 584 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 596  Unit Six  The Regulatory Environment metes and bounds 587 necessity 582 nonpossessory interests 582 periodic tenancy 581 prescription 582 profit 582 quitclaim deed 587 recording statute 587 residential use 593 restrictive covenant 592 special-use permit 594 special warranty deed 587 taking 590 tenancy at sufferance 581 tenancy at will 581 tenancy by the entirety 581 tenancy in common 580 title insurance 584 variance 594 warranty deed 587 waste 580 zoning laws 593 ExamPrep Issue Spotters Bernie sells his house to Consuela under a warranty deed Later, Delmira appears, holding a better title to the house than Consuela has Delmira wants to have Consuela evicted from the property What can Consuela do? (See page 587.) Grey owns a commercial building in fee simple Grey transfers temporary possession of the building to Haven Corporation Can Grey enter the building without Haven Corporation’s permission? Explain (See page 581.) •  Check your answers to the Issue Spotters against the answers provided in Appendix E at the end of this text Before the Test  Go to www.cengagebrain.com, enter the ISBN 9781285428949, and click on “Find” to locate this textbook’s Web site Then, click on “Access Now” under “Study Tools,” and select Chapter 26 at the top There, you will find an Interactive Quiz that you can take to assess your mastery of the concepts in this chapter, as well as Flashcards and a Glossary of important terms Business Scenarios 26–1. Property Ownership.  Madison owned a tract of land, but he was not sure that he had full title to the property When Rafael expressed an interest in buying the land, Madison sold it to Rafael and executed a quitclaim deed Rafael properly recorded the deed immediately Several months later, Madison learned that he had had full title to the tract of land He then sold the land to Linda by warranty deed Linda knew of the earlier purchase by Rafael but took the deed anyway and later sued to have Rafael evicted from the land Linda claimed that because she had a warranty deed, her title to the land was better than that conferred by Rafael’s quitclaim deed Will Linda succeed in claiming title to the land? Explain (See page 587.) 26–2. Zoning.  The county intends to rezone an area from industrial use to residential use Land within the affected area is largely undeveloped, but nonetheless it is expected that the proposed action will reduce the market value of the affected land by as much as 50 percent Will the landowners be successful in suing to have the action declared a taking of their property, entitling them to just compensation? Why or why not? (See page 592.) Business Case Problems 26–3. Eminent Domain. The Hope Partnership for Education, a religious organization, proposed to build a private independent middle school in a run-down neighborhood in Philadelphia, Pennsylvania The Hope Partnership asked the Redevelopment Authority of the City of Philadelphia to acquire specific land for the project and sell it to the Hope Partnership for a nominal price The land included a house on North Eighth Street owned by Mary Smith, Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 26  Real Property and Land-Use Control  whose daughter Veronica lived there with her family The Authority offered Smith $12,000 for the house and initiated a taking of the property Smith filed a suit in state court against the Authority, admitting that the house was a “substandard structure in a blighted area,” but arguing that the taking was unconstitutional because its beneficiary was private The Authority asserted that only the public purpose of the taking should be considered, not the status of the property’s developer On what basis can a government entity use the power of eminent domain to take property? What are the limits to this power? How should the court rule? Why? [ Redevelopment Authority of City of Philadelphia v New Eastwick Corp., 588 Pa 789, 906 A.2d 1197 (2006)] (See page 590.) 26–4. Ownership in Fee Simple. Thomas and Teresa Cline built a house on a 76-acre parcel of real estate next to Roy Berg’s home and property in Augusta County, Virginia The homes were about 1,800 feet apart but in view of each other After several disagreements between the parties, Berg equipped an 11-foot tripod with motion sensors and floodlights that intermittently illuminated the Clines’ home Berg also installed surveillance cameras that tracked some of the movement on the Clines’ property The cameras transmitted on an open frequency that could be received by any television within range The Clines asked Berg to turn off, or at least redirect, the lights When he refused, they erected a fence for 200 feet along the parties’ common property line The 32-foot-high fence consisted of 20 utility poles spaced 10 feet apart with plastic wrap stretched between the poles This effectively blocked the lights and cameras Berg filed a suit against the Clines in a Virginia state court, complaining that the fence interfered unreasonably with his use and enjoyment of his property He asked the court to order the Clines to take the fence down What are the limits on an owner’s use of property? How should the court rule in this case? Why? [Cline v Berg, 273 Va 142, 639 S.E.2d 231 (2007)] (See page 579.) 26–5. Adverse Possession. In 1974, the Mansells built a garage with a dirt floor at the back of their property The structure went beyond the Mansells’ property line and encroached approximately fourteen feet on the neighboring property The neighbor knew of the encroachment and informally approved it, but did not transfer ownership of the property In 2001, Betty Hunter bought the neighbor’s property The survey done at that time revealed the encroachment In 2003, Hunter’s attorney notified the Mansells about the encroachment, and the parties held some informal conversations but did not reach an agreement In 2006, the Mansells installed a concrete foundation and ran electricity to the structure Hunter then sought a declaratory judgment that she was the fee simple owner of the property partially covered by the garage that encroached on her property She demanded the removal of the encroaching structure The Mansells filed a counterclaim, arguing that their possession of the property from 1974 to 2001 gave them ownership by adverse posses- 597 sion The trial court held that the property still belonged to Hunter, but did not order removal of the garage Hunter and Mrs Mansell (whose husband had died in the meantime) both appealed Did the open occupation of the property for twenty-eight years give Mansell title by adverse possession? Why or why not? [Hunter v Mansell, 240 P.3d 469 (Colo.App 2010)] (See page 588.) 26–6.  Business Case Problem with Sample Answer:  Adverse Possession The McKeag family operated a marina on their lakefront property in Bolton, New York For more than forty years, the McKeags used a section of property belonging to their neighbors, the Finleys, as a beach for the marina’s customers The McKeags also stored a large float on the beach during the winter months, built their own retaining wall, and planted bushes and flowers there The McKeags prevented others from using the property, including the Finleys Nevertheless, the families always had a friendly relationship, and one of the Finleys gave the McKeags permission to continue using the beach in 1992 He also reminded them of his ownership several times, to which they said nothing The McKeags also asked for permission to mow grass on the property and once apologized for leaving a jet ski there Can the McKeags establish adverse possession over the statutory period of ten years? Why or why not? [McKeag v Finley, 939 N.Y.S.2d 644 (N.Y.App.Div 2012)] (See page 588.) • For a sample answer to Problem 26–6, go to Appendix F at the end of this text 26–7   A Question of Ethics:  Seller’s Duty to Disclose In 1999, Stephen and Linda Kailin bought the Monona Center, a mall in Madison, Wisconsin, from Perry Armstrong for $760,000 The contract provided, “Seller represents to Buyer that as of the date of acceptance Seller had no notice or knowledge of conditions affecting the Property or transaction” other than certain items disclosed at the time of the offer Armstrong told the Kailins of the Center’s eight tenants, their lease expiration dates, and the monthly and annual rent due under each lease One of the lessees, Ring’s All-American Karate, occupied about a third of the Center’s space under a five-year lease Because of Ring’s financial difficulties, Armstrong had agreed to reduce its rent for nine months in 1997 By the time of the sale to the Kailins, Ring owed $13,910 in unpaid rent, but Armstrong did not tell the Kailins, who did not ask Ring continued to fail to pay rent and finally vacated the Center The Kailins filed a suit in a Wisconsin state court against Armstrong and others, alleging, among other things, misrepresentation [  Kailin v Armstrong, 2002 WI App 70, 252 Wis.2d 676, 643 N.W.2d 132 (2002)] (See page 584.) (a) Did Armstrong have a duty to disclose Ring’s delinquency and default to the Kailins? Explain (b) If Armstrong did not violate the terms of the sales contract, did he have an ethical obligation to the Kailins? If so, did he violate it? Discuss Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 598  Unit Six  The Regulatory Environment 26–8.  Special Case Analysis:  Eminent Domain Go to Case Analysis Case 26.3, Town of Midland v Morris, on pages 590–592 Read the excerpt and answer the following questions (a) Issue: On what issue did the parties ask the court to focus? (b) Rule of Law: What rule or test did the court apply? (c) Applying the Rule of Law: How did the court apply the rule to the facts in this case? (d) Conclusion: What did the court conclude? Why? Legal Reasoning Group Activity 26–9. Adverse Possession.  The Wallen family owned a cabin on Lummi Island in the state of Washington A driveway ran from the cabin across their property to South Nugent Road Floyd Massey bought the adjacent lot and built a cabin on it in 1980 To gain access to his property, Massey used a bulldozer to extend the driveway, without the Wallens’ permission but also without their objection In 2005, the Wallens sold their property to Wright Fish Company Massey continued to use and maintain the driveway without permission or objection In 2011, Massey sold his property to Robert Drake Drake and his employees continued to use and maintain the driveway without permission or objection, although Drake knew it was located largely on Wright’s property In 2013, Wright sold its lot to Robert Smersh The next year, Smersh told Drake to stop using the driveway Drake filed a suit against Smersh, claiming an easement by prescription (which is created by meeting the same requirements as adverse possession) (See page 588.) (a) The first group will decide whether Drake’s use of the driveway meets all of the requirements for adverse possession (easement by prescription) (b) The second group will determine how the court should rule in this case and why Does it matter that Drake knew the driveway was located largely on Wright’s (and then Smersh’s) property? Should it matter? Why or why not? (c) A third group will evaluate the underlying policy and fairness of adverse possession laws Should the law reward persons who take possession of someone else’s land for their own use? Does it make sense to punish owners who allow someone else to use their land without complaint? Explain Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 27 Antitrust Law A fter the Civil War (1861– 1865), the American public became increasingly concerned about declining competition in the marketplace Large corporate enterprises were attempting to reduce or eliminate competition by legally tying themselves together in contracts to create business trusts (unincorporated organizations with limited liability) The most famous trust was the Standard Oil trust of the late 1800s Its participants transferred their stock to a trustee who then fixed prices, controlled production, and established exclusive geographic markets for all of the oil companies that were members of the trust Some observers began to argue that the trust wielded so much economic power that corporations outside the trust could not compete effectively Eventually, legislation began to be enacted at both the state and the federal level to rein in the trusts Hence, the laws that regulate economic competition in the United States today are still referred to as antitrust laws At the national level, antitrust legislation began when Congress passed the Interstate Commerce Act1 in 1887, followed by the Sherman Antitrust Act2 in 1890 In 1914, Congress passed the Clayton Act3 and the Federal Trade 49 U.S.C Sections 501–526 15 U.S.C Sections 1–7 15 U.S.C Sections 12–27 SECTION The Sherman Antitrust Act The author of the Sherman Antitrust Act of 1890, Senator John Sherman, was the brother of the famed Civil War general and a recognized financial authority He had been concerned for years about what he saw as diminishing competition within U.S industry and the emergence of monopolies He told Congress that the Sherman Act “does not announce a new principle of law, but applies old and well-recognized principles of the common law.”5 Indeed, not only the legislation that Sherman proposed but subsequent antitrust laws as well were the direct descendants of common law actions intended 21 Congressional Record 2456 (1890) Commission Act4 to further curb anticompetitive or unfair business practices This chapter examines these major antitrust statutes, focusing particularly on the Sherman Act and the Clayton Act, as amended, and the types of activities they prohibit As you read the chapter, remember that the purpose of antitrust legislation was—and still is—to foster competition Behind the laws lies our society’s belief that competition leads to lower prices, better products, a wider selection of goods, and more product information This is why the U.S government became concerned about the pricing of e-books, as you will read later in this chapter 15 U.S.C Sections 41–58a to limit restraints of trade (agreements between firms that have the effect of reducing competition in the marketplace) The common law was not always consistent, however, and had not been effective in curbing the trusts Therefore, in 1890 Congress passed “An Act to Protect Trade and Commerce against Unlawful Restraints and Monopolies”—more commonly referred to as the Sherman Antitrust Act, or simply the Sherman Act Major Provisions of the Sherman Act Sections and contain the main provisions of the Sherman Act: Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade 599 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 600  Unit Six  The Regulatory Environment or commerce among the several States, or with foreign nations, is hereby declared to be illegal [and is a felony punishable by fine and/or imprisonment] Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony [and is similarly punishable] Differences between Section and Section These two sections of the Sherman Act are quite different Section requires two or more persons, as a person cannot contract, combine, or conspire alone Thus, the essence of the illegal activity is the act of joining together Section 2, though, can apply either to one person or to two or more persons because it refers to “every person.” Thus, unilateral conduct can result in a violation of Section The cases brought to the courts under Section of the Sherman Act differ from those brought under Section Section cases are often concerned with whether an agreement (written or oral) leads to a restraint of trade Section cases deal with the structure of a monopoly that exists in the marketplace The term monopoly generally is used to describe a market in which there is a single seller or a very limited number of sellers Whereas Section focuses on agreements that are restrictive—that is, agreements that have a wrongful purpose—Section looks at the so-called misuse of monopoly power in the marketplace Monopoly power exists when a firm has an extreme amount of market power—the ability to affect the market price of its product Both Section and Section seek to curtail market practices that result in undesired monopoly pricing and output behavior For a case to be brought under Section 2, however, the “threshold” or “necessary” amount of monopoly power must already exist Jurisdictional Requirements The Sherman Act applies only to restraints that have a significant impact on interstate commerce Courts have generally held that any activity that substantially affects interstate commerce falls within the scope of the Sherman Act As will be discussed later in this chapter, the Sherman Act also extends to U.S nationals abroad that are engaged in activities that affect U.S foreign commerce Federal courts have exclusive jurisdiction over antitrust cases brought under the Sherman Act State laws regulate local restraints on competition, and state courts can decide claims brought under those laws SECTION Section of the Sherman Act The underlying assumption of Section of the Sherman Act is that society’s welfare is harmed if rival firms are permitted to join in an agreement that consolidates their market power or otherwise restrains competition The types of trade restraints that Section of the Sherman Act prohibits generally fall into two broad categories: horizontal restraints and ­vertical restraints, both of which will be discussed shortly First, though, we look at the rules that the courts may apply when assessing the anticompetitive impact of alleged restraints of trade Per Se Violations versus the Rule of Reason Some restraints are so substantially anticompetitive that they are deemed per se violations—illegal per se (inherently)—under Section Other agreements, however, even though they result in enhanced market power, not unreasonably restrain trade and are therefore lawful Using the rule of reason, the courts analyze anticompetitive agreements that allegedly violate Section of the Sherman Act to determine whether they actually constitute reasonable restraints of trade Rationale for the Rule of Reason  The need for a rule-of-reason analysis of some agreements in restraint of trade is obvious If the rule of reason had not been developed, almost any business agreement could conceivably be held to violate the Sherman Act Factors That Courts Consider  When analyzing an alleged Section violation under the rule of reason, a court will consider the following factors: The purpose of the agreement The parties’ ability to implement the agreement to achieve that purpose Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 27  Antitrust Law  The effect or potential effect of the agreement on competition Whether the parties could have relied on less restrictive means to achieve their purpose ▶ Case in Point 27.1  The National Football League (NFL) includes thirty-two separately owned professional football teams Each team has its own name, colors, and logo, and owns related intellectual property that it markets through National Football League Properties (NFLP) Until 2000, the NFLP granted nonexclusive licenses to a number of vendors, permitting them to manufacture and sell apparel bearing NFL team insignias American Needle, Inc., was one of those licensees In late 2000, the teams authorized the NFLP to grant exclusive licenses The NFLP granted Reebok International, Ltd., an exclusive ten-year license to manufacture and sell trademarked headwear for all thirty-two teams It then declined to renew American Needle’s nonexclusive license American Needle sued, claiming that the NFL teams, the NFLP, and Reebok had violated Section 1 of the Sherman Act The United States Supreme Court agreed The Court concluded that the agreement among the NFL teams to license their intellectual property exclusively through the NFLP to Reebok constituted concerted activity.6  ◀ Horizontal Restraints The term horizontal restraint is encountered frequently in antitrust law A horizontal restraint is any agreement that in some way restrains competition between rival firms competing in the same market Horizontal restraints may include price fixing, group boycotts, market divisions, and trade associations Price Fixing Any price-fixing agreement—an agreement among competitors to fix prices—constitutes a per se violation of Section The agreement on price need not be explicit As long as it restricts output or artificially fixes price, it violates the law ▶ Case in Point 27.2  Independent oil producers in Texas and Louisiana were caught between falling demand due to the Great Depression of the 1930s and increasing supply from newly discovered oil fields in the region In response to these conditions, a group of the major refining companies agreed to buy “distress” American Needle, Inc v National Football League, 560 U.S 183, 130 S.Ct 2201, 176 L.Ed.2d 947 (2010) 601 gasoline (excess supplies) from the independents so as to dispose of it in an “orderly manner.” Although there was no explicit agreement as to price, it was clear that the purpose of the agreement was to limit the supply of gasoline on the market and thereby raise prices There may have been good reasons for the agreement Nonetheless, the United States Supreme Court recognized the potentially adverse effects that such an agreement could have on open and free competition The Court held that the reasonableness of a price-fixing agreement is never a defense Any agreement that restricts output or artificially fixes price is a per se violation of Section 1.7  ◀ Price Fixing and E-Books.  The U.S government actively pursues companies that it suspects of being involved in price-fixing cartels (groups) ▶ Case in Point 27.3  In 2012, the U.S Justice Department filed a lawsuit against five major book publishers and Apple, Inc., charging that they had conspired to fix the prices of e-books Increased competition among e-book sellers— such as Amazon—had reduced e-book prices to $9.99 per e-book, which cut into the retail profit margins of the five publishers and Apple The companies allegedly responded by working together to raise retail e-book prices and eliminate price competition—and the price of e-books did go up All five of the book publishers subsequently settled with the Justice Department, but Apple proceeded to trial and lost The court ruled that compelling evidence showed that Apple had conspired to fix prices in violation of the Sherman Act.8  ◀ Price Fixing and Drug Manufacturers.  Price-fixing accusations are also frequently made against drug manufacturers ▶ Case in Point 27.4  The manufacturer of the prescription drug Cardizem CD, which can help prevent heart attacks, was about to lose its patent on the drug Another company had developed a generic version in anticipation of the patent’s expiration After the two firms became involved in litigation over the patent, the original manufacturer agreed to pay the second company $40 million per year not to market the generic version until their dispute was resolved This agreement was held to be a per se violation of the Sherman Act because it restrained competition between rival firms and delayed the entry of generic versions of Cardizem into the market.9  ◀ United States v Socony-Vacuum Oil Co., 310 U.S 150, 60 S.Ct 811, 84 L.Ed 1129 (1940) United States v Apple, Inc., _ F.Supp.2d _, 2013 WL 3454986 (S.D.N.Y 2013) In re Cardizem CD Antitrust Litigation, 332 F.3d 896 (6th Cir 2003) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 602  Unit Six  The Regulatory Environment Group Boycotts  A group boycott is an agreement by two or more sellers to refuse to deal with (boycott) a particular person or firm Because they involve concerted action, group boycotts have been held to constitute per se violations of Section of the Sherman Act To prove a violation of Section 1, the plaintiff must demonstrate that the boycott or joint refusal to deal was undertaken with the intention of eliminating competition or preventing entry into a given market Although most boycotts are illegal, a few, such as group boycotts against a supplier for political reasons, may be protected under the First Amendment right to freedom of expression Horizontal Market Division  It is a per se violation of Section of the Sherman Act for competitors to divide up territories or customers ▶  Example 27.5  Alred Office Supply, Belmont Business, and Carlson’s, Inc., compete against each other in the states of Kansas, Nebraska, and Oklahoma They agree that Alred will sell products only in Kansas, Belmont will sell only in Nebraska, and Carlson’s will sell only in Oklahoma This concerted action reduces the firms’ marketing costs and allows all three (assuming there is no other competition) to raise the price of the goods sold in their respective states—a per se violation of Section The same violation would take place if the three firms agreed to divide up their territories by customers For example, Alred might sell only to institutional purchasers (such as governments and schools) in all three states, Belmont only to wholesalers, and Carlson only to retailers.  ◀ Trade Associations  Businesses in the same general industry or profession frequently organize trade associations to pursue common interests A trade association may engage in various joint activities, such as exchanging information, representing the members’ business interests before governmental bodies, and conducting advertising campaigns Trade associations also frequently are involved in setting regulatory standards to govern the industry or profession Generally, the rule of reason is applied to many of these horizontal actions If a court finds that a trade association practice or agreement that restrains trade is nonetheless sufficiently beneficial both to the association and to the public, it may deem the restraint reasonable In concentrated industries, however, trade associations can be, and have been, used as a means to facilitate anticompetitive actions, such as fixing prices or allocating markets A concentrated industry is one in which either a single firm or a small number of firms control a large percentage of market sales When trade association agreements have substantially anticompetitive effects, a court will consider them to be in violation of Section of the Sherman Act Vertical Restraints A vertical restraint of trade results from an agreement between firms at different levels in the manufacturing and distribution process In contrast to horizontal relationships, which occur at the same level of operation, vertical relationships encompass the entire chain of production The chain of production normally includes the purchase of inventory, basic manufacturing, distribution to wholesalers, and eventual sale of a product at the retail level For some products, these distinct phases are carried on by different firms In other instances, a single firm carries out two or more of the separate functional phases Such enterprises are said to be vertically integrated firms Even though firms operating at different functional levels are not in direct competition with one another, they are in competition with other firms Thus, agreements between firms standing in a vertical relationship may affect competition Some vertical restraints are per se violations of Section Others are judged under the rule of reason Territorial or Customer Restrictions  In arranging for the distribution of its products, a manufacturing firm often wishes to insulate dealers from direct competition with other dealers selling its products To so, the manufacturer may institute territorial restrictions or attempt to prohibit wholesalers or retailers from reselling the products to certain classes of buyers, such as competing retailers May Have Legitimate Purpose.  A firm may have legitimate reasons for imposing such territorial or customer restrictions For instance, an electronics manufacturer may wish to prevent a dealer from reducing costs and undercutting rivals by offering its products without promotion or customer service The manufacturer legitimately seeks to prevent the cost-cutting dealer from reaping the benefits (sales of the product) paid for by other dealers who undertake promotion and provide customer service By not offering customer service (and relying on a nearby dealer to provide these services), the cost-cutting dealer may also harm the manufacturer’s reputation Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 27  Antitrust Law  Judged under the Rule of Reason.  Territorial and customer restrictions were once considered per se violations of Section 1,10 but in 1977, the United States Supreme Court held that they should be judged under the rule of reason ▶ Case in Point 27.6  GTE Sylvania, Inc., a manufacturer of television sets, limited the number of retail franchises that it granted in any given geographic area It also required each franchisee to sell only Sylvania products from the location at which it was franchised Sylvania retained sole discretion to increase the number of retailers in an area When Sylvania decided to open a new franchise, it terminated the franchise of Continental T.V., Inc., an existing franchisee in that area that would have been in competition with the new franchise Continental filed a lawsuit claiming that Sylvania’s vertically restrictive franchise system violated Section of the Sherman Act The United States Supreme Court found that “vertical restrictions promote interbrand competition by allowing the manufacturer to achieve certain efficiencies in the distribution of his products.” Therefore, Sylvania’s vertical system, which was not price restrictive, did not constitute a per se violation of Section of the Sherman Act.11  ◀ 10 See United States v Arnold, Schwinn & Co., 388 U.S 365, 87 S.Ct 1856, 18 L.Ed.2d 1249 (1967) 11 Continental T.V., Inc v GTE Sylvania, Inc., 433 U.S 36, 97 S.Ct 2549, 53 L.Ed.2d 568 (1977) 603 The decision in the Continental case marked a definite shift from rigid characterization of territorial and customer restrictions to a more flexible, economic analysis of these vertical restraints under the rule of reason This rule is still applied in most vertical restraint cases Resale Price Maintenance Agreements An agreement between a manufacturer and a distributor or retailer in which the manufacturer specifies what the retail prices of its products must be is known as a resale price maintenance agreement Such agreements were once considered to be per se violations of Section of the Sherman Act In 1997, however, the United States Supreme Court ruled that maximum resale price maintenance agreements should be judged under the rule of reason.12 The setting of a maximum price that retailers and distributors can charge for a manufacturer’s products may sometimes increase competition and benefit consumers The question before the United States Supreme Court in the following case was whether minimum resale price maintenance agreements should be treated as per se violations 12 State Oil Co v Khan, 522 U.S 3, 118 S.Ct 275, 139 L.Ed.2d 199 (1997) Cas e Analy A naly s is Case 27.1  Leegin Creative Leather Products, Inc v PSKS, Inc Supreme Court of the United States, 551 U.S 877, 127 S.Ct 2705, 168 L.Ed.2d 623 (2007) IN THE LANGUAGE OF THE COURT Justice KENNEDY delivered the opinion of the Court * * * * Petitioner, Leegin Creative Leather Products, Inc (Leegin), designs, manufactures, and distributes leather goods and accessories In 1991, Leegin began to sell [products] under the brand name “Brighton.” Respondent, PSKS, Inc (PSKS), operates Kay’s Kloset, a women’s apparel store in Lewisville, Texas * * * It first started purchasing Brighton goods from Leegin in 1995 * * * * In December 2002, Leegin discovered Kay’s Kloset had been marking down Brighton’s entire line by 20 percent * * * Leegin stopped selling [Brighton products] to the store PSKS sued Leegin in the United States District Court for the Eastern District of Texas It alleged, among other claims, that Leegin had violated the antitrust laws by “enter[ing] into agreements with retailers to charge only those prices fixed by Leegin.” * * * [The court] entered judgment against Leegin in the amount of $3,975,000.80 The [U.S.] Court of Appeals for the Fifth Circuit affirmed * * * We granted certiorari * * *  * * * * The rule of reason is the accepted standard for testing whether a practice restrains trade in violation of [Section] [of the Sherman Act] * * * * Resort to per se rules is confined to restraints * * * that would always or almost always tend to restrict competition and decrease output To justify a per se prohibition a restraint must have manifestly anticompetitive effects, CASE 27.1 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 604  Unit Six  The Regulatory Environment CASE 27.1 CONTINUEd and lack * * * any redeeming virtue [Emphasis added.] As a consequence, the per se rule is appropriate only after courts have had considerable experience with the type of restraint at issue, and only if courts can predict with confidence that it would be invalidated in all or almost all instances under the rule of reason * * * * The reasoning of the Court’s more recent jurisprudence has rejected the rationales on which [the application of the per se rule to minimum resale price maintenance agreements] was based * * * [These rationales were] based on formalistic legal doctrine rather than demonstrable economic effect * * * Furthermore [the Court] treated vertical agreements a manufacturer makes with its distributors as analogous to a horizontal combination among competing distributors * * * Our recent cases formulate antitrust principles in accordance with the appreciated differences in economic effect between vertical and horizontal agreements * * *  * * * * The justifications for vertical price restraints are similar to those for other vertical restraints Minimum resale price maintenance can stimulate interbrand competition * * * by reducing intrabrand competition * * *  The promotion of interbrand competition is important because the primary purpose of the antitrust laws is to protect this type of competition * * * Resale price maintenance also has the potential to give consumers more options so that they can choose among low-price, lowservice brands; high-price, high-service brands; and brands that fall in between [Emphasis added.] * * * * While vertical agreements setting minimum resale prices can have procompetitive justifications, they may have anticompetitive effects in other cases; and unlawful price fixing, designed solely to obtain monopoly profits, is an ever present temptation * * * * Notwithstanding the risks of unlawful conduct, it cannot be stated with any degree of confidence that resale price maintenance always or almost always tends to restrict competition and decrease output Vertical agreements establishing minimum resale prices can have either procompetitive or anticompetitive effects, depending upon the circumstances in which they are formed * * * As the [per se] rule would proscribe a significant amount of procompetitive conduct, these agreements appear ill suited for per se condemnation * * * * The judgment of the Court of Appeals is reversed, and the case is remanded for proceedings consistent with this opinion LEGAL REASONING QUESTIONS Should the Court have applied the doctrine of stare decisis to hold that minimum resale price maintenance agreements are still subject to the per se rule? Why or why not? What factors might the courts consider in applying the rule of reason to minimum resale price maintenance agreements? In what ways minimum resale price maintenance agreements facilitate interbrand competition? In general, how are the interests of manufacturers, retailers, and consumers aligned—and in conflict—with respect to a product’s profit margin? (A product’s profit margin is the difference between the price a manufacturer charges retailers and the price retailers charge consumers.) SECTION Section of the Sherman Act Section of the Sherman Act proscribes certain concerted, or joint, activities that restrain trade In contrast, Section condemns “every person who shall monopolize, or attempt to monopolize.” Thus, two distinct types of behavior are subject to sanction under Section 2: monopolization and attempts to monopolize One tactic that may be involved in either offense is predatory pricing Predatory pricing occurs when one firm (the predator) attempts to drive its competitors from the market by selling its product at prices substantially below the normal costs of production Once the competitors are eliminated, the predator presumably will raise its prices far above their competitive levels to recapture its losses and earn higher profits Monopolization The United States Supreme Court has defined ­monopolization as involving the following two elements: Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 27  Antitrust Law  The possession of monopoly power in the relevant market “The willful acquisition or maintenance of the power as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident.”13 To establish a violation of Section 2, a plaintiff must prove both of these elements—monopoly power and an intent to monopolize Monopoly Power  The Sherman Act does not define monopoly In economic theory, monopoly refers to control of a specific market by a single entity It is well established in antitrust law, however, that a firm may be a monopolist even though it is not the sole seller in a market Additionally, size alone does not determine whether a firm is a monopoly ▶  Example 27.7  A 13 United States v Grinnell Corp., 384 U.S 563, 86 S.Ct 1698, 16 L.Ed.2d 778 (1966) 605 “mom and pop” grocery located in the isolated town of Happy Camp, Idaho, is a monopolist if it is the only grocery serving that particular market Size in relation to the market is what matters because monopoly involves the power to affect prices.  ◀ Monopoly power may be proved by direct evidence that the firm used its power to control prices and restrict output.14 Usually, though, there is not enough evidence to show that the firm intentionally controlled prices, so the plaintiff has to offer indirect, or circumstantial, evidence of monopoly power To prove monopoly power indirectly, the plaintiff must show that the firm has a dominant share of the relevant market and that there are significant barriers for new competitors entering that market In the following case, the court had to decide whether there was sufficient evidence to show that a company possessed monopoly power in the relevant market 14 See, for example, Broadcom Corp v Qualcomm, Inc., 501 F.3d 297 (3d Cir 2007) Case 27.2 E.I DuPont de Nemours and Co v Kolon Industries United States Court of Appeals, Fourth Circuit, 637 F.3d 435 (2011) COMPANY PROFILE  DuPont was founded in 1802 as a gunpowder manufacturer Today, it operates in ninety countries in the fields of agriculture, apparel, communications, electronics, home construction, nutrition, and transportation It recently made a major investment in a biodegradable ingredient used in cosmetics, liquid detergents, and antifreeze BACKGROUND AND FACTS  DuPont manufactures and sells para-aramid fiber, which is a complex synthetic fiber used to make body armor, fiber-optic cables, and tires, among other things Although several companies around the world manufacture this fiber, only three sell into the U.S market—DuPont (based in the United States), Teijin (based in the Netherlands), and Kolon Industries, Inc (based in Korea) DuPont is the industry leader, producing more than 70 percent of all para-aramid fibers purchased in the United States In 2009, DuPont brought a lawsuit against Kolon for misappropriation of trade secrets Kolon counterclaimed that DuPont had monopolized and attempted to monopolize the para-aramid market in violation of Section of the Sherman Act Kolon claimed that DuPont had illegally used multiyear supply agreements for all of its high-volume para-aramid fiber customers Under the agreements, the customers were required to purchase between 80 and 100 percent of their para-aramid needs from DuPont Kolon alleged that those agreements removed substantial commercial opportunities from competition and limited other para-aramid fiber producers’ ability to compete On DuPont’s motion, a federal district court dismissed Kolon’s counterclaim, finding that Kolon had failed to sufficiently plead (demonstrate) unlawful exclusionary conduct Kolon appealed to the U.S Court of Appeals for the Fourth Circuit IN THE LANGUAGE OF THE COURT James WYNN, United States Circuit Judge * * * * * * * To prove a Section monopolization offense, a plaintiff must establish two elements: (1) the possession of monopoly power; and (2) willful acquisition or maintenance of that power—as CASE 27.2 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 606  Unit Six  The Regulatory Environment CASE 27.2 CONTINUEd opposed
to simply superior products or historic accidents An attempted monopolization offense consists of: (1) the use of anticompetitive conduct; (2) with specific intent to monopolize; and (3) a dangerous probability of success [Emphasis added.] * * * * * * * To run afoul of Section 2, a defendant must be guilty of illegal conduct “to foreclose competition, to gain a competitive advantage, or to destroy a competitor.” Conduct that might otherwise be lawful may be impermissibly exclusionary under antitrust law when practiced by a monopolist Indeed, “a monopolist is not free to take certain actions that a company in a competitive * * * market may take, because there is no market constraint on a monopolist’s behavior.” And although not per se illegal, exclusive dealing arrangements can constitute an improper means of acquiring or maintaining a monopoly * * * * Here, the district court assumed that Kolon adequately pled possession of monopoly power That assumption was correct, given that Kolon pled, among other things, that: numerous barriers to entry into the U.S para-aramid fiber market exist and supply is low; DuPont has long dominated the U.S para-aramid fiber market; and DuPont currently controls over 70 percent of that market, [that is,] that “DuPont’s market share remains greater than 70% of all sales by purchase volume of para-aramid fiber in the United States.” * * * * * * * Kolon complained that “because DuPont’s supply contracts severely restricted access to customers and preclude effective competition, DuPont’s conduct has had a direct, substantial, and adverse effect on competition And DuPont’s anticompetitive conduct has allowed it to control output and increase prices for para-aramid fiber in the United States.” And “by precluding Kolon from competition for these customers when demand for para-aramid fibers has significantly increased and supply is low, DuPont’s conduct has constrained the only potential entrant to the United States in decades from effectively entering the market, reducing if not practically eliminating additional competition, as well as preserving and growing DuPont’s monopoly position.” These allegations are sufficient to withstand a motion to dismiss DECISION AND REMEDY  The federal appellate court reversed the district court’s decision The appellate court found that Kolon had alleged sufficient facts to show that DuPont’s behavior violated the ­prohibition against monopolization and attempted monopolization in Section of the Sherman Act WHAT IF THE FACTS WERE DIFFERENT?  Suppose that DuPont had 45 percent of the market and Kolon and numerous other competitors had the remaining 55 percent Would the appellate court have ruled the same way? Why or why not? MANAGERIAL IMPLICATIONS  Kolon’s success in raising antitrust issues against a major ­supplier of a particular product
in the United States can give some hope to other companies that
are attempting to expand their market share against a dominant competitor In other words, managers who see competitive opportunities, even though their companies have only a very small market share, may be able to resort to the courts to prevent the dominant company or companies from acting in anticompetitive ways Relevant Market  Before a court can determine whether a firm has a dominant market share, it must define the relevant market The relevant market consists of two elements: (1) a relevant product market and (2) a relevant geographic market Relevant Product Market.  The relevant product market includes all products that, although produced by different firms, have identical attributes, such as sugar It also includes products that are reasonably interchangeable for the purpose for which they are produced Products will be considered reasonably interchangeable if consumers treat them as acceptable substitutes Establishing the relevant product market is often the key issue in monopolization cases because the way the market is defined may determine whether a firm has monopoly power By defining the product Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 27  Antitrust Law  market narrowly, the degree of a firm’s market power is enhanced ▶ Case in Point 27.8  Whole Foods Market, Inc., wished to acquire Wild Oats Markets, Inc., its main competitor in nationwide high-end organic food supermarkets The Federal Trade Commission (FTC) filed a Section claim against Whole Foods to prevent the merger The FTC argued that the relevant product market consisted of only “premium natural and organic supermarkets” rather than all supermarkets, as Whole Foods maintained An appellate court accepted the FTC’s narrow definition of the relevant market and remanded the case to the lower court to decide what remedies were appropriate, as the merger had already taken place Whole Foods later entered into a settlement with the FTC under which it was required to divest (sell or give up control over) thirteen stores, most of which were formerly Wild Oats outlets.15  ◀ Relevant Geographic Market.  The second component of the relevant market is the geographic extent of the market in which the firm and its competitors sell the product or services For products that are sold nationwide, the geographic boundaries of the market can encompass the entire United States If transportation costs are significant or a producer and its competitors sell in only a limited area (one in which customers have no access to other sources of the product), then the geographic market is limited to that area A national firm may thus compete in several distinct areas and have monopoly power in one geographic area but not in another Generally, the geographic market is that section of the country within which a firm can increase its price a bit without attracting new sellers or without losing many customers to alternative suppliers outside that area Of course, the Internet is changing perceptions of the size and limits of a geographic market Indeed, it has become difficult to show that a geographic market is strictly local, except for products that are not easily transported, such as concrete The Intent Requirement  Monopoly power, in and of itself, does not constitute the offense of monopolization under Section of the Sherman Act The offense also requires an intent to monopolize Why Intent Is Required.  A dominant market share may be the result of good business judgment or the devel15 Federal Trade Commission v Whole Foods Market, Inc., 548 F.3d 1028 (D.C.Cir 2008); and 592 F.Supp.2d 107 (D.D.C 2009) 607 opment of a superior product It may simply be the result of a historical accident In these situations, the acquisition of monopoly power is not an antitrust violation It would not be in society’s interest to condemn every firm that acquired a position of power because it was well managed and efficient and marketed a product desired by consumers Inferred from Anticompetitive Conduct.  If a firm possesses market power as a result of carrying out some purposeful act to acquire or maintain that power through anticompetitive means, then it is in violation of Section In most monopolization cases, intent may be inferred from evidence that the firm had monopoly power and engaged in anticompetitive behavior ▶ Case in Point 27.9  When Navigator, the first popular graphical Internet browser, was introduced, Microsoft perceived a threat to its dominance of the operating-system market Microsoft developed a competing browser, Internet Explorer (IE), and then began to require computer makers that wanted to install the Windows operating system to install IE and exclude Navigator Microsoft included codes in Windows that would cripple the operating system if IE was deleted and paid Internet service providers to distribute IE and exclude Navigator Because of this pattern of exclusionary conduct, a court found that Microsoft was guilty of monopolization The court reasoned that Microsoft’s pattern of conduct could be rational only if the firm knew that it possessed monopoly power.16  ◀ Unilateral Refusals to Deal  As discussed previously, joint refusals to deal (group boycotts) are subject to close scrutiny under Section of the Sherman Act A single manufacturer acting unilaterally, though, normally is free to deal, or not to deal, with whomever it wishes.17 Nevertheless, in some instances, a unilateral refusal to deal will violate Section of the Sherman Act These instances occur only if (1) the firm refusing to deal has—or is likely to acquire—monopoly power and (2) the refusal is likely to have an anticompetitive effect on a particular market 16 United States v Microsoft Corp., 253 F.3d 34 (D.C.Cir 2001) Microsoft has faced numerous antitrust claims and has settled a number of lawsuits in which it was accused of antitrust violations and anticompetitive tactics 17 For a classic case in this area, see United States v Colgate & Co., 250 U.S 300, 39 S.Ct 465, 63 L.Ed 992 (1919) See also Pacific Bell Telephone Co v Linkline Communications, Inc., 555 U.S 438, 129 S.Ct 1109, 172 L.Ed.2d 836 (2009) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 608  Unit Six  The Regulatory Environment ▶ Case in Point 27.10  Aspen Skiing Company, the owner of three of the four major ski areas in Aspen, Colorado, refused to continue its participation in a jointly offered “all Aspen” lift ticket The United States Supreme Court ruled that the owner’s refusal to cooperate with its smaller competitor was a violation of Section of the Sherman Act Because the company owned three-fourths of the local ski areas, it had monopoly power, and thus its unilateral refusal had an anticompetitive effect on the market.18  ◀ SECTION The Clayton Act Attempts to Monopolize In 1914, Congress enacted the Clayton Act The act was aimed at specific anticompetitive or monopolistic practices that the Sherman Act did not cover The substantive provisions of the act—set out in Sections 2, 3, 7, and 8—deal with four distinct forms of business behavior, which are declared illegal but not criminal For each provision, the act states that the behavior is illegal only if it tends to substantially lessen competition or to create monopoly power Section also prohibits attempted monopolization of a market, which requires proof of the following three elements: Section 2—Price Discrimination Anticompetitive conduct The specific intent to exclude competitors and garner monopoly power A “dangerous” probability of success in achieving monopoly power The probability cannot be dangerous unless the alleged offender possesses some degree of market power.19 As mentioned earlier, predatory pricing is a form of anticompetitive conduct that, in theory, could be used by firms that are attempting to monopolize (Predatory pricing may also lead to claims of price discrimination, to be discussed shortly.) Predatory bidding involves the acquisition and use of monopsony power, which is market power on the buy side of a market This may occur when a buyer bids up the price of an input too high for its competitors to pay, causing them to leave the market The predatory bidder may then attempt to drive down input prices so that it can reap above-­ competitive profits and recoup any losses it suffered in bidding up the prices The United States Supreme Court has held that the antitrust test that applies to claims of predatory pricing also applies to claims of predatory bidding.20 18 Aspen Skiing Co v Aspen Highlands Skiing Corp., 472 U.S 585, 105 S.Ct 2847, 86 L.Ed.2d 467 (1985) See also America Channel, LLC v Time Warner Cable, Inc., 2007 WL 142173 (D.Minn 2007) 19 See, for example, Nobody in Particular Presents, Inc v Clear Channel Communications, Inc., 311 F.Supp.2d 1048 (D.Colo 2004); and City of Moundridge, Kansas v Exxon Mobil Corp., 471 F.Supp.2d 20 (D.D.C 2007) 20 Weyerhaeuser Co v Ross-Simmons Hardwood Lumber Co., 549 U.S 312, 127 S.Ct 1069, 166 L.Ed.2d 911 (2007) Section of the Clayton Act prohibits price ­discrimination, which occurs when a seller charges different prices to competing buyers for identical goods or services Congress strengthened this section by amending it with the passage of the RobinsonPatman Act in 1936 As amended, Section prohibits price discrimination that cannot be justified by differences in production costs, transportation costs, or cost differences due to other reasons In short, a seller is prohibited from charging one buyer a lower price than it charges that buyer’s competitor Required Elements  To violate Section 2, the seller must be engaged in interstate commerce, the goods must be of like grade and quality, and the goods must have been sold to two or more purchasers In addition, the effect of the price discrimination must be to substantially lessen competition, tend to create a monopoly, or otherwise injure competition Without proof of an actual injury resulting from the price discrimination, the plaintiff cannot recover damages Note that price discrimination claims can arise from discounts, offsets, rebates, or allowances given to one buyer over another Moreover, giving favorable credit terms, delivery, or freight charges to some buyers, but not others, can also lead to allegations of price discrimination For example, when a seller offers goods to different customers at the same price but includes free delivery for certain buyers, it may violate Section in some circumstances Defenses  There are several statutory defenses to liability for price discrimination Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 27  Antitrust Law  609 Cost justification If the seller can justify the price reduction by demonstrating that a particular buyer’s purchases saved the seller costs in producing and selling the goods, the seller will not be liable for price discrimination Meeting a competitor’s prices If the seller charged the lower price in a good faith attempt to meet an equally low price of a competitor, the seller will not be liable for price discrimination ▶ Case in Point 27.11  Water Craft was a retail dealership of Mercury Marine outboard motors On discovering that Mercury was selling its outboard motors at a substantial discount to Water Craft’s largest competitor, Water Craft filed a price discrimination lawsuit against Mercury Mercury Marine was able to show that the discounts were made in good faith to meet the low price charged by another manufacturer of marine motors Therefore, the court found that the “meeting competition defense” applied.21  ◀ Changing market conditions A seller may lower its price on an item in response to changing conditions affecting the market for or the marketability of the goods concerned Sellers are allowed to readjust their prices to meet the realities of the market without liability for price discrimination Thus, if an advance in technology makes a particular product less marketable than it was previously, a seller can lower the product’s price In the past, courts were more inclined than courts today to find that exclusive-dealing contracts substantially lessened competition ▶ Case in Point 27.12  In one classic case, Standard Oil Company, the largest gasoline seller in the nation in the late 1940s, made exclusive-dealing contracts with independent stations in seven western states The contracts involved 16 percent of all retail outlets, whose sales were approximately 7 percent of all retail sales in that market The United States Supreme Court ruled that the market was substantially concentrated because the seven largest gasoline suppliers all used exclusive-dealing contracts with their independent retailers and together controlled 65 percent of the market Looking at market conditions after the arrangements were instituted, the Court found that market shares were extremely stable and that entry into the market was apparently restricted Thus, the Court held that the Clayton Act had been violated because competition was “foreclosed in a substantial share” of the relevant market.22  ◀ In recent years, however, a number of decisions have called into doubt the Supreme Court’s holding in Case in Point 27.12 Today, it is clear that to violate antitrust law, an exclusive-dealing agreement (or a tying arrangement, discussed next) must qualitatively and substantially harm competition To prevail, a plaintiff must present affirmative evidence that the performance of the agreement will foreclose competition and harm consumers Section 3—Exclusionary Practices Exclusive-Dealing Contracts  A contract under which a seller forbids a buyer to purchase products from the seller’s competitors is called an exclusivedealing contract A seller is prohibited from making an exclusive-dealing contract under Section if the effect of the contract is “to substantially lessen competition or tend to create a monopoly.” Tying Arrangements  When a seller conditions the sale of a product (the tying product) on the buyer’s agreement to purchase another product (the tied product) produced or distributed by the same seller, a tying arrangement results The legality of a tying arrangement (or tie-in sales agreement) depends on several factors, such as the purpose of the agreement Courts also focus on the agreement’s likely effect on competition in the relevant markets (the market for the tying product and the market for the tied product) ▶  Example 27.13  Morshigi Precision, Inc., manufactures laptop hardware and provides repair service for the hardware Morshigi also makes and markets software, but the company will provide support for buyers of the software only if they also buy its hardware service This is a tying arrangement Depending on the purpose of the agreement and the effect of the 21 Water Craft Management, LLC v Mercury Marine, 457 F.3d 484 (5th Cir 2006) 22 Standard Oil Co of California v United States, 337 U.S 293, 69 S.Ct 1051, 93 L.Ed 1371 (1949) Under Section of the Clayton Act, sellers or lessors cannot sell or lease goods “on the condition, agreement or understanding that the purchaser or lessee thereof shall not use or deal in the goods of a competitor or competitors of the seller.” In effect, this section prohibits two types of vertical agreements involving exclusionary practices—exclusive-dealing contracts and tying arrangements Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 610  Unit Six  The Regulatory Environment agreement on competition in the market for the two products, the agreement may be illegal.  ◀ Section of the Clayton Act has been held to apply only to commodities, not to services Tying arrangements, however, can also be considered agreements that restrain trade in violation of Section of the Sherman Act Thus, cases involving tying arrangements of services have been brought under Section of the Sherman Act Although earlier cases condemned tying arrangements as illegal per se, courts now evaluate tying agreements under the rule of ­reason.23 Section 7—Mergers Under Section of the Clayton Act, a person or business organization cannot hold stock or assets in more than one business when “the effect may be to substantially lessen competition.” Section is the statutory authority for preventing mergers that could result in monopoly power or a substantial lessening of competition in the marketplace Section applies to both horizontal and vertical mergers, as discussed in the following subsections A crucial consideration in most merger cases is market concentration Determining market concentration involves allocating percentage market shares among the various companies in the relevant market When a small number of companies share a large part of the market, the market is concentrated ▶  Example 27.14  If the four largest grocery stores in Chicago accounted for 80 percent of all retail food sales, the market clearly would be concentrated in those four firms If one of these stores absorbed the assets and liabilities of another, so the other ceased to exist, the resulting merger would further concentrate the market and possibly diminish competition.  ◀ Competition is not necessarily diminished solely as a result of market concentration, however Courts will consider other factors in determining if a merger violates Section One factor of particular importance is whether the merger will make it more difficult for potential competitors to enter the relevant market Horizontal Mergers  Mergers between firms that compete with each other in the same market are called horizontal mergers If a horizontal merger creates an entity with a significant market share, the 23 The United States Supreme Court held that the rule of reason applies to tying arrangements in Illinois Tool Works, Inc v Independent Ink, Inc., 547 U.S 28, 126 S.Ct 1281, 164 L.Ed.2d 26 (2006) This decision was the first time the Court recognized that tying arrangements can have legitimate business justifications merger may be considered illegal because it increases market concentration The Federal Trade Commission (FTC) and the U.S Department of Justice (DOJ) have established guidelines for determining which mergers will be challenged.24 When analyzing the legality of a horizontal merger, the courts consider three additional factors The first factor is the overall concentration of the relevant market The second is the relevant market’s history of tending toward concentration The final factor is whether the merger is apparently designed to establish market power or restrict competition Vertical Mergers A vertical merger occurs when a company at one stage of production acquires a company at a higher or lower stage of production An example of a vertical merger is a company merging with one of its suppliers or retailers Whether a vertical merger will be deemed illegal generally depends on several factors, such as whether the merger creates a single firm that controls an undue percentage share of the relevant market The courts also analyze whether the merger results in a significant increase in the concentration of firms in that market, barriers to entry into the market, and the apparent intent of the merging parties If a merger does not prevent competitors of either of the merging firms from competing in a segment of the market, the merger will not be condemned as foreclosing competition and thus is legal Section 8—Interlocking Directorates Section of the Clayton Act deals with interlocking directorates—that is, the practice of having individuals serve as directors on the boards of two or more competing companies simultaneously Specifically, no person may be a director for two or more competing corporations at the same time if either of the corporations has capital, surplus, or undivided profits aggregating more than $28,883,000 or competitive sales of $2,888,300 or more The Federal Trade Commission adjusts these threshold amounts each year (The amounts given here are those announced by the commission in 2013.) 24 These guidelines include a formula for assessing the degree of concentration in the relevant market called the Herfindahl-Hirschman Index (HHI) The HHI was revised in 2010 and is available at www justice.gov/atr/public/guidelines/hmg-2010.html Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 27  Antitrust Law  SECTION Enforcement and Exemptions The federal agencies that enforce the federal antitrust laws are the U.S Department of Justice (DOJ) and the Federal Trade Commission (FTC), which was established by the Federal Trade Commission Act of 1914 Section of that act condemns all forms of anticompetitive behavior that are not covered under other federal antitrust laws Agency Actions Only the DOJ can prosecute violations of the Sherman Act, which can be either criminal or civil offenses Violations of the Clayton Act are not crimes, but the act can be enforced by either the DOJ or the FTC through civil proceedings The DOJ or the FTC may ask the courts to impose various remedies, including divestiture (making a company give up one or more of its operations) and dissolution A meatpacking firm, for instance, might be forced to divest itself of control or ownership of butcher shops The FTC has sole authority to enforce violations of Section of the Federal Trade Commission Act FTC actions are effected through administrative orders, but if a firm violates an FTC order, the FTC can seek court sanctions for the violation The president, of course, plays a role in establishing enforcement policies at the agencies The Obama administration—much like the European Union— has vigorously enforced antitrust regulations in recent years Private Actions A private party who has been injured as a result of a violation of the Sherman Act or the Clayton Act can sue for treble damages (three times the actual damages suffered) and attorneys’ fees In some instances, private parties may also seek injunctive relief to prevent antitrust violations Required Elements  A party wishing to sue under the Sherman Act must prove that: The antitrust violation either caused or was a substantial factor in causing the injury that was suffered 611 The unlawful actions of the accused party affected business activities of the plaintiff that were protected by the antitrust laws Proof of Illegality  Additionally, the United States Supreme Court has held that to pursue antitrust lawsuits, private parties must present some evidence suggesting that an illegal agreement was made ▶ Case in Point 27.15  A group of subscribers to local telephone and high-speed Internet services filed a class-action lawsuit against several regional telecommunication companies (including Bell Atlantic) The plaintiffs claimed that the companies had conspired with one another and engaged in ­parallel conduct—offering similar services and pricing—over a period of years to prevent other companies from entering the market and competing The United States Supreme Court dismissed the case, finding that “without more, parallel conduct does not suggest conspiracy.” A bare assertion of conspiracy is not enough to allow an antitrust lawsuit to go forward The Court noted that more specificity is necessary to avoid potentially “massive” discovery costs, which are especially likely to occur when the suit is brought by a large class of plaintiffs.25  ◀ Exemptions from Antitrust Laws There are many legislative and constitutional limitations on antitrust enforcement Most of the statutory and judicially created exemptions to the antitrust laws apply in such areas as labor, insurance, and foreign trade (see Exhibit 27–1 on the following page) One of the most significant exemptions covers joint efforts by businesspersons to obtain legislative, judicial, or executive action Under this exemption, for example, Blu-ray producers can jointly lobby Congress to change the copyright laws without being held liable for attempting to restrain trade Another exemption covers professional baseball teams SECTION U.S Antitrust Laws in the Global Context U.S antitrust laws have a broad application Not only may persons in foreign nations be subject to their provisions, but the laws may also be applied to protect 25 Bell Atlantic Corp v Twombly, 550 U.S 544, 127 S.Ct 1955, 167 L.Ed.2d 929 (2007) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 612  Unit Six  The Regulatory Environment EXHI B IT 27–1  Exemptions to Antitrust Enforcement Exemption Source and Scope Labor Clayton Act—Permits unions to organize and bargain without violating antitrust laws and specifies that strikes and other labor activities normally not violate any federal law Agricultural associations Clayton Act and Capper-Volstead Act—Allow agricultural cooperatives to set prices Fisheries Fisheries Cooperative Marketing Act—Allows the fishing industry to set prices Insurance companies McCarran-Ferguson Act—Exempts the insurance business in states in which the industry is regulated Exporters Webb-Pomerene Act—Allows U.S exporters to engage in cooperative activity to compete with similar foreign associations Export Trading Company Act—Permits the U.S Department of Justice to exempt certain exporters Professional baseball The United States Supreme Court has held that professional baseball is exempt because it is not “interstate commerce.”a Oil marketing Interstate Oil Compact—Allows states to set quotas on oil to be marketed in interstate commerce Defense activities Defense Production Act—Allows the president to approve, and thereby exempt, certain activities to further the military defense of the United States Small businesses’ cooperative Small Business Administration Act—Allows small firms to undertake cooperative research research State actions The United States Supreme Court has held that actions by a state are exempt if the state clearly articulates and actively supervises the policy behind its action.b Regulated industries Industries (such as airlines) are exempt when a federal administrative agency (such as the Federal Aviation Administration) has primary regulatory authority Businesspersons’ joint efforts to seek government action Cooperative efforts by businesspersons to obtain legislative, judicial, or executive action are exempt unless it is clear that an effort is “objectively baseless” and is an attempt to make anticompetitive use of government processes.c a F ederal Baseball Club of Baltimore, Inc v National League of Professional Baseball Clubs, 259 U.S 200, 42 S.Ct 465, 66 L.Ed 898 (1922) A federal district court has held that this exemption applies only to the game’s reserve system (Under the reserve system, teams hold players’ contracts for the players’ entire careers The reserve system generally is being replaced by the free agency system.) See Piazza v Major League Baseball, 831 F.Supp 420 (E.D.Pa 1993) b See Parker v Brown, 317 U.S 341, 63 S.Ct 307, 87 L.Ed 315 (1943) c E  astern Railroad Presidents Conference v Noerr Motor Freight, Inc., 365 U.S 127, 81 S.Ct 523, L.Ed.2d 464 (1961); and United Mine Workers of America v. Pennington, 381 U.S 657, 89 S.Ct 1585, 14 L.Ed.2d 626 (1965) These two cases established the exception often referred to as the Noerr-Pennington doctrine foreign consumers and competitors from violations committed by U.S business firms Consequently, ­foreign persons, a term that by definition includes foreign governments, may sue under U.S antitrust laws in U.S courts The Extraterritorial Application of U.S Antitrust Laws Section of the Sherman Act provides for the extraterritorial effect of the U.S antitrust laws The United States is a major proponent of free competition in the global economy, and thus any conspiracy that has a substantial effect on U.S commerce is within the reach of the Sherman Act The violation may even occur outside the United States, and foreign governments as well as individuals can be sued for violation of U.S antitrust laws Before U.S courts will exercise jurisdiction and apply antitrust laws, it must be shown that the alleged violation had a substantial effect on U.S commerce U.S jurisdiction is automatically invoked, however, when a per se violation occurs If a domestic firm, for example, joins a foreign cartel to control the production, price, or distribution of goods, and this cartel has a substantial effect on U.S commerce, a per se violation may exist Hence, both the domestic firm and the foreign cartel could be sued Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 27  Antitrust Law  for violation of the U.S antitrust laws Likewise, if a foreign firm doing business in the United States enters into a price-fixing or other anticompetitive agreement to control a portion of U.S markets, a per se violation may exist 613 In the following case, the court had to decide whether an alleged anticompetitive conspiracy had a substantial effect on U.S commerce Case 27.3 Carrier Corp v Outokumpu Oyj United States Court of Appeals, Sixth Circuit, 673 F.3d 430 (2012) BACKGROUND AND FACTS  Carrier Corporation is a U.S firm that manufactures air-­ conditioning and refrigeration (ACR) equipment To make these products, Carrier uses ACR copper tubing bought from Outokumpu Oyj, a Finnish company Carrier is one of the world’s largest purchasers of ACR copper tubing The Commission of the European Communities (EC) found that Outokumpu had conspired with other companies to fix ACR tubing prices in Europe Carrier then filed a suit in a U.S court, alleging that the cartel had also conspired to fix prices in the United States by agreeing that only Outokumpu would sell ACR tubing in the U.S market The district court dismissed Carrier’s claim for lack of jurisdiction Carrier appealed IN THE Language OF THE COURT Karen Nelson MOORE, Circuit Judge * * * * Carrier’s complaint describes, in some detail, an elaborate worldwide conspiracy in which the U.S market for ACR copper tubing was assigned to Outokumpu Furthermore, Carrier alleges that this conspiracy caused the price of goods purchased within the United States to increase, which in turn caused a direct antitrust injury In support of these allegations, the complaint references numerous specific dates during which the * * * cartel met and the various agreements its members entered into Assuming that these allegations are true, as we must, we conclude that Carrier has met any applicable requirement that it allege a [substantial] effect on U.S commerce [Emphasis added.] Outokumpu, which attached the full EC decision to its motion to dismiss, counters that many of the details contained in the complaint are drawn from [an] EC * * * decision that found no evidence that the cartel’s focus extended beyond Europe * * * As a consequence, Outokumpu argues that any details regarding specific meetings and agreements occurring during the [cartel] meetings are of no assistance to Carrier because they relate only to a European conspiracy We are [not] persuaded by this argument * * * The EC * * * decision clearly states that “insofar as the activities of the cartel relate to sales in countries that are not members of the Community * * * they lie outside the scope of this Decision.” Thus, any silence on the part of the EC decision as to U.S markets may simply reflect the limited scope of the decision * * * * Furthermore, Carrier offers additional circumstantial allegations that corroborate its claim that the market-allocation scheme extended to the United States Although Carrier’s complaint provides numerous circumstantial allegations, of particular interest is its claim that [Outokumpu’s competitors] initially refrained from aggressively competing for Carrier’s U.S business until 2003, and then suddenly began doing so at that time It is true that the mere fact that competitors not intrude upon one another’s markets does not necessarily mean that an illegal market-allocation scheme is taking place When two companies refrain from entering a market and then suddenly so after a cartel dissolves, however, there are good grounds for suspicion CASE 27.3 CONTINUES  • Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 614  Unit Six  The Regulatory Environment CASE 27.3 CONTINUEd DECISION AND REMEDY  The federal appellate court found that the district court had jurisdiction over Carrier’s Sherman Act claims It therefore reversed the district court’s judgment for the defendants THE LEGAL ENVIRONMENT DIMENSION  When this case proceeds, should the district court apply the rule of reason? Why or why not? What If the Facts Were Different?  Suppose that Carrier had engaged in anticompetitive conduct that affected Outokumpu Discuss fully whether the foreign firm would be protected from illegal competition by the U.S firm The Application of Foreign Antitrust Laws $2 billion in the last ten years for anticompetitive conduct.  ◀ Large U.S companies increasingly need to worry about the application of foreign antitrust laws as well The European Union (EU), in particular, has stepped up its enforcement actions against antitrust violators in recent years Increased Enforcement in Asia and Latin America  Many other nations also have laws that European Union Enforcement  The EU’s laws promoting competition are stricter in many respects than those of the United States and define more conduct as anticompetitive The EU actively pursues antitrust violators, especially individual companies and cartels that allegedly engage in monopolistic conduct ▶  Example 27.16  The EU fined Intel, Inc., the world’s largest semiconductor chip maker, $1.44 billion in an antitrust case According to European regulators, Intel offered computer manufacturers and retailers price discounts and marketing subsidies if they agreed to buy Intel’s chips rather than the chips produced by Intel’s main competitor in Europe The EU has also fined Microsoft Corporation more than promote competition and prohibit trade restraints For instance, Japanese antitrust laws forbid unfair trade practices, monopolization, and restrictions that unreasonably restrain trade China’s antitrust rules restrict monopolization and price fixing (although the Chinese government may set prices on exported goods without violating these rules) Indonesia, Malaysia, South Korea, and Vietnam all have statutes protecting competition Argentina, Brazil, Chile, Peru, and several other Latin American countries have adopted modern antitrust laws as well Most of the antitrust laws apply extraterritorially, as U.S antitrust laws This means that a U.S company may be subject to another nation’s antitrust laws if the company’s conduct has a substantial effect on that nation’s commerce For instance, South Korea once fined Intel $25 million for antitrust violations, and Japan settled an antitrust case against Intel Reviewing: Antitrust Law The Internet Corporation for Assigned Names and Numbers (ICANN) is a nonprofit entity that organizes Internet domain names It is governed by a board of directors elected by various groups with commercial interests in the Internet One of ICANN’s functions is to authorize an entity to serve as a registry for certain “Top-Level Domains” (TLDs) ICANN and VeriSign entered into an agreement that authorized VeriSign to serve as a registry for the “.com” TLD and provide registry services in accordance with ICANN’s specifications VeriSign complained that ICANN was restricting the services that it could make available as a registrar and blocking new services, imposing unnecessary conditions on those services, and setting the prices at which the services were offered VeriSign claimed that ICANN’s control of the registry services for domain names violated Section of the Sherman Act Using the information presented in the chapter, answer the following questions Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 27  Antitrust Law  615 Should ICANN’s actions be judged under the rule of reason or be deemed per se violations of Section of the Sherman Act? Why? Should ICANN’s actions be viewed as a horizontal or a vertical restraint of trade? Why? Does it matter that ICANN’s directors are chosen by groups with a commercial interest in the Internet? Explain If the dispute is judged under the rule of reason, what might be ICANN’s defense for having a standardized set of registry services that must be used? Debate This The Internet and the rise of e-commerce have rendered our current antitrust concepts and laws obsolete Terms and Concepts antitrust law 599 attempted monopolization 608 concentrated industry 602 divestiture 611 exclusive-dealing contract 609 group boycott 602 horizontal merger 610 horizontal restraint 601 market concentration 610 market power 600 monopolization 604 monopoly 600 monopoly power 600 per se violation 600 predatory pricing 604 price discrimination 608 price-fixing agreement 601 resale price maintenance agreement 603 restraint of trade 599 rule of reason 600 treble damages 611 tying arrangement 609 vertical merger 610 vertical restraint 602 vertically integrated firm 602 ExamPrep Issue Spotters Under what circumstances would Pop’s Market, a small store in a small, isolated town, be considered a monopolist? If Pop’s is a monopolist, is it in violation of Section of the Sherman Act? Why or why not? (See page 604.) Maple Corporation conditions the sale of its syrup on the buyer’s agreement to buy Maple’s pancake mix What factors would a court consider to decide whether this arrangement violates the Clayton Act? (See page 609.) •  Check your answers to the Issue Spotters against the answers provided in Appendix E at the end of this text Before the Test  Go to www.cengagebrain.com, enter the ISBN 9781285428949, and click on “Find” to locate this textbook’s Web site Then, click on “Access Now” under “Study Tools,” and select Chapter 27 at the top There, you will find an Interactive Quiz that you can take to assess your mastery of the concepts in this chapter, as well as Flashcards and a Glossary of important terms Business Scenarios 27–1.  Group Boycott. Jorge’s Appliance Corp was a new retail seller of appliances in Sunrise City Because of its innovative sales techniques and financing, Jorge’s caused the appliance department of No-Glow Department Store, a large chain store with a great deal of buying power, to lose a substantial amount of sales No-Glow told a number of appliance manufacturers from whom it made large- volume purchases that if they continued to sell to Jorge’s, No-Glow would stop buying from them The manufacturers immediately stopped selling appliances to Jorge’s Jorge’s filed a suit against No-Glow and the manufacturers, claiming that their actions constituted an antitrust violation No-Glow and the manufacturers were able to prove that Jorge’s was a small retailer with a small market Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 616  Unit Six  The Regulatory Environment share They claimed that because the relevant market was not substantially affected, they were not guilty of restraint of trade Discuss fully whether there was an antitrust violation (See page 602.) 27–2. Antitrust Laws.  Allitron, Inc., and Donovan, Ltd., are interstate competitors selling similar appliances, princi- pally in the states of Illinois, Indiana, Kentucky, and Ohio Allitron and Donovan agree that Allitron will no longer sell in Indiana and Ohio and that Donovan will no longer sell in Illinois and Kentucky Have Allitron and Donovan violated any antitrust laws? If so, which law? Explain (See page 602.) Business Case Problems 27–3. Tying Arrangement.  John Sheridan owned a Marathon gas station franchise He sued Marathon Petroleum Co under Section of the Sherman Act and Section of the Clayton Act, charging it with illegally tying the processing of credit-card sales to the gas station As a condition of obtaining a Marathon dealership, dealers had to agree to let the franchisor process credit cards They could not shop around to see if credit-card processing could be obtained at a lower price from another source The district court dismissed the case for failure to state a claim Sheridan appealed Is there a tying arrangement? If so, does it violate the law? Explain [Sheridan v Marathon Petroleum Co., 530 F.3d 590 (7th Cir 2008)] (See page 608.) 27–4. Monopolization. When Deer Valley Resort Co (DVRC) was developing its ski resort in the Wasatch Mountains near Park City, Utah, it sold parcels of land in the resort village to third parties Each sales contract reserved the right of approval over the conduct of certain businesses on the property, including ski rentals For fifteen years, DVRC permitted Christy Sports, LLC, to rent skis in competition with DVRC’s ski rental outlet When DVRC opened a new midmountain ski rental outlet, it revoked Christy’s permission to rent skis This meant that most skiers who flew into Salt Lake City and shuttled to Deer Valley had few choices: they could carry their ski equipment with them on their flights, take a shuttle into Park City and look for cheaper ski rentals there, or rent from DVRC Christy filed a suit in a federal district court against DVRC Was DVRC’s action an attempt to monopolize in violation of Section of the Sherman Act? Why or why not? [Christy Sports, LLC v Deer Valley Resort Co., 555 F.3d 1188 (10th Cir 2009)] (See page 604.) 27–5. Price Fixing. Together, EMI, Sony BMG Music Entertainment, Universal Music Group Recordings, Inc., and Warner Music Group Corp produced, licensed, and distributed 80 percent of the digital music sold in the United States The companies formed MusicNet to sell music to online services that sold the songs to consumers MusicNet required all of the services to sell the songs at the same price and subject to the same restrictions Digitization of music became cheaper, but MusicNet did not change its prices Did MusicNet violate the antitrust laws? Explain [Starr v Sony BMG Music Entertainment, 592 F.3d 314 (2d Cir 2010)] (See page 601.) 27–6.  BUSINESS CASE PROBLEM WITH SAMPLE ANSWER:  Price Discrimination Dayton Superior Corp sells its products in interstate commerce to several companies, including Spa Steel Products, Inc The purchasers often compete directly with each other for customers From 2005 to 2007, one of Spa Steel’s customers purchased Dayton Superior’s products from two of Spa Steel’s competitors According to the customer, Spa Steel’s prices were always 10 to 15 percent higher for the same products As a result, Spa Steel lost sales to at least that customer and perhaps others Spa Steel wants to sue Dayton Superior for price discrimination Which requirements for such a claim under Section of the Clayton Act does Spa Steel satisfy? What additional facts will it need to prove? [Dayton Superior Corp v Spa Steel Products, Inc., 2012 WL 113663 (N.D.N.Y 2012)] (See page 608.) •  For a sample answer to Problem 27–6, go to Appendix F at the end of this text 27–7.  Special Case Analysis:  Resale Price Maintenance Agreements Go to Case Analysis Case 27.1, Leegin Creative Leather Products, Inc v PSKS, Inc., on pages 603 and 604 Read the excerpt and answer the following questions (a) Issue: The dispute in this case was between which parties and turned on what legal issue? (b) Rule of Law: In resolving this dispute, what common law rule did the Court overturn, and what rule did the Court create to replace this rejected precedent? (c) Applying the Rule of Law: What reasons did the Court give to justify its change in the law, and how did the new rule apply in this case? (d) Conclusion: In whose favor did the Court rule and why? 27–8.  A Question of Ethics:  Section of the Sherman Act In the 1990s, DuCoa, L.P., made choline chloride, a B-complex vitamin essential for the growth and development of animals DuCoa, Bioproducts, Inc., and Chinook Group, Ltd., each had one-third of the U.S market for choline chloride To stabilize the market and keep the price of the vitamin higher than it would otherwise have been, the companies agreed to fix the price and allocate market share by deciding which of them would offer the lowest price to Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 27  Antitrust Law  each customer At times, however, the companies disregarded the agreement During an increase in competitive activity in August 1997, Daniel Rose became president of DuCoa The next month, a subordinate advised him of the conspiracy By February 1998, Rose had begun to implement a strategy to persuade DuCoa’s competitors to rejoin the conspiracy By April, the three companies had reallocated their market shares and increased their prices In June, the U.S Department of Justice began to investigate allegations of price fixing in the vitamin market Ultimately, a federal district court convicted Rose of conspiracy to violate Section of the Sherman Act [United States v Rose, 449 F.3d 627 (5th Cir 2006)] (See page 600.) 617 (a) The court “enhanced” Rose’s sentence to thirty months’ imprisonment, one year of supervised release, and a $20,000 fine based, among other things, on his role as “a manager or supervisor” in the conspiracy Rose appealed this enhancement to the U.S Court of Appeals for the Fifth Circuit Was it fair to increase Rose’s sentence on this ground? Why or why not? (b) Was Rose’s participation in the conspiracy unethical? If so, how might Rose have behaved ethically instead? If not, could any of the participants’ conduct be considered unethical? Explain Legal Reasoning Group Activity 27–9. Antitrust Violations.  Residents of the city of Madison, Wisconsin, became concerned about overconsumption of liquor near the campus of the University of Wisconsin (UW) The city initiated a new policy, imposing conditions on area bars to discourage reduced-price “specials” that were believed to encourage high-volume and dangerous drinking In 2012, the city began to draft an ordinance to ban all drink specials Bar owners responded by announcing that they had “voluntarily” agreed to discontinue drink specials on Friday and Saturday nights after 8:00 p.m The city put its ordinance on hold Several UW students filed a lawsuit against the local bar owners association, alleging violations of antitrust law (See page 601.) (a) The first group will identify the grounds on which the plaintiffs might base their claim for relief and formulate an argument on behalf of the plaintiffs (b) The second group will determine whether the defendants are exempt from the antitrust laws (c) The third group will decide how the court should rule in this dispute and provide reasons for the ruling Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 28 Investor Protection and Corporate Governance A fter the stock market crash of October 29, 1929, and the ensuing economic depression, Congress enacted legislation to regulate securities markets The result was the Securities Act of 19331 and the Securities Exchange Act of 1934.2 Both acts were designed to provide investors with more information to help them make buying and selling decisions about securities and to prohibit deceptive, unfair, and manipulative practices Securities generally include any instruments evidencing corporate ownership (stock) or debts (bonds) Today, the sale and transfer of securities are heavily regulated by federal and state statutes and by government agencies Moreover, the Securities and Exchange Commission has implemented new regulations since Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act3 in reaction to the latest economic reces- 15 U.S.C Sections 77a–77aa 15 U.S.C Sections 78a–78mm Pub L No 111–203, July 21, 2010, 124 Stat 1376; 12 U.S.C Sections 5301 et seq SECTION The Securities and Exchange Commission The Securities Exchange Act of 1934 created the Securities and Exchange Commission (SEC) as an independent regulatory agency The SEC administers the Securities Act of 1933 and the 1934 act The SEC also plays a key role in interpreting the provisions of these acts (and their amendments) and in creating regulations governing the purchase and sale of securities The basic functions of the SEC are as follows: Interprets federal securities laws and investigates securities law violations Issues new rules and amends existing rules Oversees the inspection of securities firms, brokers, investment advisers, and ratings agencies Oversees private regulatory organizations in the securities, accounting, and auditing fields Coordinates U.S securities regulation with federal, state, and foreign authorities sion This chapter discusses the nature of federal securities regulation and its effect on the business world We also discuss corporate governance and the Sarbanes-Oxley Act, which significantly affects certain types of securities transactions In the concluding pages of this chapter, we look at how securities laws are being adapted to the online environment Updating the Regulatory Process The SEC is working to make the regulatory process more efficient and more relevant to today’s securities trading practices To this end, the SEC has embraced modern technology and communications methods, especially the Internet, more completely than many other federal agencies have For instance, the agency requires companies to file certain information electronically so that it can be posted on the SEC’s EDGAR (Electronic Data Gathering, Analysis, and Retrieval) database In addition, the SEC now requires companies to make disclosures about the potential impacts of climate change on their future profitability.4 For instance, companies should disclose estimates for any material capital expenditures for pollution-control facilities and risk factors relating to existing or pending environmental legislation 17 C.F.R Parts 211, 231, and 241 618 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 28  Investor Protection and Corporate Governance  The SEC’s Expanding Regulatory Powers Since the SEC’s creation, its regulatory functions have gradually been increased by legislation granting it authority in different areas For instance, to further curb securities fraud, Congress enacted the Securities Enforcement Remedies and Penny Stock Reform Act of 1990.5 This act expanded the SEC’s enforcement options and allowed SEC administrative law judges to hear cases involving more types of alleged securities law violations, such as fraudulent financial reporting and financial fraud The Securities Acts Amendments of 1990 authorized the SEC to seek sanctions against those who violate foreign securities laws.6 The National Securities Markets Improvement Act of 1996 expanded the power of the SEC to exempt persons, securities, and transactions from the requirements of the securities laws.7 The Sarbanes-Oxley Act of 2002, which you will read about later in this chapter, further expanded the authority of the SEC and required the SEC to adopt new rules SECTION The Securities Act of 1933 The Securities Act of 1933 governs initial sales of stock by businesses The act was designed to prohibit various forms of fraud and to stabilize the securities industry by requiring that investors receive financial and other significant information concerning the securities being offered for public sale Basically, the purpose of this act is to require disclosure The 1933 act provides that all securities transactions must be registered with the SEC unless they are specifically exempt from the registration requirements What Is a Security? Section 2(1) of the Securities Act of 1933 contains a broad definition of securities, which generally include the following:8 Instruments commonly known as securities, such as preferred and common stocks, treasury stocks, bonds, debentures, and stock warrants 15 U.S.C Section 77g 15 U.S.C Section 78a 15 U.S.C Sections 77z-3, 78mm 15 U.S.C Section 77b(1) Amendments in 1982 added stock options 619 Any interests commonly known as securities, such as stock options, puts, calls, or other types of privilege on a security or on the right to purchase a security or a group of securities in a national security exchange Notes, instruments, or other evidence of indebtedness, including certificates of interest in a profitsharing agreement and certificates of deposit Any fractional undivided interest in oil, gas, or other mineral rights Investment contracts, which include interests in limited partnerships and other investment schemes The Howey Test  In interpreting the 1933 act, the United States Supreme Court has held that an investment contract is any transaction in which a person (1) invests (2) in a common enterprise (3) reasonably expecting profits (4) derived primarily or substantially from others’ managerial or entrepreneurial efforts Known as the Howey test, this definition continues to guide the determination of what types of contracts can be considered securities.9 ▶  Case in Point 28.1  Alpha Telcom sold, installed, and maintained pay-phone systems The company guaranteed buyers of the systems a 14 percent annual return Alpha was operating at a net loss, however, and continually borrowed funds to pay investors the fixed rate of return it had promised Eventually, the company filed for bankruptcy, and the SEC brought an action alleging that Alpha had violated the Securities Act of 1933 A federal court concluded that the payphone program was a security because it involved an investment contract.10  ◀ Many Types of Securities  For our purposes, it is convenient to think of securities in their most common form—stocks and bonds issued by corporations Bear in mind, though, that securities can take many forms, including interests in whiskey, cosmetics, worms, beavers, boats, vacuum cleaners, muskrats, and cemetery lots Almost any stake in the ownership or debt of a company can be considered a security Investment contracts in condominiums, franchises, limited partnerships in real estate, and oil or gas or other mineral rights have qualified as securities  9 SEC v W J Howey Co., 328 U.S 293, 66 S.Ct 1100, 90 L.Ed 1244 (1946) 10 SEC v Alpha Telcom, Inc., 187 F.Supp.2d 1250 (2002) See also SEC v Edwards, 540 U.S 389, 124 S.Ct 892, 157 L.Ed.2d 813 (2004), in which the United States Supreme Court held that an investment scheme offering contractual entitlement to a fixed rate of return can be an investment contract and therefore can be considered a security under federal law Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 620  Unit Six  The Regulatory Environment Registration Statement Section of the Securities Act of 1933 broadly provides that if a security does not qualify for an exemption, that security must be registered before it is offered to the public Issuing corporations must file a registration statement with the SEC and must provide all investors with a prospectus A prospectus is a disclosure document that describes the security being sold, the financial operations of the issuing corporation, and the investment or risk attaching to the security The prospectus also serves as a selling tool for the issuing corporation The SEC now allows an issuer to deliver its prospectus to investors electronically via the Internet.11 In principle, the registration statement and the prospectus supply sufficient information to enable unsophisticated investors to evaluate the financial risk involved Contents of the Registration Statement  The registration statement must be written in plain English and fully describe the following: The securities being offered for sale, including their relationship to the registrant’s other capital securities The corporation’s properties and business (including a financial statement certified by an independent public accounting firm) The management of the corporation, including managerial compensation, stock options, pensions, and other benefits Any interests of directors or officers in any material transactions with the corporation must be disclosed How the corporation intends to use the proceeds of the sale Any pending lawsuits or special risk factors All companies, both domestic and foreign, must file their registration statements electronically so that they can be posted on the SEC’s EDGAR database (mentioned previously) and investors can access the information via the Internet The EDGAR database includes material on initial public offerings (IPOs), proxy statements, corporations’ annual reports, registration statements, and other documents that have been filed with the SEC 11 Basically, an electronic prospectus must meet the same requirements as a printed prospectus The SEC rules address situations in which the graphics, images, or audio files in or accompanying a printed prospectus cannot be reproduced in an electronic form 17 C.F.R Section 232.304 Registration Process  The registration statement does not become effective until it has been reviewed and approved by the SEC (unless it is filed by a wellknown seasoned issuer, as will be discussed shortly) The 1933 act restricts the types of activities that an issuer can engage in at each stage of the registration process If an issuer violates these restrictions, investors can rescind their contracts to purchase the securities Prefiling Period.  During the prefiling period (before the registration statement is filed), the issuer normally cannot sell or offer to sell the securities Once the registration statement has been filed, a waiting period begins while the SEC reviews the registration statement for completeness.12 Waiting Period.  During the waiting period, the securities can be offered for sale but cannot be sold by the issuing corporation Only certain types of offers are allowed All issuers can distribute a preliminary prospectus,13 which contains most of the information that will be included in the final prospectus but often does not include a price Most issuers can also use a free-writing prospectus during this period (although some inexperienced issuers will need to file a preliminary prospectus first) A free-writing prospectus is any type of written, electronic, or graphic offer that describes the issuer or its securities and includes a legend indicating that the investor may obtain the prospectus at the SEC’s Web site Posteffective Period.  Once the SEC has reviewed and approved the registration statement and the waiting period is over, the registration is effective, and the posteffective period begins The issuer can now offer and sell the securities without restrictions If the company issued a preliminary or free-writing prospectus to investors, it must provide those investors with a final prospectus either before or at the time they purchase the securities The issuer can require investors to download the final prospectus from a Web site if it notifies them of the appropriate Internet address 12 The waiting period must last at least twenty days but always extends much longer because the SEC inevitably requires numerous changes and additions to the registration statement 13 A preliminary prospectus may also be called a red herring prospectus The name comes from the legend printed in red across the prospectus stating that the registration has been filed but has not become effective Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 28  Investor Protection and Corporate Governance  Well-Known Seasoned Issuers A well-known seasoned issuer (WKSI) is a firm that has issued at least $1 billion in securities in the last three years or has at least $700 million of value of outstanding stock in the hands of the public WKSIs can file registration statements the day they announce a new offering and are not required to wait for SEC review and approval They can also use a free-writing prospectus at any time, even during the prefiling period Exempt Securities and Transactions Certain types of securities are exempt from the registration requirements of the Securities Act of 1933 These securities—which generally can also be resold without being registered—are summarized under the heading “Exempt Securities” in Exhibit 28–1 on the following page.14 The exhibit also lists and describes certain transactions that are exempt from registration requirements under various SEC regulations The transaction exemptions are the most important because they are very broad and can enable an issuer to avoid the high cost and complicated procedures associated with registration Because the coverage of the exemptions overlaps somewhat, an offering may qualify for more than one Therefore, many sales occur without registration Even when a transaction is exempt from the registration requirements, the offering is still subject to the antifraud provisions of the 1933 act (as well as those of the 1934 act, to be discussed later in this chapter) Regulation A Offerings  An exemption from registration is available for an issuer’s offerings that not exceed $5 million in securities during any twelvemonth period.15 Under Regulation A,16 the issuer must file with the SEC a notice of the issue and an offering circular, which must also be provided to investors before the sale This process is much less expensive than the procedures associated with full registration Testing the Waters.  Companies are allowed to “test the waters” for potential interest before preparing the offering circular To test the waters means to determine potential interest without actually selling any securities or requiring any commitment from those 14 15 U.S.C Section 77c 15 15 U.S.C Section 77c(b) 16 17 C.F.R Sections 230.251–230.263 621 who express interest Small-business issuers can also use an integrated registration and reporting system that requires simpler forms than the full registration system Using the Internet.  Some companies have sold their securities via the Internet using Regulation A ▶  Example 28.2  The Spring Street Brewing Company was the first company to sell securities via an online initial public offering (IPO) Spring Street raised about $1.6 million—without having to pay any commissions to brokers or underwriters.  ◀ Such online IPOs are particularly attractive to small companies and start-up ventures that may find it difficult to raise capital from institutional investors or through underwriters By making the offering online, the company can avoid both commissions and the costly and time-consuming filings required for a traditional IPO under federal and state law Small Offerings—Regulation D  The SEC’s Regulation D contains several exemptions from registration requirements (Rules 504, 504a, 505, and 506) for offers that either involve a small dollar amount or are made in a limited manner Rule 504.  Rule 504 is the exemption used by most small businesses It provides that noninvestment company offerings up to $1 million in any twelve-month period are exempt.17 Noninvestment companies are firms that are not engaged primarily in the business of investing or trading in securities (In contrast, an investment company is a firm that buys a large portfolio of securities and professionally manages it on behalf of many smaller shareholders/owners A mutual fund is a well-known type of investment company.) ▶  Example 28.3  Zeta Enterprises is a limited partnership that develops commercial property Zeta intends to offer $600,000 of its limited partnership interests for sale between June and May 31 of the next year The buyers will become limited partners in Zeta Because an interest in a limited partnership meets the definition of a security (discussed earlier in this chapter), this offering would be subject to the registration and prospectus requirements of the Securities Act of 1933 17 17 C.F.R Section 230.504 Small businesses in California may also be exempt under SEC Rule 1001 California’s rule permits limited offerings of up to $5 million per transaction, if they satisfy certain conditions Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 622  Unit Six  The Regulatory Environment E X HI B I T 28 – 1  Exemptions for Securities Offerings under the 1933 Securities Act ALL SECURITIES OFFERINGS NONEXEMPT SECURITIES Exempt Transactions Exempt Securities • • • Government-issued securities Regulation A— Securities issued by an issuer that has offered less than $5 million in securities during any twelve-month period if the issuer meets specific requirements Bank and financial institution securities, which are regulated by banking authorities Short-term notes and drafts (negotiable instruments that have a maturity date that does not exceed nine months) • Securities of nonprofit, educational, and charitable organizations • Securities issued by common carriers (railroads and trucking companies) • Any insurance, endowment, or annuity contract issued by a state-regulated insurance company • Securities issued in a corporate reorganization in which one security is exchanged for another or in a bankruptcy proceeding • Securities issued in stock dividends and stock splits Unregistered Unrestricted Securities Nonexempt Transactions All nonexempt securities that are not offered in an exempt transaction normally require registration with the SEC Regulation D— • Rule 504: Noninvestment company offerings up to $1 million in any twelve-month period • Rule 505: Private, noninvestment company offerings up to $5 million in any twelve-month period • Rule 506: Private, noninvestment company offerings in unlimited amounts that are not generally advertised or solicited Unregistered Restricted Securities Registered Unrestricted Securities Restricted securities must be registered before resale unless they qualify for a safe harbor under Rule 144 or 144A Except when the seller is an issuer, underwriter, or dealer, unrestricted securities generally can be resold without first being registered Under Rule 504, however, the sales of Zeta’s interests are exempt from these requirements because Zeta is a noninvestment company making an offering of less than $1 million in a given twelve-month period Therefore, Zeta can sell its interests without filing a registration statement with the SEC or issuing a prospectus to any investor.  ◀ Rule 505.  Another exemption is available under Rule 505 for private, noninvestment company offerings up to $5 million in any twelve-month period Under this exemption, the offer may be made to an unlimited number of accredited investors and up to thirtyfive unaccredited investors Accredited investors include banks, insurance companies, investment Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 28  Investor Protection and Corporate Governance  companies, employee benefit plans, the issuer’s executive officers and directors, and persons whose income or net worth exceeds a certain threshold The SEC must be notified of the sales, and precautions must be taken because these restricted securities may be resold only by registration or in an exempt transaction No general solicitation or advertising is allowed The issuer must provide any unaccredited investors with disclosure documents that generally are the same as those used in registered offerings Rule 506—Private Placement Exemption. Rule 506 exempts private, noninvestment company offerings in unlimited amounts that are not generally solicited or advertised This exemption is often referred to as the private placement exemption because it exempts “transactions not involving any public offering.”18 There can be an unlimited number of accredited investors and up to thirty-five unaccredited investors To qualify for the exemption, the issuer must believe that each unaccredited investor has sufficient knowledge or experience in financial matters to be capable of evaluating the investment’s merits and risks.19 The private placement exemption is perhaps the most important exemption for firms that want to raise funds through the sale of securities without registering them ▶  Example 28.4  Citco Corporation needs to raise capital to expand its operations Citco decides to make a private $10 million offering of its common stock directly to two hundred accredited investors and a group of thirty highly sophisticated, but unaccredited, investors Citco provides all of these investors with a prospectus and material information about the firm, including its most recent financial statements As long as Citco notifies the SEC of the sale, this offering will likely qualify as an exempt transaction under Rule 506 The offering is nonpublic and not generally advertised There are fewer than thirty-five unaccredited investors, and each of them possesses sufficient knowledge and experience to evaluate the risks involved The issuer has provided all purchasers with the material information Thus, Citco will not be required to comply with the registration requirements of the Securities Act of 1933.  ◀ Resales and Safe Harbor Rules  Most securities can be resold without registration The Securities Act of 1933 provides exemptions for resales by most persons other than issuers or underwriters The average 18 15 U.S.C Section 77d(2) 19 17 C.F.R Section 230.506 623 investor who sells shares of stock need not file a registration statement with the SEC Resales of restricted securities acquired under Rule 505 or Rule 506, however, trigger the registration requirements unless the party selling them complies with Rule 144 or Rule 144A These rules are sometimes referred to as safe harbors Rule 144.  Rule 144 exempts restricted securities from registration on resale if all of the following conditions are met: There is adequate current public information about the issuer (“Adequate current public information” refers to the reports that certain companies are required to file under the Securities Exchange Act of 1934.) The person selling the securities has owned them for at least six months if the issuer is subject to the reporting requirements of the 1934 act.20 If the issuer is not subject to the 1934 act’s reporting requirements, the seller must have owned the securities for at least one year The securities are sold in certain limited amounts in unsolicited brokers’ transactions The SEC is notified of the resale.21 Rule 144A.  Securities that at the time of issue were not of the same class as securities listed on a national securities exchange or quoted in a U.S automated interdealer quotation system may be resold under Rule 144A.22 They may be sold only to a qualified institutional buyer (an institution, such as an insurance company or a bank, that owns and invests at least $100 million in securities) The seller must take reasonable steps to ensure that the buyer knows that the seller is relying on the exemption under Rule 144A Violations of the 1933 Act It is a violation of the Securities Act of 1933 to intentionally defraud investors by misrepresenting or omitting facts in a registration statement or prospectus Liability is also imposed on those who are negligent 20 Before 2008, when amendments to Rule 144 became effective, the holding period for restricted securities was one year if the issuer was subject to the reporting requirements of the 1934 act See the revised SEC Rules and Regulations at 72 Federal Rules 71546-01, 2007 WL 4368599, Release No 33-8869 This reduced holding period allows nonpublic issuers to raise capital electronically from private and overseas sources more quickly 21 17 C.F.R Section 230.144 22 17 C.F.R Section 230.144A Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 624  Unit Six  The Regulatory Environment in not discovering the fraud Selling securities before the effective date of the registration statement or under an exemption for which the securities not qualify results in liability Remedies  Criminal violations are prosecuted by the U.S Department of Justice Violators may be fined up to $10,000, imprisoned for up to five years, or both The SEC is authorized to impose civil sanctions against those who willfully violate the 1933 act It can request an injunction to prevent further sales of the securities involved or ask a court to grant other relief, such as ordering a violator to refund profits Private parties who purchase securities and suffer harm as a result of false or omitted statements or other violations may bring a suit in a federal court to recover their losses and additional damages The statement or omission was not material The plaintiff knew about the misrepresentation at the time the stock was purchased The defendant exercised due diligence in preparing the registration and reasonably believed at the time that the statements were true The due diligence defense is the most important because it can be asserted by any defendant, except the issuer of the stock The defendant must prove that she or he reasonably believed, at the time the registration statement became effective, that the statements in it were true and there were no omissions of material facts The following case involved allegations of omissions of material information from an issuing company’s registration statement The defendants contended that the omissions were not material Defenses  There are three basic defenses to charges of violations under the 1933 act A defendant can avoid liability by proving any of the following: Case 28.1 Litwin v Blackstone Group, LP 
United States Court of Appeals, Second Circuit, 634 F.3d 706 (2011) BACKGROUND AND FACTS  Blackstone Group, LP, manages investments Its corporate private equity division accounts for nearly 40 percent of the assets under the company’s management In preparation for an initial public offering (IPO), Blackstone filed a registration statement with the Securities and Exchange Commission (SEC) At the time, corporate private equity’s investments included FGIC Corporation and Freescale Semiconductor, Inc FGIC insured investments in subprime mortgages Before the IPO, FGIC’s customers began to suffer large losses By the time of the IPO, this situation was generating substantial losses for FGIC and, in turn, for Blackstone Meanwhile, Freescale had recently lost an exclusive contract to make wireless 3G chipsets for Motorola, Inc (its largest customer) Blackstone’s registration statement did not mention the impact on its revenue of the investments in FGIC and Freescale Martin Litwin and others who invested in the IPO filed a suit in a federal district court against Blackstone and its officers, alleging material omissions from the statement Blackstone filed a motion to dismiss, which the court granted The plaintiffs appealed IN THE LANGUAGE OF THE COURT STRAUB, Circuit Judge: * * * * Materiality is an inherently fact-specific finding that is satisfied when a plaintiff alleges a statement or omission that a reasonable investor would have considered significant in making investment decisions * * * However, it is not necessary to assert that the investor would have acted differently if an accurate disclosure was made Rather, when a district court is presented with a motion [to dismiss,]
a complaint may not properly be dismissed on the ground that the alleged misstatements or omissions are not material unless they are so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance [Emphasis added.] In this case, the key information that plaintiffs assert should have been disclosed is whether, and to what extent, the particular known trend, event, or uncertainty might have Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 28  Investor Protection and Corporate Governance  CASE 28.1 CONTINUEd 625 been reasonably expected
to materially affect Blackstone’s investments * * * Plaintiffs are not seeking the disclosure of the mere fact of Blackstone’s investment in FGIC, of the downward trend in the real estate market, or of Freescale’s loss of its exclusive contract with Motorola Rather, plaintiffs claim that Blackstone was required to disclose the manner in which those then-known trends, events, or uncertainties might reasonably be expected to materially impact Blackstone’s future revenues * * * The question, of course, is not whether a loss in a particular investment’s value will merely affect revenues, because * * * it will almost certainly have some effect The relevant question is whether Blackstone reasonably expects the impact to be material [Emphasis added.] * * * Because Blackstone’s Corporate Private Equity segment plays such an important role in Blackstone’s business and provides value to all of its other asset management and financial advisory services, a reasonable investor would almost certainly want to know information related to that segment that Blackstone reasonably expects will have a material adverse effect on its future revenues Therefore, the alleged * * * omissions relating to FGIC and Freescale were plausibly material DECISION AND REMEDY  The U.S Court of Appeals for the Second Circuit vacated the lower court’s dismissal and remanded the case The plaintiffs had provided sufficient allegations that Blackstone had omitted material information that it was required to disclose under the securities laws for the case to go to trial THE LEGAL ENVIRONMENT DIMENSION  Litwin alleged that Blackstone had negligently omitted material information from the registration statement What will he and the others have to show to prove their case? THE ECONOMIC DIMENSION  Blackstone raised more than $ 4.5 billion through the IPO Blackstone officers received nearly all of the net proceeds If the company had disclosed the omitted information in its registration statement, how might these results have been different? SECTION The Securities Exchange Act of 1934 The Securities Exchange Act of 1934 provides for the regulation and registration of securities exchanges, brokers, dealers, and national securities associations, such as the National Association of Securities Dealers (NASD) Unlike the 1933 act, which is a one-time disclosure law, the 1934 act provides for continuous periodic disclosures by publicly held corporations to enable the SEC to regulate subsequent trading The Securities Exchange Act of 1934 applies to companies that have assets in excess of $10 million and five hundred or more shareholders These corporations are referred to as Section 12 companies because they are required to register their securities under Section 12 of the 1934 act Section 12 companies are required to file reports with the SEC annually and quarterly, and sometimes even monthly if specified events occur (such as a merger) The act also authorizes the SEC to engage in market surveillance to deter undesirable market practices such as fraud, market manipulation, and misrepresentation In addition, the act provides for the SEC’s regulation of proxy solicitations for voting (discussed in Chapter 19) Section 10(b), SEC Rule 10b-5, and Insider Trading Section 10(b) is one of the more important sections of the Securities Exchange Act of 1934 This section prohibits the use of any manipulative or deceptive mechanism in violation of SEC rules and regulations Among the rules that the SEC has promulgated pursuant to the 1934 act is SEC Rule 10b-5, which prohibits the commission of fraud in connection with the purchase or sale of any security SEC Rule 10b-5 applies to almost all cases concerning the trading of securities, whether on organized exchanges, in over-the-counter markets, or in private transactions Generally, the rule covers just about any Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 626  Unit Six  The Regulatory Environment form of security The securities need not be registered under the 1933 act for the 1934 act to apply Private parties can sue for securities fraud under the 1934 act and SEC rules The basic elements of a securities fraud action are as follows: A material misrepresentation (or omission) in connection with the purchase and sale of securities Scienter (a wrongful state of mind) Reliance by the plaintiff on the material misrepresentation An economic loss Causation, meaning that there is a causal connection between the misrepresentation and the loss Insider Trading  One of the major goals of Section 10(b) and SEC Rule 10b-5 is to prevent insider trading, which occurs when persons buy or sell securities on the basis of information that is not available to the public Corporate directors, officers, and others, such as majority shareholders, often have advance inside information that can affect the future market value of the corporate stock Obviously, if they act on this information, their positions give them a trading advantage over the general public and other shareholders The 1934 Securities Exchange Act defines inside information It also extends liability to those who take advantage of such information in their personal transactions when they know that the information is unavailable to those with whom they are dealing Section 10(b) of the 1934 act and SEC Rule 10b-5 apply to anyone who has access to or receives information of a nonpublic nature on which trading is based—not just to corporate “insiders.” Disclosure under SEC Rule 10b-5  Any material omission or misrepresentation of material facts in connection with the purchase or sale of a security may violate Section 10(b) of the 1934 act and SEC Rule 10b-5 The key to liability (which can be civil or criminal) is whether the information omitted or misrepresented is material The following are some examples of material facts calling for disclosure under SEC Rule 10b-5: Fraudulent trading in the company stock by a broker-dealer A dividend change (whether up or down) A contract for the sale of corporate assets A new discovery, a new process, or a new product A significant change in the firm’s financial condition Potential litigation against the company Note that any one of these facts, by itself, is not automatically considered material Rather, it will be regarded as a material fact only if it is significant enough that it would likely affect an investor’s decision as to whether to purchase or sell the company’s securities ▶  Example 28.5  Zilotek, Inc., is the defendant in a class-action product liability suit that its attorney believes the company will lose The attorney has advised Zilotek’s directors, officers, and accountants that the company will likely have to pay a substantial damages award Zilotek plans to make a $5 million offering of newly issued stock before the date when the trial is expected to end Zilotek’s potential liability and the financial consequences to the firm are material facts that must be disclosed because they are significant enough to affect an investor’s decision as to whether to purchase the stock.  ◀ The case that follows is a classic decision interpreting materiality under SEC Rule 10b-5 Classic Case 28.2 SEC v Texas Gulf Sulphur Co United States Court of Appeals, Second Circuit, 401 F.2d 833 (1968) BACKGROUND AND FACTS  Texas Gulf Sulphur Company (TGS) conducted aerial geophysical surveys over more than 15,000 square miles of eastern Canada The operations indicated concentrations of commercially exploitable minerals At one site near Timmins, Ontario, TGS drilled a hole that appeared to yield a core with an exceedingly high mineral content The company did not disclose the results of the core sample to the public After learning of the sample, TGS officers and employees made substantial purchases of TGS’s stock or accepted stock options (rights to purchase stock) Further drilling, however, was necessary to establish whether there was enough ore to be mined commercially Several months later, TGS Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 28  Investor Protection and Corporate Governance  CASE 28.2 CONTINUEd 627 announced that the strike was expected to yield at least 25 million tons of ore Subsequently, the price of TGS stock rose substantially The Securities and Exchange Commission (SEC) brought a suit against the officers and employees of TGS for violating SEC Rule 10b-5 The officers and employees argued that the information on which they had traded had not been material at the time of their trades because the mine had not then been commercially proved The trial court held that most of the defendants had not violated SEC Rule 10b-5, and the SEC appealed IN THE LANGUAGE OF THE COURT WATERMAN, Circuit Judge * * * * * * * Whether facts are material within Rule 10b-5 when the facts relate to a particular event and are undisclosed by those persons who are knowledgeable thereof will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity Here, * * * knowledge of the possibility, which surely was more than marginal, of the existence of a mine of the vast magnitude indicated by the remarkably rich drill core located rather close to the surface (suggesting mineability by the less expensive openpit method) within the confines of a large anomaly (suggesting an extensive region of mineralization) might well have affected the price of TGS stock and would certainly have been an important fact to a reasonable, if speculative, investor in deciding whether he should buy, sell, or hold [Emphasis added.] * * * * * * * A major factor in determining whether the * * * discovery was a material fact is the importance attached to the drilling results by those who knew about it * * * The timing by those who knew of it of their stock purchases * * *—purchases in some cases by individuals who had never before purchased * * * TGS stock—virtually compels the inference that the insiders were influenced by the drilling results DECISION AND REMEDY  The appellate court ruled in favor of the SEC All of the trading by insiders who knew of the mineral find before its true extent had been publicly announced violated SEC Rule 10b-5 what if the facts were different?  Suppose that further drilling had revealed that there was not enough ore at this site for it to be mined commercially Would the defendants still have been liable for violating SEC Rule 10b-5? Why or why not? IMPACT OF THIS CASE ON TODAY’S LAW  This landmark case affirmed the principle that the test of whether information is “material,” for SEC Rule 10b-5 purposes, is whether it would affect the judgment of reasonable investors The corporate insiders’ purchases of stock and stock options indicated that they were influenced by the drilling results and that the information about the drilling results was material The courts continue to cite this case when applying SEC Rule 10b-5 to cases of alleged insider trading Outsiders and SEC Rule 10b-5 The traditional insider-trading case involves true insiders—corporate officers, directors, and majority shareholders who have access to (and trade on) inside information Increasingly, however, liability under Section 10(b) of the 1934 act and SEC Rule 10b-5 has been extended to include certain “outsiders”—those who trade on inside information acquired indirectly Two theories have been developed under which outsiders may be held liable for insider trading: the tipper/tippee theory and the misappropriation theory Tipper/Tippee Theory.  Anyone who acquires inside information as a result of a corporate insider’s breach of his or her fiduciary duty can be liable under SEC Rule 10b-5 This liability extends to tippees (those who receive “tips” from insiders) and even remote tippees (tippees of tippees) The key to liability under this theory is that the inside information must be obtained as a result of someone’s breach of a fiduciary duty to the corporation whose shares are traded The tippee is liable only if the following requirements are met: Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 628  Unit Six  The Regulatory Environment There is a breach of a duty not to disclose inside information The disclosure is made in exchange for personal benefit The tippee knows (or should know) of this breach and benefits from it.23 Misappropriation Theory.  Liability for insider trading may also be established under the misappropriation theory This theory holds liable an individual who wrongfully obtains (misappropriates) inside information and trades on it for her or his personal gain because the individual basically stole information rightfully belonging to another The misappropriation theory has been controversial because it significantly extends the reach of SEC Rule 10b-5 to outsiders who ordinarily would not be deemed fiduciaries of the corporations in whose stock they trade It is not always wrong to disclose material, nonpublic information about a company to a person who would not otherwise be privy to it Nevertheless, a person who obtains the information and trades securities on it can be held liable ▶  Case in Point 28.6  Patricia Rocklage was the wife of Scott Rocklage, the CEO of Cubist Pharmaceuticals, Inc Scott had sometimes disclosed material, nonpublic information about Cubist to Patricia She had always kept the information confidential When Scott told Patricia that one of Cubist’s key drugs had failed its clinical trial, however, Patricia informed her brother, William Beaver, who owned Cubist stock Beaver sold his Cubist shares and tipped his friend David Jones, who sold his shares When Cubist publicly announced the trial results, the price of its stock dropped Beaver and Jones avoided significant losses by selling when they did The SEC filed a lawsuit against Patricia, Beaver, and Jones The court found all three defendants guilty of insider trading under the misappropriation theory.24  ◀ Insider Reporting and Trading—Section 16(b) Section 16(b) of the 1934 act provides for the recapture by the corporation of all profits realized by certain insiders on any purchase and sale or sale and purchase of the corporation’s stock within any six23 See, for example, Chiarella v United States, 445 U.S 222, 100 S.Ct 1108, 63 L.Ed.2d 348 (1980); and Dirks v SEC, 463 U.S 646, 103 S.Ct 3255, 77 L.Ed.2d 911 (1983) 24 SEC v Rocklage, 470 F.3d (1st Cir 2006) month period It is irrelevant whether the insider actually uses inside information—all such short-swing profits must be returned to the corporation In this context, insiders means officers, directors, and large stockholders of Section 12 corporations (those owning 10 percent of the class of equity securities registered under Section 12 of the 1934 act).25 To discourage such insiders from using nonpublic information about their companies to their personal benefit in the stock market, they must file reports with the SEC concerning their ownership and trading of the corporation’s securities Section 16(b) applies not only to stock but also to warrants, options, and securities convertible into stock In addition, the courts have fashioned complex rules for determining profits Note that the SEC exempts a number of transactions under Rule 16b3.26 For all of these reasons, corporate insiders should seek the advice of competent counsel before trading in the corporation’s stock Exhibit 28–2 on the facing page compares the effects of SEC Rule 10b-5 and Section 16(b) The Private Securities Litigation Reform Act The disclosure requirements of SEC Rule 10b-5 had the unintended effect of deterring the disclosure of forward-looking information To understand why, consider the following situation ▶  Example 28.7  QT Company announces that it projects that its earnings in a future time period will be a certain amount, but the forecast turns out to be wrong The earnings are in fact much lower, and the price of the company’s stock is affected—negatively The shareholders then bring a class-action suit against the company, alleging that the directors violated SEC Rule 10b-5 by disclosing misleading financial information.  ◀ In an attempt to rectify this problem and promote disclosure, in 1995 Congress passed the Private Securities Litigation Reform Act (PSLRA) Among other things, the PSLRA provides a “safe harbor” for publicly held companies that make forward-looking statements, such as financial forecasts Those who make such statements are protected against liability for securities fraud if they include “meaningful cautionary statements identifying important factors that 25 15 U.S.C Section 78l Note that Section 403 of the Sarbanes-Oxley Act shortened the reporting deadlines specified in Section 16(b) 26 17 C.F.R Section 240.16b-3 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 28  Investor Protection and Corporate Governance  629 Ex h i b i t 28 – 2  Comparison of Coverage, Application, and Liability under SEC Rule 10b-5 and Section 16(b) Area of Comparison SEC Rule 10b-5 Section 16(b) What is the subject matter of the transaction? Any security (does not have to be registered) Any security (does not have to be registered) What transactions are covered? Purchase or sale Short-swing purchase and sale or shortswing sale and purchase Who is subject to liability? Almost anyone with inside information under a duty to disclose—including officers, directors, controlling shareholders, and tippees Officers, directors, and certain shareholders who own 10 percent or more Is omission or misrepresentation necessary for liability? Yes No Are there any exempt transactions? No Yes, there are a number of exemptions Who may bring an action? A person transacting with an insider, the SEC, or a purchaser or seller damaged by a wrongful act A corporation or a shareholder by derivative action could cause actual results to differ materially from those in the forward-looking statement.”27 The PSLRA also affected the level of detail required in securities fraud complaints Plaintiffs must specify each misleading statement and say how it led them to a mistaken belief Regulation of Proxy Statements Section 14(a) of the Securities Exchange Act of 1934 regulates the solicitation of proxies (see Chapter 19) from shareholders of Section 12 companies The SEC regulates the content of proxy statements Whoever solicits a proxy must fully and accurately disclose in the proxy statement all of the facts that are pertinent to the matter on which the shareholders are to vote SEC Rule 14a-9 is similar to the antifraud provisions of SEC Rule 10b-5 Remedies for violations are extensive, ranging from injunctions to prevent a vote from being taken to monetary damages Violations of the 1934 Act As mentioned earlier, violations of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, including insider trading, may lead to both criminal and civil liability 27 15 U.S.C Sections 77z-2, 78u-5 Scienter Requirement  For either criminal or civil sanctions to be imposed, however, scienter must exist—that is, the violator must have had an intent to defraud or knowledge of his or her misconduct Scienter can be proved if it is shown that the defendant made false statements or wrongfully failed to disclose material facts In some situations, scienter can even be proved by showing that the defendant was consciously reckless as to the truth or falsity of his or her statements ▶  Case in Point 28.8  Alvin Gebhart and Jack Archer started a business venture purchasing mobile home parks (MHPs) from owners and converting them to resident ownership They formed MHP Conversions, LP, to facilitate the conversion process and issue promissory notes that were sold to investors to raise funds for the purchases Archer ran the MHP program, and Gebhart sold the promissory notes Gebhart sold nearly $2.4 million in MHP promissory notes to clients, who bought the notes based on Gebhart’s positive statements about the investment During the time Gebhart was selling the notes, however, he never actually looked into the finances of the MHP program He relied entirely on information that Archer gave him, some of which was not true When Gebhart was later sued for securities fraud, a federal appellate court concluded that there was sufficient evidence of scienter Gebhart knew that he had no knowledge of the financial affairs of MHP, and he had been consciously Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 630  Unit Six  The Regulatory Environment reckless as to the truth or falsity of his statements about investing in MHP.28  ◀ In the complaint, the plaintiff must state facts giving rise to an inference of scienter at least as likely as any plausible opposing inference Opposing inferences and their proof were at issue in the following case 28 Gebhart v SEC, 595 F.3d 1034 (9th Cir 2010) C A S E ANALY S IS Case 28.3 City of Livonia Employees’ Retirement System and Local 295/Local 851 v Boeing Co United States Court of Appeals, Seventh Circuit, 711 F.3d 754 (2013) In the language of the court posner, Circuit Judge * * * * * * * On April 21 [2009] Boeing [Company] performed a stress test on the wings of its new 787-8 Dreamliner, a plane that had not yet flown The wings failed the test * * *  Yet Boeing announced on May that “all structural tests required on the static airframe prior to first flight are complete” and that “the initial results of the test are positive” * * *  The implication was that the plane was on track for its “First Flight,” which had been scheduled for June 30 In mid-May, after making some changes in the design * * * , Boeing conducted another test Although the plane failed that test too, [Boeing’s chief executive officer James] McNerney stated publicly that he thought the plane would fly in June Later [the head of Boeing’s commercial aircraft division Scott] Carson told [the media] that the Dreamliner “definitely will fly” this month (June) * * * Yet on June 23, * * * Boeing announced that the First Flight of the Dreamliner had been canceled because, Carson explained, of an “anomaly” revealed by the * * * tests He said that Boeing had hoped to be able to solve the problem in time for a First Flight in June, but had been unable to so In fact the First Flight did not take place until December 2009 When Boeing announced the cancellation of the First Flight, it also announced that the cancellation would cause a delay of unspecified length in the delivery of the Dreamliner, which many airlines had already ordered In the two days after these announcements, Boeing’s stock price dropped by more than 10 percent * * * Persons who bought Boeing stock between the tests and the announcements of the cancellation and of the delay in delivery and who therefore lost money when the price dropped [filed a suit in a federal district court against Boeing and its officers, alleging violations of Section 10(b) and Rule 10b-5] The district judge dismissed the * * * complaint [The plaintiffs appealed.] There is no securities fraud by hindsight The law does not require public disclosure of mere risks of failure No prediction—even a prediction that the sun will rise tomorrow—has a 100 percent probability of being correct The future is shrouded in uncertainty If a mistaken prediction is deemed a fraud, there will be few predictions, including ones that are well grounded, as no one wants to be held hostage to an unknown future [Emphasis added.] Any sophisticated purchaser of a product that is still on the drawing boards knows, moreover, that its market debut may be delayed, or indeed that the project may be abandoned before it yields salable product The purchasers of the Dreamliner protected themselves against the possibility of delay in delivery by reserving the right to cancel their orders; there are no allegations regarding cancellation penalties, or for that matter penalties imposed on Boeing for delivery delays And therefore * * * the defendants * * * had, so far as appears, little incentive to delay the announcement of the postponement Without a motive to commit securities fraud, businessmen are unlikely to commit it A more plausible inference than that of fraud is that the defendants, unsure whether they could fix the problem by the end of June, were reluctant to tell the world “we have a problem and maybe it will cause us to delay the First Flight and maybe not, but we’re working on the problem and we hope we can fix it in time to prevent any significant delay, but we can’t be sure, so stay tuned.” There is a difference * * * between a duty of truthfulness and a duty of candor, or between a lie and reticence [uncommunicativeness] There is no duty of total corporate transparency—no rule that every hitch or glitch, every pratfall [embarrassing mistake], in a company’s operations must be disclosed in real time, forming a running commentary, a baring of the corporate innards, day and night [Emphasis added.] * * * * * * * The * * * complaint alleged [that] what McNerney and Carson knew about the likely postponement of the First Flight * * * was confirmed by “internal e-mails” of Boeing The reference to internal e-mails implied that someone inside Boeing was aiding the plaintiffs But as no such Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 28  Investor Protection and Corporate Governance  631 CASE 28.3 CONTINUEd person was identified, the judge could not determine whether such e-mails * * * existed Allegations * * * merely implying unnamed confidential sources of damaging information require a heavy discount The sources may be ill-informed, may be acting from spite rather than knowledge, may be misrepresented, may even be nonexistent * * *  The district judge therefore rightly refused to give any weight to the “internal e-mails” to which the complaint referred * * * * The judgment dismissing the suit is affirmed Legal Reasoning Questions Which pleading (a document filed with the court—see Chapter 2) was at the center of the dispute in this case? What must this pleading state in a suit alleging violations of Section 10(b) and Rule 10b-5? Did the court conclude that the pleading here met this requirement? Why or why not? If a pleading does not meet this requirement, should the court impose sanctions on the lawyers who filed it? Discuss Scienter Not Required for Section 16(b) Violations  Violations of Section 16(b) include the sale by insiders of stock acquired less than six months before the time of sale (or less than six months after the sale, if selling short—that is, selling securities that one does not yet own) These violations are subject to civil sanctions Liability under Section 16(b) is strict liability Neither scienter nor negligence is required Criminal Penalties  For violations of Section 10(b) and Rule 10b-5, an individual may be fined up to $5 million, imprisoned for up to twenty years, or both A partnership or a corporation may be fined up to $25 million Under Section 807 of the Sarbanes-Oxley Act of 2002, for a willful violation of the 1934 act the violator can be imprisoned for up to twenty-five years (in addition to being subject to a fine) For a defendant to be convicted in a criminal prosecution under the securities laws, there can be no reasonable doubt that the defendant knew he or she was acting wrongfully In other words, a jury is not allowed merely to speculate that the defendant may have acted willfully ▶  Case in Point 28.9  Martha Stewart, founder of a well-known media and homemaking empire, was charged with intentionally deceiving investors based on statements she made at a conference In 2001, Stewart’s stockbroker allegedly informed Stewart that the head of ImClone Systems, Inc., was selling his shares in that company Stewart then sold her ImClone shares The next day, ImClone announced that the U.S Food and Drug Administration had failed to approve Erbitux, the company’s greatly anticipated medication After the government began investigating Stewart’s ImClone trades, she publicly stated that she had pre- viously instructed her stockbroker to sell her ImClone stock if the price fell to $60 per share The government prosecutor claimed that Stewart’s statement showed she had the intent to deceive investors The court, however, acquitted Stewart on this charge because “to find the essential element of criminal intent beyond a reasonable doubt, a rational juror would have to speculate.”29  ◀ Civil Sanctions  The SEC can also bring a civil action against anyone who purchases or sells a security while in the possession of material nonpublic information in violation of the 1934 act or SEC rules.30 The violation must occur through the use of a national securities exchange or a broker or dealer.31 A court can assess a penalty amounting to as much as triple the profits gained or the loss avoided by the guilty party.32 The Insider Trading and Securities Fraud Enforcement Act enlarged the class of persons who may be subject to civil liability for insider trading This act also gave the SEC authority to offer monetary rewards to informants.33 Private parties may also sue violators of Section 10(b) and Rule 10b-5 A private party can obtain rescission (cancellation) of a contract to buy securities or damages to the extent of the violator’s illegal profits Those found liable have a right to seek contribution from those who share responsibility for the violations, 29 United States v Stewart, 305 F.Supp.2d 368 (S.D.N.Y 2004) (Stewart was later convicted on other charges relating to her ImClone trading that did not require proof of intent.) 30 15 U.S.C Section 78u(d)(2)(A) 31 Transactions pursuant to a public offering by an issuer of securities are excepted 32 15 U.S.C Section 78u(d)(2)(C) 33 15 U.S.C Section 78u-1 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 632  Unit Six  The Regulatory Environment including accountants, attorneys, and corporations For violations of Section 16(b), a corporation can bring an action to recover the short-swing profits SECTION State Securities Laws Today, every state has its own corporate securities laws, or blue sky laws, that regulate the offer and sale of securities within its borders (The phrase blue sky laws comes from a 1917 United States Supreme Court decision The Court stated that the purpose of such laws was to prevent “speculative schemes which have no more basis than so many feet of ‘blue sky.’ ”)34 Article of the Uniform Commercial Code also imposes various requirements relating to the purchase and sale of securities Requirements Typically, state laws have disclosure requirements and antifraud provisions, many of which are patterned after Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 State laws also provide for the registration of securities offered or issued for sale within the state and impose disclosure requirements Methods of registration, required disclosures, and exemptions from registration vary among states Unless an exemption from registration is applicable, issuers must register or qualify their stock with the appropriate state official, often called a corporations commissioner Additionally, most state securities laws regulate securities brokers and dealers Concurrent Regulation State securities laws apply mainly to intrastate transactions Since the adoption of the 1933 and 1934 federal securities acts, the state and federal governments have regulated securities concurrently Issuers must comply with both federal and state securities laws, and exemptions from federal law are not exemptions from state laws The dual federal and state system has not always worked well, particularly during the early 1990s, when the securities markets underwent considerable expansion Today, many of the duplicate regulations have been eliminated, and the SEC has exclusive 34 Hall v Geiger-Jones Co., 242 U.S 539, 37 S.Ct 217, 61 L.Ed 480 (1917) power to regulate most national securities activities The National Conference of Commissioners on Uniform State Laws also substantially revised the Uniform Securities Act in 2002 to coordinate state and federal securities regulation and enforcement efforts Seventeen states have adopted the most recent version of the Uniform Securities Act.35 SECTION Corporate Governance Corporate governance can be narrowly defined as the relationship between a corporation and its shareholders Defined more broadly, corporate governance specifies the rights and responsibilities among different corporate participants (including stakeholders) and spells out the rules and procedures for making decisions on corporate affairs Regardless of the way it is defined, effective corporate governance requires more than just compliance with laws and regulations Effective corporate governance is essential in large corporations because corporate ownership (by shareholders) is separated from corporate control (by officers and managers) Under these circumstances, officers and managers may attempt to advance their own interests at the expense of the shareholders The well-publicized corporate scandals in the early 2000s clearly illustrate the reasons for concern about managerial opportunism Indeed, corporate governance has become an issue of concern for corporate entities around the world With the globalization of business, a corporation’s bad acts (or lack of control systems) can have far-reaching consequences Attempts at Aligning the Interests of Officers with Those of Shareholders Some corporations have sought to align the financial interests of their officers with those of the company’s shareholders by providing the officers with stock options, which enable them to purchase shares of the corporation’s stock at a set price When the market price rises above that level, the officers can sell their 35 At the time this book went to press, the Uniform Securities Act had been adopted in Georgia, Hawaii, Idaho, Indiana, Iowa, Kansas, Maine, Michigan, Minnesota, Mississippi, Missouri, New Mexico, Oklahoma, South Carolina, South Dakota, Vermont, and Wisconsin, as well as in the U.S Virgin Islands You can find current information on state adoptions at www.uniformlaws.org Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 28  Investor Protection and Corporate Governance  shares for a profit Because a stock’s market price generally increases as the corporation prospers, the options give the officers a financial stake in the corporation’s well-being and supposedly encourage them to work hard for the benefit of the shareholders Options have turned out to be an imperfect device for providing effective governance, however Executives in some companies have “cooked” the company’s books in order to keep share prices high so that they could sell their stock for a profit Executives in other corporations have experienced no losses when share prices dropped because their options were “repriced” so that they did not suffer from the share price decline Thus, although stock options theoretically can motivate officers to protect shareholder interests, stock option plans have sometimes become a way for officers to take advantage of shareholders With stock options generally failing to work as planned, there has been an outcry for more “outside” directors (those with no formal employment affiliation with the company) The theory is that independent directors will more closely monitor the actions of corporate officers Hence, today we see more boards with outside directors Note, though, that outside directors may not be truly independent of corporate officers They may be friends or business associates of the leading officers The Goal Is to Promote Accountability Effective corporate governance standards are designed to address problems such as those briefly discussed above and to motivate officers to make decisions that promote the financial interests of the company’s shareholders Generally, corporate governance entails corporate decision-making structures that monitor employees (particularly officers) to ensure that they are acting for the benefit of the shareholders Thus, corporate governance involves, at a minimum: The audited reporting of financial conditions at the corporation so that managers can be evaluated Legal protections for shareholders so that violators of the law who attempt to take advantage of shareholders can be punished for misbehavior and victims can recover damages for any associated losses The Company Benefits  Effective corporate governance can have considerable practical significance Firms that are more accountable to shareholders typically report higher profits, higher sales growth, higher firm value, and other economic advantages Thus, a 633 corporation with better corporate governance and greater accountability to investors may also have a higher valuation than a corporation that is less concerned about governance Corporations that promote diversity in the workplace, and especially in management, may similarly experience increased profits, growth, and value Governance and Corporate Law  State corporation statutes set up the legal framework for corporate governance Under the corporate law of Delaware, where most major companies incorporate, all corporations must have certain structures of corporate governance in place The most important structure, of course, is the board of directors because the board makes the major decisions about the future of the corporation The Board of Directors  Under corporate law, a corporation must have a board of directors elected by the shareholders Almost anyone can become a director, though some organizations, such as the New York Stock Exchange, require certain standards of service for directors of their listed corporations Directors are responsible for ensuring that the corporation’s officers are operating wisely and in the exclusive interest of shareholders Directors receive reports from the officers and give them managerial directions In reality, though, corporate directors devote a relatively small amount of time to monitoring officers Ideally, shareholders would monitor the directors’ supervision of the officers In practice, however, it can be difficult for shareholders to monitor directors and hold them responsible for corporate failings Although the directors can be sued if they fail to their jobs effectively, directors are rarely held personally liable The Compensation Committee  An important committee of the board of directors is the compensation committee, which determines the compensation to be paid to the company’s officers As part of this process, the committee must assess the officers’ performance and design a compensation system that will best align the officers’ interests with those of the shareholders The Sarbanes-Oxley Act In 2002, Congress passed the Sarbanes-Oxley Act (introduced in Chapter 4) in response to a series of corporate scandals The act addresses certain issues relating to corporate governance Generally, the act attempts to increase corporate accountability by imposing strict disclosure requirements and harsh penalties for violations Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 634  Unit Six  The Regulatory Environment of securities laws Among other things, the act requires chief corporate executives to take personal responsibility for the accuracy of financial statements and reports that are filed with the SEC Additionally, the act requires that certain financial and stock-transaction reports be filed with the SEC earlier than was required under the previous rules The act also created a new entity, called the Public Company Accounting Oversight Board, which regulates and oversees public accounting firms Other provisions of the act established private civil actions and expanded the SEC’s remedies in administrative and civil actions Because of the importance of this act for corporate leaders and for those dealing with securities transactions, we present excerpts and explanatory comments in Appendix D at the end of this text We also highlight some of its key provisions relating to corporate accountability in Exhibit 28–3 on the next page More Internal Controls and Accountability  The Sarbanes-Oxley Act also introduced direct federal corporate governance requirements for public companies (companies whose shares are traded in the public securities markets) The law addressed many of the corporate governance procedures just discussed and created new requirements in an attempt to make the system work more effectively The requirements deal with independent monitoring of company officers by both the board of directors and auditors Sections 302 and 404 of the Sarbanes-Oxley Act require high-level managers (the most senior officers) to establish and maintain an effective system of internal controls Moreover, senior management must reassess the system’s effectiveness annually Some companies had to take expensive steps to bring their internal controls up to the new federal standards These include “disclosure controls and procedures” to ensure that company financial reports are accurate and timely and to document financial results prior to reporting After the act was passed, hundreds of companies reported that they had identified and corrected shortcomings in their internal control systems Exemptions for Smaller Companies The act initially required all public companies to have an independent auditor file a report with the SEC on management’s assessment of internal controls Congress, however, enacted an exemption for smaller companies in 2010 in an effort to reduce compliance costs Public companies with a market capitalization, or public float, of less than $75 million no longer need to have an auditor report on management’s assessment of internal controls Certification and Monitoring Requirements  Section 906 of the Sarbanes-Oxley Act requires that chief executive officers and chief financial officers certify the accuracy of the information in the corporate financial statements These corporate officers are subject to both civil and criminal penalties for violations of this section This requirement makes the officers directly accountable for the accuracy of their financial reporting and precludes any “ignorance defense” if shortcomings are later discovered The act also includes requirements to improve directors’ monitoring of officers’ activities All members of a publicly traded corporation’s audit committee, which oversees the corporation’s accounting and financial reporting processes, must be outside directors (The New York Stock Exchange has a similar rule that also extends to the board’s compensation committee, which monitors and determines the compensation of the company’s officers.) The audit committee must have a written charter that sets out its duties and provides for performance appraisal At least one “financial expert” must serve on the audit committee, which must hold executive meetings without company officers being present The audit committee must also establish procedures to encourage whistleblowers (see Chapter 21) to report violations In addition to reviewing the internal controls, the committee also monitors the actions of the outside auditor SECTION Online Securities Fraud A major problem facing the SEC today is how to enforce the antifraud provisions of the securities laws in the online environment In 1999, in the first cases involving illegal online securities offerings, the SEC filed suit against three individuals for illegally offering securities on an Internet auction site.36 In essence, all three indicated that their companies would soon go public and attempted to sell unregistered securities via the Web auction site All of these actions were in violation of Sections 5, 17(a)(1), and 17(a)(3) of the 1933 Securities Act Since then, the SEC has brought a variety of Internet-related fraud cases and regularly issues interpretive releases to explain how securities laws apply in the online environment 36 In re Davis, SEC Administrative File N.o 3-10080 (October 20, 1999); In re Haas, SEC Administrative File No 3-10081 (October 20, 1999); and In re Sitaras, SEC Administrative File No 3-10082 (October 20, 1999) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 28  Investor Protection and Corporate Governance  635 E X HI B I T 28 – 3  S  ome Key Provisions of the Sarbanes-Oxley Act Relating to Corporate Accountability Certification Requirements—Under Section 906 of the Sarbanes-Oxley Act, the chief executive officers (CEOs) and chief financial officers (CFOs) of most major companies listed on public stock exchanges must certify financial statements that are filed with the SEC CEOs and CFOs have to certify that filed financial reports “fully comply” with SEC requirements and that all of the information reported “fairly represents in all material respects, the financial conditions and results of operations of the issuer.”   Under Section 302 of the act, CEOs and CFOs of reporting companies are required to certify that a signing officer reviewed each quarterly and annual filing with the SEC and that none contained untrue statements of material fact Also, the signing officer or officers must certify that they have established an internal control system to identify all material information and that any deficiencies in the system were disclosed to the auditors Effectiveness of Internal Controls on Financial Reporting—Under Section 404(a), all public companies are required to assess the effectiveness of their internal control over financial reporting Section 404(b) requires independent auditors to report on management’s assessment of internal controls, but companies with a public float of less than $75 million are exempted from this requirement Loans to Directors and Officers—Section 402 prohibits any reporting company, as well as any private company that is filing an initial public offering, from making personal loans to directors and executive officers (with a few limited exceptions, such as for certain consumer and housing loans) Protection for Whistleblowers—Section 806 protects “whistleblowers”—employees who report (“blow the whistle” on) securities violations by their employers—from being fired or in any way discriminated against by their employers Blackout Periods—Section 306 prohibits certain types of securities transactions during “blackout periods”—periods during which the issuer’s ability to purchase, sell, or otherwise transfer funds in individual account plans (such as pension funds) is suspended Enhanced Penalties for— • Violations of Section 906 Certification Requirements—A CEO or CFO who certifies a financial report or statement filed with the SEC knowing that the report or statement does not fulfill all of the requirements of Section 906 will be subject to criminal penalties of up to $1 million in fines, ten years in prison, or both Willful violators of the certification requirements may be subject to $5 million in fines, twenty years in prison, or both • Violations of the Securities Exchange Act of 1934—Penalties for securities fraud under the 1934 act were also increased (as discussed earlier in this chapter) Individual violators may be fined up to $5 million, imprisoned for up to twenty years, or both Willful violators may be imprisoned for up to twenty-five years in addition to being fined • Destruction or Alteration of Documents—Anyone who alters, destroys, or conceals documents or otherwise obstructs any official proceeding will be subject to fines, imprisonment for up to twenty years, or both • Other Forms of White-Collar Crime—The act stiffened the penalties for certain criminal violations, such as federal mail and wire fraud, and ordered the U.S Sentencing Commission to revise the sentencing guidelines for white-collar crimes (see Chapter 7) Statute of Limitations for Securities Fraud—Section 804 provides that a private right of action for securities fraud may be brought no later than two years after the discovery of the violation or five years after the violation, whichever is earlier Online Investment Scams As discussed in Chapter 7, the Internet has created a new vehicle for criminals to use to commit fraud and provided them with new ways of targeting innocent investors The criminally inclined can use spam, online newsletters and bulletin boards, chat rooms, blogs, social media, and tweets to spread false information and perpetrate fraud For a relatively small cost, criminals can even build sophisticated Web pages to facilitate their investment scams Fraudulent E-Mail  There are countless variations of investment scams, but they almost always prom- ise spectacular returns for small investments A person might receive spam e-mail that falsely claims that a home business can “turn $5 into $60,000 in just three to six weeks.” Although most people today are dubious of the bogus claims made in spam messages, such offers can appear more attractive during times of economic recession Often, investment scams are simply the electronic version of pyramid schemes in which the participants attempt to profit solely by recruiting new participants Online Investment Newsletters and Forums  Hundreds of online investment newsletters provide free information on stocks Legitimate online Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 636  Unit Six  The Regulatory Environment newsletters can help investors gather valuable information, but some online newsletters are used for fraud The law allows companies to pay people who write these newsletters to tout their securities, but the newsletters are required to disclose who paid for the advertising Many fraudsters either fail to disclose or lie about who paid them Thus, an investor reading an online newsletter may believe that the information is unbiased, when in fact the fraudsters will directly profit by convincing investors to buy or sell particular stocks The same deceptive tactics can be used on online bulletin boards (such as newsgroups and usenet groups), blogs, and social networking sites, including Twitter While hiding their true identity, fraudsters may falsely pump up a company or reveal some “inside” information about a new product or lucrative contract to convince people to invest By using multiple aliases on an online forum, a single person can easily create the illusion of widespread interest in a small stock Ponzi Schemes Although securities fraud is increasingly occurring online, schemes conducted primarily offline have not disappeared In recent years, the SEC has filed an increasing number of enforcement actions against perpetrators of Ponzi schemes (see Chapter 7) Since 2010, the SEC has brought more than a hundred enforcement actions against nearly two hundred individuals and two hundred and fifty entities for carrying out Ponzi schemes It has also barred more than sixty-five persons from working in the securities industry Offshore Fraud  Ponzi schemes sometimes target U.S residents and convince them to invest in offshore companies or banks ▶  Case in Point 28.10  In 2012, Texas billionaire R Allen Stanford, of the Stanford Financial Group, was convicted for orchestrating a $7 billion scheme to defraud more than five thousand investors Stanford had advised clients to buy certificates of deposit with improbably high interest rates from his Antigua-based Stanford International Bank Although some early investors were paid returns from the funds provided by later investors, Stanford used $1.6 billion of the funds for personal purchases He also falsified financial statements that were filed with the SEC and reportedly paid more than $100,000 in bribes to an Antigua official to ensure that the bank would not be audited.37  ◀ “Risk-Free” Fraud  Another type of online fraud scheme offers risk-free or low-risk investments to lure investors ▶  Case in Point 28.11  Michael C Regan used his firm, Regan & Company, to fraudulently obtain at least $15.9 million from dozens of investors by selling securities in his River Stream Fund Regan told investors that he had a “proven track record” of successful securities trading He showed them false account statements and tax returns that listed artificially high account balances In reality, Regan was not a registered investment adviser, had not traded any securities for several years, and had suffered substantial losses on investments he did make Regan promised investors returns averaging 20 percent with minimal risk to their principal and claimed to be using an investment strategy based on “short-term price trends.” He used less than half of the funds entrusted to him for trading purposes and spent at least $2.4 million for his personal and family expenses In 2009, the SEC filed a complaint alleging that Regan and his company had engaged in a multimillion-dollar Ponzi scheme Regan agreed to settle the case and return more than $8.7 million (plus interest) of the wrongfully acquired funds.38  ◀ 37 United States v Stanford, 860 F.Supp.2d 371 (S.D.Tex 2012) 38 You can read the SEC’s complaint against Regan at www.sec.gov/ litigation/complaints/2009/comp21102.pdf Reviewing: Investor Protection and Corporate Governance Dale Emerson served as the chief financial officer for Reliant Electric Company, a distributor of electricity serving portions of Montana and North Dakota Reliant was in the final stages of planning a takeover of Dakota Gasworks, Inc., a natural gas distributor that operated solely within North Dakota Emerson went on a weekend fishing trip with his uncle, Ernest Wallace Emerson mentioned to Wallace that he Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 28  Investor Protection and Corporate Governance  637 had been putting in a lot of extra hours at the office planning a takeover of Dakota Gasworks When he returned from the fishing trip, Wallace purchased $20,000 worth of Reliant stock Three weeks later, Reliant made a tender offer to Dakota Gasworks stockholders and purchased 57 percent of Dakota Gasworks stock Over the next two weeks, the price of Reliant stock rose 72 percent before leveling out Wallace then sold his Reliant stock for a gross profit of $14,400 Using the information presented in the chapter, answer the following questions Would registration with the SEC be required for Dakota Gasworks securities? Why or why not? Did Emerson violate Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5? Why or why not? What theory or theories might a court use to hold Wallace liable for insider trading? Under the Sarbanes-Oxley Act of 2002, who would be required to certify the accuracy of the financial statements Reliant filed with the SEC? Debate This  Insider trading should be legalized Terms and Concepts accredited investor 622 blue sky laws 632 corporate governance 632 free-writing prospectus 620 insider trading 626 investment company 621 investment contract 619 mutual fund 621 prospectus 620 SEC Rule 10b-5 625 securities 618 stock option 632 tippee 627 ExamPrep Issue Spotters When a corporation wishes to issue certain securities, it must provide sufficient information for an unsophisticated investor to evaluate the financial risk involved Specifically, the law imposes liability for making a false statement or omission that is “material.” What sort of information would an investor consider material? (See page 626.) Lee is an officer of Magma Oil, Inc Lee knows that a Magma geologist has just discovered a new deposit of oil Can Lee take advantage of this information to buy and sell Magma stock? Why or why not? (See page 626.) •  Check your answers to the Issue Spotters against the answers provided in Appendix E at the end of this text Before the Test  Go to www.cengagebrain.com, enter the ISBN 9781285428949, and click on “Find” to locate this textbook’s Web site Then, click on “Access Now” under “Study Tools,” and select Chapter 28 at the top There, you will find an Interactive Quiz that you can take to assess your mastery of the concepts in this chapter, as well as Flashcards and a Glossary of important terms Business Scenarios 28–1. Registration Requirements.  Estrada Hermanos, Inc., a corporation incorporated and doing business in Florida, decides to sell $1 million worth of its common stock to the public The stock will be sold only within the state of Florida José Estrada, the chair of the board, says the offering need not be registered with the Securities and Exchange Commission His brother, Gustavo, disagrees Who is right? Explain (See page 620.) 28–2. Registration Requirements.  Huron Corp has 300,000 common shares outstanding The owners of these outstanding shares live in several different states Huron has decided to split the 300,000 shares two for one Will Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 638  Unit Six  The Regulatory Environment Huron Corp have to file a registration statement and prospectus on the 300,000 new shares to be issued as a result of the split? Explain (See page 620.) 28–3. Insider Trading. David Gain was the chief executive officer (CEO) of Forest Media Corp., which became interested in acquiring RS Communications, Inc To initiate negotiations, Gain met with RS’s CEO, Gill Raz, on Friday, July 12 Two days later, Gain phoned his brother Mark, who bought 3,800 shares of RS stock on the following Monday Mark discussed the deal with their father, Jordan, who bought 20,000 RS shares on Thursday On July 25, the day before the RS bid was due, Gain phoned his parents’ home, and Mark bought another 3,200 RS shares The same routine was followed over the next few days, with Gain periodically phoning Mark or Jordan, both of whom continued to buy RS shares Forest’s bid was refused, but on August 5, RS announced its merger with another company The price of RS stock rose 30 percent, increasing the value of Mark and Jordan’s shares by $664,024 and $412,875, respectively Did Gain engage in insider trading? What is required to impose sanctions for this offense? Could a court hold Gain liable? Why or why not? (See page 626.) Business Case Problems 28–4.  Violations of the 1934 Act.  To comply with accounting principles, a company that engages in software development must either “expense” the cost (record it immediately on the company’s financial statement) or “capitalize” it (record it as a cost incurred in increments over time) If the project is in the pre- or post-development stage, the cost must be expensed Otherwise it may be capitalized Capitalizing a cost makes a company look more profitable in the short term Digimarc Corp., which provides secure personal identification documents, announced that it had improperly capitalized software development costs over at least the previous eighteen months The errors resulted in $2.7 million in overstated earnings, requiring a restatement of prior financial statements Zucco Partners, LLC, which had bought Digimarc stock within the relevant period, filed a suit in a federal district court against the firm Zucco claimed that it could show that there had been disagreements within Digimarc over its accounting Is this sufficient to establish a violation of SEC Rule 10b5? Why or why not? [Zucco Partners, LLC v Digimarc Corp., 552 F.3d 981 (9th Cir 2009)] (See page 629.) 28–5. Insider Trading.  Jabil Circuit, Inc., is a publicly traded electronics and technology company headquartered in St Petersburg, Florida In 2008, a group of shareholders who had owned Jabil stock from 2001 to 2007 sued the company and its auditors, directors, and officers for insider trading Jabil’s compensation for executives included stock options Some stock options were backdated to a point in time when the stock price was lower, making the options worth more to certain company executives Backdating is legal as long as it is reported, but Jabil did not report that backdating had occurred Thus, expenses were understated and net income was overstated by millions of dollars The shareholders claimed that by rigging the value of the stock options by backdating, the executives had engaged in insider trading The shareholders also asserted that there was a pattern of stock sales by executives before unfavorable news about the company was reported to the public The shareholders, however, had no specific information about these stock trades or when (or even if) a particular executive was aware of any accounting errors related to backdating Were the shareholders’ allegations sufficient to assert that insider trading had occurred under SEC Rule 10b-5? Why or why not? [Edward J Goodman Life Income Trust v Jabil Circuit, Inc., 594 F.3d 783 (11th Cir 2010)] (See page 626.) 28–6.  Business Case Problem with Sample Answer:  Violations of the 1934 Act.  Matrixx Initiatives, Inc., makes and sells over-thecounter pharmaceutical products Its core brand is Zicam, which accounts for 70 percent of its sales Matrixx received reports that some consumers had lost their sense of smell (a condition called anosmia) after using Zicam Cold
 Remedy Four product liability suits were filed against Matrixx,
 seeking damages for anosmia In public statements relating to revenues and product safety, however, Matrixx did not reveal 
this information James Siracusano and other Matrixx investors 
filed a suit in a federal district court against the company and
its executives under Section 10(b) of the Securities Exchange
Act of 1934 and SEC Rule 10b-5, claiming that the statements 
were misleading because they did not disclose the information
 regarding the product liability suits Matrixx argued that to be
 material, information must consist of a statistically significant number of adverse events that require disclosure Because Siracusano’s claim did not allege that Matrixx knew of a statistically significant number of adverse events, the company contended that the claim should be dismissed What is the standard for materiality in this context? Should Siracusano’s claim be dismissed? Explain [Matrixx Initiatives, Inc v Siracusano, 
U.S , 131 S.Ct 1309, 179 L.Ed.2d 398 (2011)] (See page 629.) •  For a sample answer to Problem 28–6, go to Appendix F at the end of this text 28–7. Disclosure under SEC Rule 10b-5. Dodona I, LLC, invested $4 million in two securities offerings from Goldman, Sachs & Co The investments were in collateralized debt obligations (CDOs) Their value depended on residential mortgage-backed securities (RMBS), whose value in turn depended on the performance of Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 28  Investor Protection and Corporate Governance  subprime residential mortgages Before marketing the CDOs, Goldman had noticed several “red flags” relating to investments in the subprime market, in which it had invested heavily To limit its risk, Goldman began betting against subprime mortgages, RMBS, and CDOs, including the CDOs it had sold to Dodona In an internal e-mail, one Goldman official commented that the company had managed to “make some lemonade from some big old lemons.” Nevertheless, Goldman’s marketing materials provided only boilerplate statements about the risks of investing in the securities The CDOs were later downgraded to junk status, and Dodona suffered a major loss while Goldman profited Assuming that Goldman did not affirmatively misrepresent any facts about the CDOs, can Dodona still recover under SEC Rule 10b-5? If so, how? [Dodona I, LLC v Goldman, Sachs & Co., 847 F.Supp.2d 624 (S.D.N.Y 2012)] (See page 625.) 28–8.  A Question of Ethics:  Violations of the 1934 Act Melvin Lyttle told John Montana and Paul Knight about a “Trading Program” that purportedly would buy and sell securities in deals that were fully insured, as well as monitored and controlled by the Federal Reserve Without checking the details or even verifying whether the Program existed, Montana and Knight, with Lyttle’s help, began to sell interests in the Program to investors For a minimum investment of $1 million, the investors were promised extraordinary rates of return—from 10 percent to as much as 100 percent per week—without risk They were told, 639 among other things, that the Program would “utilize banks that can ensure full bank integrity of The Transaction whose undertaking[s] are in complete harmony with international banking rules and protocol and who guarantee maximum security of a Funder’s Capital Placement Amount.” Nothing was required but the investors’ funds and their silence—the Program was to be kept secret Over a four-month period in 1999, Montana raised approximately $23 million from twenty-two investors The promised gains did not accrue, however Instead, Montana, Lyttle, and Knight depleted investors’ funds in highrisk trades or spent the funds on themselves [SEC v Montana, 464 F.Supp.2d 772 (S.D.Ind 2006)] (See page 629.) (a) The Securities and Exchange Commission (SEC) filed a suit in a federal district court against Montana and the others, seeking an injunction, civil penalties, and refund of profits with interest The SEC alleged, among other things, violations of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 What is required to establish such violations? Describe how and why the facts in this case meet, or fail to meet, these requirements (b) It is often remarked, “There’s a sucker born every minute!” Does that phrase describe the Program’s investors? Ultimately, about half of the investors recouped the amount they invested Should the others be considered at least partly responsible for their own losses? Why or why not? Legal Reasoning Group Activity 28–9.  Violations of Securities Laws. Karel Svoboda, a credit officer for Rogue Bank, evaluated and approved his employer’s extensions of credit to clients These responsibilities gave Svoboda access to nonpublic information about the clients’ earnings, performance, acquisitions, and business plans from confidential memos, e-mail, and other sources Svoboda devised a scheme with Alena Robles, an independent accountant, to use this information to trade securities Pursuant to their scheme, Robles traded in the securities of more than twenty different companies and profited by more than $2 million Svoboda also executed trades for his own profit of more than $800,000, despite their agreement that Robles would all of the trading Aware that their scheme violated Rogue Bank’s policy, they attempted to conduct their trades to avoid suspicion When the bank questioned Svoboda about his actions, he lied, refused to cooperate, and was fired (See page 626.) (a) The first group will determine whether Svoboda or Robles committed any crimes (b) The second group will decide whether Svoboda or Robles is subject to civil liability If so, who could file a suit and on what ground? What are the possible sanctions? (c) A third group will identify any defenses that Svoboda or Robles could raise and determine their likelihood of success Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it 640  Six  Unit Eight  Business Organizations Unit Focus on Ethics Ethics and the Regulatory Environment If this text had been written a hundred years ago, it would have had little to say about federal government regulation Today, in contrast, just about every area of economic activity is regulated by the government Ethical issues in government regulation arise because regulation, by its very nature, means that some traditional rights and freedoms must be given up to ensure that other rights and freedoms are protected Essentially, government regulation brings two ethical principles into conflict On the one hand, deeply embedded in American culture is the idea that the government should play a limited role in directing our lives On the other hand, one of the basic functions of government is to protect the welfare of individuals and the environment in which they live Ultimately, nearly every law or rule regulating business represents a decision to give up certain rights in order to protect other perceived rights In this Focus on Ethics feature, we look at some of the ethical aspects of government regulation Television Programmers and Antitrust Law When consumers want cable or satellite television programming, they can choose among various cable and satellite providers, or distributors, but each distributor will offer multichannel packages In other words, a consumer cannot order just the channels that she or he watches regularly All of the multichannel packages include some very popular channels and some other channels that have very low viewership Thus, consumers are forced to pay for some unwanted channels in order to get the ones they want A group of consumers sued NBC Universal, the Walt Disney Company, and other programmers, as well as cable and satellite distributors The consumers claimed that the defendants, because of their full or partial ownership of broadcast channels and their ownership or control of multiple cable or satellite channels, had a higher degree of market power vis-à-vis all distributors They also claimed that the programmers had exploited this power by requiring the “bundling” of numerous channels in each multichannel package offered to consumers The U.S Court of Appeals for the Ninth Circuit disagreed The court pointed out that the Sherman Act applies to actions that diminish competition and, in this instance, there was still competition among programmers and distributors.1 over voice messages or voice mails left by debt collectors The Fair Debt Collection Practices Act (FDCPA) prohibits disclosures about a debt to third parties Does leaving a voice message regarding a debt collection on an answering machine constitute such a disclosure? That depends on the jurisdiction and the situation In one case, a Florida court ruled in favor of the debtor It stated that if a collection agency leaves a voice message for a consumer on an answering machine—even at home—other people (third parties) could hear the message.2 In another case, a federal district court in California held that a debt-collection company had violated the FDCPA by leaving a voice message for the debtor The message announcing that the debtor had failed to pay his auto insurance was overheard by his mother.3 In contrast, a federal court in Minnesota held that leaving voice messages on a debtor’s cell phone did not violate the FDCPA, even though the debtor’s children listened to them Because the messages did not identify the debtor or the debt, the court reasoned that “they conveyed no more information than would have been obvious in caller ID.” The suit against the debt collector was dismissed.4 Legal Reasoning Do you think that debt collectors should be able to leave voice messages regarding the debt on a debtor’s phone? Why or why not? Does the fact that many people today only have cell phones affect your answer? Explain Environmental Law Questions of fairness inevitably arise in regard to environmental law Has the government gone too far—or not far enough—in regulating businesses in the interest of protecting the environment? At what point the costs of environmental regulations become too burdensome for society to bear? Consider the problem of toxic waste Although everybody is in favor of cleaning up America’s toxic waste dumps, nobody knows what this task will ultimately cost Moreover, there is no agreed-on standard as to how clean a site must be before it no longer poses any threat Must 100 percent of the contamination be removed, or would removal of some lesser amount achieve a reasonable degree of environmental quality? Legal Reasoning Concerns over Pharmaceuticals in Drinking Water Should TV programmers and distributors be held in violation of the Sherman Act for requiring consumers to buy multichannel packages? Why or why not? The amount of pharmaceuticals used by the U.S public and in agriculture (antibiotics and hormones given to livestock) has grown substantially in recent years Widespread trace amounts of many drugs have been detected in our nation’s water supply The drinking water of at least 41 million Americans Privacy Concerns and the Fair Debt Collection Practices Act Debt-collection practices have often raised privacy concerns There have been many lawsuits against collection agencies Brantley v NBC Universal, Inc., 675 F.3d 1192 (9th Cir 2012) Berg v Merchants Association Collection Division, Inc., 586 F.Supp.2d 1336 (S.D.Fla 2008) Branco v Credit Collection Services, Inc., 2011 WL 3684503 (E.D.Cal 2011) Zortman v J.C Christensen & Associates, Inc., 2012 WL 1563918 (D.Minn 2012) 640 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Chapter 42  Securities Law and Corporate Governance  Unit Six  Focus on Ethics 641 Ethics and the Regulatory Environment, Continued in twenty-four regions across the country has been found to contain small amounts of prescription drugs Some of these trace amounts came from unmetabolized drugs that had passed through the humans and animals that ingested them, but the rest had been flushed down the toilet For many years, pharmacists, physicians, and the federal government have recommended that people dispose of unused medications by flushing them away This prevents children from accidentally ingesting the drugs and keeps controlled substances such as the painkillers oxycodone and morphine from falling into the hands of people who might abuse them At the time, no one considered the long-term effect on the environment of adding pharmaceuticals to the water supply The quantities present in water now are far below medicinal doses, but no one knows how long-term exposure to random combinations of drugs will affect humans or wildlife As yet, there is little scientific evidence about the long-term effects The federal government does not require drinking water to be tested for drugs, so Americans not know whether their drinking water is contaminated Requiring that water be tested and that all traces of drugs be filtered from it would be enormously expensive Legal Reasoning Should the government wait until there is scientific proof of the harmful effects on humans and wildlife before attempting to regulate pharmaceuticals in drinking water? Or should the government enact legislation to address the problem now— before it becomes worse? Discuss fully Land-Use Regulations and the “Takings Clause” When property owners claim that a “regulatory taking” has occurred, the courts decide the issue on a case-by-case basis In other words, there is no general rule that indicates whether a specific situation will be deemed a taking In a case decided in 2010, a group of Florida beachfront property owners challenged the constitutionality of the state’s decision to add seventy-five feet of sand to the shoreline Under Florida law, the boundary between private beachfront property and state-owned land is ordinarily the average high-water line The state owns any land submerged beneath the ocean or other navigable waters It is common for storms to cause some fluctuation in the shoreline, however, as sand is deposited or washed away by waves A change that occurs gradually and imperceptibly over time is called an accretion, whereas a sudden change is called an avulsion If an accretion deposits more sand on the shore, the owners of private beachfront property automatically acquire ownership rights to more land—to the new high-water line If an avulsion occurs, however, the property owners’ boundaries remain the same, so the state owns the land abutting the water’s edge As a result of several hurricanes, 6.9 miles of beach were eroded (an avulsion) in the city of Destin and Walton County The state therefore requested and received a permit from the Florida Department of Environmental Protection to add seventy-­five feet of dry sand on its side (the seaward side) of the high-water line Owners of the private beachfront property in the area formed a nonprofit corporation to fight the proposed addition of sand, but they lost at an administrative hearing They then filed a lawsuit claiming that the state’s action constituted an unlawful taking of their beachfront property The Courts Disagree  A Florida appellate court agreed with the property owners that the state had taken their rights to receive accretions and to have their property remain in contact with the water The Florida Supreme Court reversed, and the United States Supreme Court granted certiorari The United States Supreme Court held that Florida had not engaged in an unconstitutional taking According to the Court, there was no taking because the property owners did not show that their rights to future accretions and to contact with the water were superior to Florida’s right to fill in its submerged land The state did not relocate the property line to take private property, but simply added sand to property that it already owned (on the side toward the water) Therefore, the state had a right to restore the beach even though the addition of sand interfered with the property owners’ rights to have their property touch the water.5 Although a majority of the Supreme Court justices concurred in the result, there were substantial differences in their reasoning A Question of Fairness  The question of whether private landowners should be compensated when their land is essentially “taken” for public use by environmental and land-use regulations clearly involves issues of fairness On the one hand, states, cities, and other local governments want to preserve their natural resources and need some authority to regulate land use to achieve this goal On the other hand, private property owners complain that they alone should not have to bear the costs of creating a benefit—such as more sandy beaches for recreation or environmental preservation These are benefits that all members of the public enjoy In addition, as a different group of Florida beachfront property owners complained in 2013, if the state adds sand to beaches in front of their property, it may lower the property’s value Legal Reasoning Is it fair for courts to decide whether a regulatory taking has occurred on a case-by-case basis, rather than articulating a general rule on which landowners can rely? Why or why not? Stop the Beach Renourishment, Inc v Florida Department of Environmental Protection, _ U.S _, 130 S.Ct 2592, 177 L.Ed.2d 184 (2010) Focus on Ethics CONTINUES  • 641 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Unit Six  Focus on Ethics Ethics and the Regulatory Environment, Continued Corporate Blogs and Tweets and Securities Fraud In the fast-paced world of securities trading, there is a great demand for the latest information about companies, earnings, and market conditions Corporations have adapted to technology by establishing Web sites and blogs, and by using other social and online media, such as Twitter and online shareholder forums Nearly 20 percent of Fortune 500 companies sponsor blogs Corporations that use the Internet to distribute information about the company to investors, however, need to make sure that they comply with the regulations issued by the SEC The SEC treats statements by employees in online media, such as blogs and Twitter, the same as any other company statements for purposes of federal securities laws “Tweets” That Contain Financial Information  Some corporate blogs include links to corporate employees’ Twitter accounts so that readers can communicate directly with, and get updates from, the individual who posted the information For example, when eBay, Inc., launched its corporate blog, it hired Richard Brewer-Hay, a seasoned blogger, to report online He began tweeting about eBay’s quarterly earnings and what took place at Silicon Valley technology conferences Brewer-Hay’s tweets won him a following, but then eBay’s lawyers required him to include a regulatory disclaimer with certain posts to avoid problems with the SEC Many of his followers were disappointed by the company’s oversight, which put an end to his spontaneous, personal, and informal style Brewer-Hay’s tweets on financial matters became much more reserved and often simply repeated eBay executives’ statements verbatim.6 The SEC Provides Guidance  The reaction of eBay’s lawyers to Brewer-Hay’s tweets was prompted in part by an interpretive release that the SEC issued in August 2008 The SEC generally Cari Tuna, “Corporate Blogs and ‘Tweets’ Must Keep SEC in Mind,” online.wsj com, April 27, 2009 embraces new technology and encourages companies to use electronic communication methods The SEC noted that “the use of the Internet has grown such that, for some companies in certain circumstances, posting of the information on the company’s Web site, in and of itself, may be a sufficient method of public disclosure.” The release also addressed company-sponsored blogs, electronic shareholders’ forums, and other “interactive Web site features.” The SEC acknowledged that blogs and other interactive Web features are a useful means of ongoing communications among companies, their clients, investors, shareholders, and stakeholders The SEC cautioned, though, that all communications made by or on behalf of a company are subject to the antifraud provisions of federal securities laws “While blogs or forums can be informal and conversational in nature, statements made there will not be treated differently from other company statements.” In addition, the release stated that companies cannot require investors to waive protections under federal securities laws as a condition of participating in a blog or forum (The release also cautioned companies that they can, in some situations, be liable for providing hyperlinks to third party information or inaccurate summaries of financial information on their Web sites.)7 Legal Reasoning When a company’s executives offer opinions about the firm’s financial status and future business prospects through blogs, social media, and other Internet forums, the SEC can hold the company liable for violating securities laws Is this fair to investors who want to hear the straight scoop from the firm’s executives? What arguments can you make in favor of this restriction? What arguments can you make against it? SEC Release Nos 34–58288, IC–28351, File No.S7–23–08 Commission Guidance on the Use of Company Web Sites 642 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it appendix A How to Brief Cases and Analyze Case Problems How to Brief Cases To fully understand the law with respect to business, you need to be able to read and understand court decisions To make this task easier, you can use a method of case analysis that is called briefing There is a fairly standard procedure that you can follow when you “brief” any court case You must first read the case opinion carefully When you feel you understand the case, you can prepare a brief of it Although the format of the brief may vary, typically it will present the essentials of the case under headings such as those listed below Citation. Give the full citation for the case, including the name of the case, the date it was decided, and the court that decided it Facts.  Briefly indicate (a) the reasons for the lawsuit; (b) the identity and arguments of the plaintiff(s) and defendant(s), respectively; and (c) the lower court’s decision—if appropriate Issue.  Concisely phrase, in the form of a question, the essential issue before the court (If more than one issue is involved, you may have two—or even more—questions here.) Decision.  Indicate here—with a “yes” or “no,” if possible—the court’s answer to the question (or questions) in the Issue section above Reason. Summarize as briefly as possible the reasons given by the court for its decision (or decisions) and the case or statutory law relied on by the court in arriving at its decision An Example of a Briefed Sample Court Case As an example of the format used in briefing cases, we present here a briefed version of the sample court case that was presented in Chapter in Exhibit 1–6 Apple, inc v amazon.com, inc United States District Court, Northern District of California, F.Supp.2d , 2013 WL 11896 (2013) FACTS  In July 2008, Apple, Inc began to sell applications for its mobile devices through its APP STORE service In March 2011, Amazon.com, Inc., launched the Amazon Appstore for Android Apple filed a suit in a federal district court against Amazon in the same month, asserting false advertising Apple alleged that that by using the word “Appstore” in the name of Amazon’s store, Amazon implied that its store was affili- ated with or sponsored by Apple Apple argued that Amazon’s service did not have the characteristics and qualities that the public had come to expect from the name APP STORE For this reason, Apple contended, Amazon’s use of “Appstore” misled the public Amazon filed a motion for summary judgment issue Can a vendor use the term “Appstore” to designate a site for buying apps without representing that the nature, characteristics, or quality of the site is the same as that of another vendor’s “APP STORE”? Decision  Yes The court granted Amazon’s motion for summary judgment Reason The court pointed out that a false advertising claim requires either a false statement of fact in an ad or evidence showing “exactly what message was conveyed that was sufficient to constitute false advertising.” Here, Apple failed to show that Amazon made any false statement and presented no evidence that consumers were misled Apple did not show that consumers understood “app store” to include specific qualities, characteristics, or attributes of the Apple APP STORE or were otherwise misled by Amazon’s use of the term Nothing indicated that a consumer would expect the two sites to be identical—especially considering that Apple sold apps solely for Apple devices and Amazon sold apps solely for Android and Kindle devices Apple did not make clear how Amazon’s use of Appstore constituted a “statement” that implied something false about Apple’s APP STORE Apple “made no showing that such (implied) statement deceived or had a tendency to deceive users of Amazon’s Appstore.” Review of Sample Court Case Here we provide a review of the briefed version to indicate the kind of information that is contained in each section Citation  The name of the case is Apple, Inc v Amazon.com, Inc Apple is the plaintiff Amazon is the defendant The U.S District Court for the Northern District of California (a trial court) decided this case in 2013 The citation states that this case can be found in volume _ of the Federal Supplement, Second Series, on page _, and on Westlaw® at 2013 WL 11896 Facts The Facts section identifies the plaintiff and the defendant, describes the events leading up to this suit and the allegations made by the plaintiff in the suit If this case were a decision of one of the U.S courts of appeals, the lower court’s ruling, the party appealing, and the appellant’s contention on appeal would also be included here A–1 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–2  Appendix A  How to Brief Cases and Analyze Case Problems Issue The Issue section presents the central issue (or issues) decided by the court This case involves a false advertising claim The court considers whether a vendor can use the term “Appstore” to designate a site for buying apps without representing that the nature, characteristics, or quality of the site is the same as that of another vendor’s “APP STORE.” Decision The Decision section includes the court’s decision on the issues before it The decision reflects the opinion of the judge or justice hearing the case Here, the court determined that consumers were not deceived by the two vendors’ use of the same term There was no evidence that consumers understood “app store” to include specific qualities, characteristics, or attributes or were otherwise misled by the use of the term Decisions by appellate courts are frequently phrased in reference to the lower court’s decision That is, the appellate court may “affirm” the lower court’s ruling or “reverse” it Reason The Reason section includes references to the relevant laws and legal principles that were applied in coming to the conclusion arrived at in the case before the court The relevant law here included the principle that a false advertising claim requires either a false statement of fact in an ad or evidence showing “exactly what message was conveyed that was sufficient to constitute false advertising.” This section also explains the court’s application of the law to the facts in this case Analyzing Case Problems In addition to learning how to brief cases, students of business law and the legal environment also find it helpful to know how to analyze case problems Part of the study of business law and the legal environment usually involves analyzing case problems, such as those included in this text at the end of each chapter For each case problem in this book, we provide the relevant background and facts of the lawsuit and the issue before the court When you are assigned one of these problems, your job will be to determine how the court should decide the issue, and why In other words, you will need to engage in legal analysis and reasoning Here, we offer some suggestions on how to make this task less daunting We begin by presenting a sample problem: While Janet Lawson, a famous pianist, was shopping in Quality Market, she slipped and fell on a wet floor in one of the aisles The floor had recently been mopped by one of the store’s employees, but there were no signs warning customers that the floor in that area was wet As a result of the fall, Lawson injured her right arm and was unable to perform piano concerts for the next six months Had she been able to perform the scheduled concerts, she would have earned approximately $60,000 over that period of time Lawson sued Quality Market for this amount, plus another $10,000 in medical expenses She claimed that the store’s failure to warn customers of the wet floor constituted negligence and therefore the market was liable for her injuries Will the court agree with Lawson? Discuss Understand the Facts This may sound obvious, but before you can analyze or apply the relevant law to a specific set of facts, you must clearly understand those facts In other words, you should read through the case problem carefully—more than once, if necessary—to make sure you understand the identity of the plaintiff(s) and defendant(s) in the case and the progression of events that led to the lawsuit In the sample case problem just given, the identity of the parties is fairly obvious Janet Lawson is the one bringing the suit—therefore, she is the plaintiff Quality Market, against whom she is bringing the suit, is the defendant Some of the case problems you may work on have multiple plaintiffs or defendants Often, it is helpful to use abbreviations for the parties To indicate a reference to a plaintiff, for example, the pi symbol—p—is often used, and a defendant is denoted by a delta—D—a triangle The events leading to the lawsuit are also fairly straightforward Lawson slipped and fell on a wet floor, and she contends that Quality Market should be liable for her injuries because it was negligent in not posting a sign warning customers of the wet floor When you are working on case problems, realize that the facts should be accepted as they are given For example, in our sample problem, it should be accepted that the floor was wet and that there was no sign In other words, avoid making conjectures, such as “Maybe the floor wasn’t too wet,” or “Maybe an employee was getting a sign to put up,” or “Maybe someone stole the sign.” Questioning the facts as they are presented only adds confusion to your analysis Legal Analysis and Reasoning Once you understand the facts given in the case problem, you can begin to analyze the case Recall from Chapter that the IRAC method is a helpful tool to use in the legal analysis and reasoning process IRAC is an acronym for Issue, Rule, Application, Conclusion Applying this method to our sample problem would involve the following steps: First, you need to decide what legal issue is involved in the case In our sample case, the basic issue is whether Quality Market’s failure to warn customers of the wet floor constituted negligence As discussed in Chapter 12, negligence is a tort—a civil wrong In a tort lawsuit, the plaintiff seeks to be compensated for another’s wrongful act A defendant will be deemed negligent if he or she breached a duty of care owed to the plaintiff and the breach of that duty caused the plaintiff to suffer harm Once you have identified the issue, the next step is to determine what rule of law applies to the issue To make this determination, you will want to review carefully the text of the chapter in which the relevant rule of law for the problem appears Our sample case problem involves the tort of Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix A  How to Brief Cases and Analyze Case Problems  negligence, which is covered in Chapter 12 The applicable rule of law is the tort law principle that business owners owe a duty to exercise reasonable care to protect their customers (“business invitees”) Reasonable care, in this context, includes either removing—or warning customers of—foreseeable risks about which the owner knew or should have known Business owners need not warn customers of “open and obvious” risks, however If a business owner breaches this duty of care (fails to exercise the appropriate degree of care toward customers), and the breach of duty causes a customer to be injured, the business owner will be liable to the customer for the customer’s injuries The next—and usually the most difficult—step in analyzing case problems is the application of the relevant rule of law to the specific facts of the case you are studying In our sample problem, applying the tort law principle just discussed presents few difficulties An employee of the store had mopped the floor in the aisle where Lawson slipped and fell, but no sign was present indicating that the floor was wet That a customer might fall on a wet floor is clearly a foreseeable risk Therefore, the failure to warn customers about the wet floor was a breach of the A–3 duty of care owed by the business owner to the store’s customers Once you have completed Step in the IRAC method, you should be ready to draw your conclusion In our sample problem, Quality Market is liable to Lawson for her injuries, because the market’s breach of its duty of care caused Lawson’s injuries The fact patterns in the case problems presented in this text are not always as simple as those presented in our sample problem Often, for example, a case has more than one plaintiff or defendant A case may also involve more than one issue and have more than one applicable rule of law Furthermore, in some case problems the facts may indicate that the general rule of law should not apply For example, suppose that a store employee advised Lawson not to walk on the floor in the aisle because it was wet, but Lawson decided to walk on it anyway This fact could alter the outcome of the case because the store could then raise the defense of assumption of risk (see Chapter 12) Nonetheless, a careful review of the chapter should always provide you with the knowledge you need to analyze the problem thoroughly and arrive at accurate conclusions Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it appendix B The Constitution of the United States Preamble We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, ordain and establish this Constitution for the United States of America Article I Section 1. All legislative Powers herein granted shall be vested in a Congress of the United States, which shall consist of a Senate and House of Representatives Section 2. The House of Representatives shall be composed of Members chosen every second Year by the People of the several States, and the Electors in each State shall have the Qualifications requisite for Electors of the most numerous Branch of the State Legislature No Person shall be a Representative who shall not have attained to the Age of twenty five Years, and been seven Years a Citizen of the United States, and who shall not, when elected, be an Inhabitant of that State in which he shall be chosen Representatives and direct Taxes shall be apportioned among the several States which may be included within this Union, according to their respective Numbers, which shall be determined by adding to the whole Number of free Persons, including those bound to Service for a Term of Years, and excluding Indians not taxed, three fifths of all other Persons The actual Enumeration shall be made within three Years after the first Meeting of the Congress of the United States, and within every subsequent Term of ten Years, in such Manner as they shall by Law direct The Number of Representatives shall not exceed one for every thirty Thousand, but each State shall have at Least one Representative; and until such enumeration shall be made, the State of New Hampshire shall be entitled to chuse three, Massachusetts eight, Rhode Island and Providence Plantations one, Connecticut five, New York six, New Jersey four, Pennsylvania eight, Delaware one, Maryland six, Virginia ten, North Carolina five, South Carolina five, and Georgia three When vacancies happen in the Representation from any State, the Executive Authority thereof shall issue Writs of Election to fill such Vacancies The House of Representatives shall chuse their Speaker and other Officers; and shall have the sole Power of Impeachment Section 3.  The Senate of the United States shall be composed of two Senators from each State, chosen by the Legislature thereof, for six Years; and each Senator shall have one Vote Immediately after they shall be assembled in Consequence of the first Election, they shall be divided as equally as may be into three Classes The Seats of the Senators of the first Class shall be vacated at the Expiration of the second Year, of the second Class at the Expiration of the fourth Year, and of the third Class at the Expiration of the sixth Year, so that one third may be chosen every second Year; and if Vacancies happen by Resignation, or otherwise, during the Recess of the Legislature of any State, the Executive thereof may make temporary Appointments until the next Meeting of the Legislature, which shall then fill such Vacancies No Person shall be a Senator who shall not have attained to the Age of thirty Years, and been nine Years a Citizen of the United States, and who shall not, when elected, be an Inhabitant of that State for which he shall be chosen The Vice President of the United States shall be President of the Senate, but shall have no Vote, unless they be equally divided The Senate shall chuse their other Officers, and also a President pro tempore, in the Absence of the Vice President, or when he shall exercise the Office of President of the United States The Senate shall have the sole Power to try all Impeachments When sitting for that Purpose, they shall be on Oath or Affirmation When the President of the United States is tried, the Chief Justice shall preside: And no Person shall be convicted without the Concurrence of two thirds of the Members present Judgment in Cases of Impeachment shall not extend further than to removal from Office, and disqualification to hold and enjoy any Office of honor, Trust, or Profit under the United States: but the Party convicted shall nevertheless be liable and subject to Indictment, Trial, Judgment, and Punishment, according to Law Section 4. The Times, Places and Manner of holding Elections for Senators and Representatives, shall be prescribed in each State by the Legislature thereof; but the Congress may at any time by Law make or alter such Regulations, except as to the Places of chusing Senators The Congress shall assemble at least once in every Year, and such Meeting shall be on the first Monday in December, unless they shall by Law appoint a different Day Section 5.  Each House shall be the Judge of the Elections, Returns, and Qualifications of its own Members, and a Majority of each shall constitute a Quorum to Business; but a smaller Number may adjourn from day to day, and may be authorized to compel the Attendance of absent Members, in such Manner, and under such Penalties as each House may provide Each House may determine the Rules of its Proceedings, punish its Members for disorderly Behavior, and, with the Concurrence of two thirds, expel a Member A–5 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–6  Appendix B  The Constitution of the United States Each House shall keep a Journal of its Proceedings, and from time to time publish the same, excepting such Parts as may in their Judgment require Secrecy; and the Yeas and Nays of the Members of either House on any question shall, at the Desire of one fifth of those Present, be entered on the Journal Neither House, during the Session of Congress, shall, without the Consent of the other, adjourn for more than three days, nor to any other Place than that in which the two Houses shall be sitting Section 6.  The Senators and Representatives shall receive a Compensation for their Services, to be ascertained by Law, and paid out of the Treasury of the United States They shall in all Cases, except Treason, Felony and Breach of the Peace, be privileged from Arrest during their Attendance at the Session of their respective Houses, and in going to and returning from the same; and for any Speech or Debate in either House, they shall not be questioned in any other Place No Senator or Representative shall, during the Time for which he was elected, be appointed to any civil Office under the Authority of the United States, which shall have been created, or the Emoluments whereof shall have been increased during such time; and no Person holding any Office under the United States, shall be a Member of either House during his Continuance in Office Section 7.  All Bills for raising Revenue shall originate in the House of Representatives; but \the Senate may propose or concur with Amendments as on other Bills Every Bill which shall have passed the House of Representatives and the Senate, shall, before it become a Law, be presented to the President of the United States; If he approve he shall sign it, but if not he shall return it, with his Objections to the House in which it shall have originated, who shall enter the Objections at large on their Journal, and proceed to reconsider it If after such Reconsideration two thirds of that House shall agree to pass the Bill, it shall be sent together with the Objections, to the other House, by which it shall likewise be reconsidered, and if approved by two thirds of that House, it shall become a Law But in all such Cases the Votes of both Houses shall be determined by Yeas and Nays, and the Names of the Persons voting for and against the Bill shall be entered on the Journal of each House respectively If any Bill shall not be returned by the President within ten Days (Sundays excepted) after it shall have been presented to him, the Same shall be a Law, in like Manner as if he had signed it, unless the Congress by their Adjournment prevent its Return in which Case it shall not be a Law Every Order, Resolution, or Vote, to which the Concurrence of the Senate and House of Representatives may be necessary (except on a question of Adjournment) shall be presented to the President of the United States; and before the Same shall take Effect, shall be approved by him, or being disapproved by him, shall be repassed by two thirds of the Senate and House of Representatives, according to the Rules and Limitations prescribed in the Case of a Bill Section 8.  The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States; To borrow Money on the credit of the United States; To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes; To establish an uniform Rule of Naturalization, and uniform Laws on the subject of Bankruptcies throughout the United States; To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures; To provide for the Punishment of counterfeiting the Securities and current Coin of the United States; To establish Post Offices and post Roads; To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries; To constitute Tribunals inferior to the supreme Court; To define and punish Piracies and Felonies committed on the high Seas, and Offenses against the Law of Nations; To declare War, grant Letters of Marque and Reprisal, and make Rules concerning Captures on Land and Water; To raise and support Armies, but no Appropriation of Money to that Use shall be for a longer Term than two Years; To provide and maintain a Navy; To make Rules for the Government and Regulation of the land and naval Forces; To provide for calling forth the Militia to execute the Laws of the Union, suppress Insurrections and repel Invasions; To provide for organizing, arming, and disciplining, the Militia, and for governing such Part of them as may be employed in the Service of the United States, reserving to the States respectively, the Appointment of the Officers, and the Authority of training the Militia according to the discipline prescribed by Congress; To exercise exclusive Legislation in all Cases whatsoever, over such District (not exceeding ten Miles square) as may, by Cession of particular States, and the Acceptance of Congress, become the Seat of the Government of the United States, and to exercise like Authority over all Places purchased by the Consent of the Legislature of the State in which the Same shall be, for the Erection of Forts, Magazines, Arsenals, dock-Yards, and other needful Buildings;—And To make all Laws which shall be necessary and proper for carrying into Execution the foregoing Powers, and all other Powers vested by this Constitution in the Government of the United States, or in any Department or Officer thereof Section 9.  The Migration or Importation of such Persons as any of the States now existing shall think proper to admit, shall not be prohibited by the Congress prior to the Year one thousand eight hundred and eight, but a Tax or duty may be imposed on such Importation, not exceeding ten dollars for each Person The privilege of the Writ of Habeas Corpus shall not be suspended, unless when in Cases of Rebellion or Invasion the public Safety may require it No Bill of Attainder or ex post facto Law shall be passed Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix B  The Constitution of the United States  No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken No Tax or Duty shall be laid on Articles exported from any State No Preference shall be given by any Regulation of Commerce or Revenue to the Ports of one State over those of another: nor shall Vessels bound to, or from, one State be obliged to enter, clear, or pay Duties in another No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law; and a regular Statement and Account of the Receipts and Expenditures of all public Money shall be published from time to time No Title of Nobility shall be granted by the United States: And no Person holding any Office of Profit or Trust under them, shall, without the Consent of the Congress, accept of any present, Emolument, Office, or Title, of any kind whatever, from any King, Prince, or foreign State Section 10.  No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility No State shall, without the Consent of the Congress, lay any Imposts or Duties on Imports or Exports, except what may be absolutely necessary for executing its inspection Laws: and the net Produce of all Duties and Imposts, laid by any State on Imports or Exports, shall be for the Use of the Treasury of the United States; and all such Laws shall be subject to the Revision and Controul of the Congress No State shall, without the Consent of Congress, lay any Duty of Tonnage, keep Troops, or Ships of War in time of Peace, enter into any Agreement or Compact with another State, or with a foreign Power, or engage in War, unless actually invaded, or in such imminent Danger as will not admit of delay Article II Section 1. The executive Power shall be vested in a President of the United States of America He shall hold his Office during the Term of four Years, and, together with the Vice President, chosen for the same Term, be elected, as follows: Each State shall appoint, in such Manner as the Legislature thereof may direct, a Number of Electors, equal to the whole Number of Senators and Representatives to which the State may be entitled in the Congress; but no Senator or Representative, or Person holding an Office of Trust or Profit under the United States, shall be appointed an Elector The Electors shall meet in their respective States, and vote by Ballot for two Persons, of whom one at least shall not be an Inhabitant of the same State with themselves And they shall make a List of all the Persons voted for, and of the Number of Votes for each; which List they shall sign and certify, and transmit sealed to the Seat of the Government of the United States, directed to the President of the Senate The President of the Senate shall, in the Presence of the Senate and House of A–7 Representatives, open all the Certificates, and the Votes shall then be counted The Person having the greatest Number of Votes shall be the President, if such Number be a Majority of the whole Number of Electors appointed; and if there be more than one who have such Majority, and have an equal Number of Votes, then the House of Representatives shall immediately chuse by Ballot one of them for President; and if no Person have a Majority, then from the five highest on the List the said House shall in like Manner chuse the President But in chusing the President, the Votes shall be taken by States, the Representation from each State having one Vote; A quorum for this Purpose shall consist of a Member or Members from two thirds of the States, and a Majority of all the States shall be necessary to a Choice In every Case, after the Choice of the President, the Person having the greater Number of Votes of the Electors shall be the Vice President But if there should remain two or more who have equal Votes, the Senate shall chuse from them by Ballot the Vice President The Congress may determine the Time of chusing the Electors, and the Day on which they shall give their Votes; which Day shall be the same throughout the United States No person except a natural born Citizen, or a Citizen of the United States, at the time of the Adoption of this Constitution, shall be eligible to the Office of President; neither shall any Person be eligible to that Office who shall not have attained to the Age of thirty five Years, and been fourteen Years a Resident within the United States In Case of the Removal of the President from Office, or of his Death, Resignation or Inability to discharge the Powers and Duties of the said Office, the same shall devolve on the Vice President, and the Congress may by Law provide for the Case of Removal, Death, Resignation or Inability, both of the President and Vice President, declaring what Officer shall then act as President, and such Officer shall act accordingly, until the Disability be removed, or a President shall be elected The President shall, at stated Times, receive for his Services, a Compensation, which shall neither be increased nor diminished during the Period for which he shall have been elected, and he shall not receive within that Period any other Emolument from the United States, or any of them Before he enter on the Execution of his Office, he shall take the following Oath or Affirmation: “I solemnly swear (or affirm) that I will faithfully execute the Office of President of the United States, and will to the best of my Ability, preserve, protect and defend the Constitution of the United States.’’ Section 2.  The President shall be Commander in Chief of the Army and Navy of the United States, and of the Militia of the several States, when called into the actual Service of the United States; he may require the Opinion, in writing, of the principal Officer in each of the executive Departments, upon any Subject relating to the Duties of their respective Offices, and he shall have Power to grant Reprieves and Pardons for Offenses against the United States, except in Cases of Impeachment He shall have Power, by and with the Advice and Consent of the Senate to make Treaties, provided two thirds of the Senators present concur; and he shall nominate, and by and with the Advice and Consent of the Senate, shall appoint Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–8  Appendix B  The Constitution of the United States Ambassadors, other public Ministers and Consuls, Judges of the supreme Court, and all other Officers of the United States, whose Appointments are not herein otherwise provided for, and which shall be established by Law; but the Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments The President shall have Power to fill up all Vacancies that may happen during the Recess of the Senate, by granting Commissions which shall expire at the End of their next Session Section 3.  He shall from time to time give to the Congress Information of the State of the Union, and recommend to their Consideration such Measures as he shall judge necessary and expedient; he may, on extraordinary Occasions, convene both Houses, or either of them, and in Case of Disagreement between them, with Respect to the Time of Adjournment, he may adjourn them to such Time as he shall think proper; he shall receive Ambassadors and other public Ministers; he shall take Care that the Laws be faithfully executed, and shall Commission all the Officers of the United States Section 4. The President, Vice President and all civil Officers of the United States, shall be removed from Office on Impeachment for, and Conviction of, Treason, Bribery, or other high Crimes and Misdemeanors Article III Section 1.  The judicial Power of the United States, shall be vested in one supreme Court, and in such inferior Courts as the Congress may from time to time ordain and establish The Judges, both of the supreme and inferior Courts, shall hold their Offices during good Behaviour, and shall, at stated Times, receive for their Services a Compensation, which shall not be diminished during their Continuance in Office Section 2.  The judicial Power shall extend to all Cases, in Law and Equity, arising under this Constitution, the Laws of the United States, and Treaties made, or which shall be made, under their Authority;—to all Cases affecting Ambassadors, other public Ministers and Consuls;—to all Cases of admiralty and maritime Jurisdiction;—to Controversies to which the United States shall be a Party;—to Controversies between two or more States;—between a State and Citizens of another State;—between Citizens of different States;—between Citizens of the same State claiming Lands under Grants of different States, and between a State, or the Citizens thereof, and foreign States, Citizens or Subjects In all Cases affecting Ambassadors, other public Ministers and Consuls, and those in which a State shall be a Party, the supreme Court shall have original Jurisdiction In all the other Cases before mentioned, the supreme Court shall have appellate Jurisdiction, both as to Law and Fact, with such Exceptions, and under such Regulations as the Congress shall make The Trial of all Crimes, except in Cases of Impeachment, shall be by Jury; and such Trial shall be held in the State where the said Crimes shall have been committed; but when not committed within any State, the Trial shall be at such Place or Places as the Congress may by Law have directed Section 3. Treason against the United States, shall consist only in levying War against them, or, in adhering to their Enemies, giving them Aid and Comfort No Person shall be convicted of Treason unless on the Testimony of two Witnesses to the same overt Act, or on Confession in open Court The Congress shall have Power to declare the Punishment of Treason, but no Attainder of Treason shall work Corruption of Blood, or Forfeiture except during the Life of the Person attainted Article IV Section 1. Full Faith and Credit shall be given in each State to the public Acts, Records, and judicial Proceedings of every other State And the Congress may by general Laws prescribe the Manner in which such Acts, Records and Proceedings shall be proved, and the Effect thereof Section 2.  The Citizens of each State shall be entitled to all Privileges and I2mmunities of Citizens in the several States A Person charged in any State with Treason, Felony, or other Crime, who shall flee from Justice, and be found in another State, shall on Demand of the executive Authority of the State from which he fled, be delivered up, to be removed to the State having Jurisdiction of the Crime No Person held to Service or Labour in one State, under the Laws thereof, escaping into another, shall, in Consequence of any Law or Regulation therein, be discharged from such Service or Labour, but shall be delivered up on Claim of the Party to whom such Service or Labour may be due Section 3.  New States may be admitted by the Congress into this Union; but no new State shall be formed or erected within the Jurisdiction of any other State; nor any State be formed by the Junction of two or more States, or Parts of States, without the Consent of the Legislatures of the States concerned as well as of the Congress The Congress shall have Power to dispose of and make all needful Rules and Regulations respecting the Territory or other Property belonging to the United States; and nothing in this Constitution shall be so construed as to Prejudice any Claims of the United States, or of any particular State Section 4. The United States shall guarantee to every State in this Union a Republican Form of Government, and shall protect each of them against Invasion; and on Application of the Legislature, or of the Executive (when the Legislature cannot be convened) against domestic Violence Article V The Congress, whenever two thirds of both Houses shall deem it necessary, shall propose Amendments to this Constitution, or, on the Application of the Legislatures of two thirds of the several States, shall call a Convention for propos- Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix B  The Constitution of the United States  ing Amendments, which, in either Case, shall be valid to all Intents and Purposes, as part of this Constitution, when ratified by the Legislatures of three fourths of the several States, or by Conventions in three fourths thereof, as the one or the other Mode of Ratification may be proposed by the Congress; Provided that no Amendment which may be made prior to the Year One thousand eight hundred and eight shall in any Manner affect the first and fourth Clauses in the Ninth Section of the first Article; and that no State, without its Consent, shall be deprived of its equal Suffrage in the Senate Article VI All Debts contracted and Engagements entered into, before the Adoption of this Constitution shall be as valid against the United States under this Constitution, as under the Confederation This Constitution, and the Laws of the United States which shall be made in Pursuance thereof; and all Treaties made, or which shall be made, under the Authority of the United States, shall be the supreme Law of the Land; and the Judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding The Senators and Representatives before mentioned, and the Members of the several State Legislatures, and all executive and judicial Officers, both of the United States and of the several States, shall be bound by Oath or Affirmation, to support this Constitution; but no religious Test shall ever be required as a Qualification to any Office or public Trust under the United States Article VII The Ratification of the Conventions of nine States shall be sufficient for the Establishment of this Constitution between the States so ratifying the Same A–9 seizures, shall not be violated, and no Warrants shall issue, but upon probable cause, supported by Oath or affirmation, and particularly describing the place to be searched, and the persons or things to be seized Amendment V [1791] No person shall be held to answer for a capital, or otherwise infamous crime, unless on a presentment or indictment of a Grand Jury, except in cases arising in the land or naval forces, or in the Militia, when in actual service in time of War or public danger; nor shall any person be subject for the same offence to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation Amendment VI [1791] In all criminal prosecutions, the accused shall enjoy the right to a speedy and public trial, by an impartial jury of the State and district wherein the crime shall have been committed, which district shall have been previously ascertained by law, and to be informed of the nature and cause of the accusation; to be confronted with the witnesses against him; to have compulsory process for obtaining witnesses in his favor, and to have the Assistance of Counsel for his defence Amendment VII [1791] In Suits at common law, where the value in controversy shall exceed twenty dollars, the right of trial by jury shall be preserved, and no fact tried by jury, shall be otherwise re-examined in any Court of the United States, than according to the rules of the common law Amendment I [1791] Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assembly, and to petition the Government for a redress of grievances Amendment II [1791] A well regulated Militia, being necessary to the security of a free State, the right of the people to keep and bear Arms, shall not be infringed Amendment III [1791] No Soldier shall, in time of peace be quartered in any house, without the consent of the Owner, nor in time of war, but in a manner to be prescribed by law Amendment IV [1791] The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and Amendment VIII [1791] Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted Amendment IX [1791] The enumeration in the Constitution, of certain rights, shall not be construed to deny or disparage others retained by the people Amendment X [1791] The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people Amendment XI [1798] The Judicial power of the United States shall not be construed to extend to any suit in law or equity, commenced or Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–10  Appendix B  The Constitution of the United States prosecuted against one of the United States by Citizens of another State, or by Citizens or Subjects of any Foreign State Amendment XII [1804] The Electors shall meet in their respective states, and vote by ballot for President and Vice-President, one of whom, at least, shall not be an inhabitant of the same state with themselves; they shall name in their ballots the person voted for as President, and in distinct ballots the person voted for as VicePresident, and they shall make distinct lists of all persons voted for as President, and of all persons voted for as Vice-President, and of the number of votes for each, which lists they shall sign and certify, and transmit sealed to the seat of the government of the United States, directed to the President of the Senate;—The President of the Senate shall, in the presence of the Senate and House of Representatives, open all the certificates and the votes shall then be counted;—The person having the greatest number of votes for President, shall be the President, if such number be a majority of the whole number of Electors appointed; and if no person have such majority, then from the persons having the highest numbers not exceeding three on the list of those voted for as President, the House of Representatives shall choose immediately, by ballot, the President But in choosing the President, the votes shall be taken by states, the representation from each state having one vote; a quorum for this purpose shall consist of a member or members from two-thirds of the states, and a majority of all states shall be necessary to a choice And if the House of Representatives shall not choose a President whenever the right of choice shall devolve upon them, before the fourth day of March next following, then the Vice-President shall act as President, as in the case of the death or other constitutional disability of the President.—The person having the greatest number of votes as Vice-President, shall be the Vice-President, if such number be a majority of the whole number of Electors appointed, and if no person have a majority, then from the two highest numbers on the list, the Senate shall choose the VicePresident; a quorum for the purpose shall consist of two-thirds of the whole number of Senators, and a majority of the whole number shall be necessary to a choice But no person constitutionally ineligible to the office of President shall be eligible to that of Vice-President of the United States Amendment XIII [1865] Section 1. Neither slavery nor involuntary servitude, except as a punishment for crime whereof the party shall have been duly convicted, shall exist within the United States, or any place subject to their jurisdiction Section 2.  Congress shall have power to enforce this article by appropriate legislation Amendment XIV [1868] Section 1.  All persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States and of the State wherein they reside No State shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States; nor shall any State deprive any person of life, liberty, or property, without due process of law; nor deny to any person within its jurisdiction the equal protection of the laws Section 2. Representatives shall be apportioned among the several States according to their respective numbers, counting the whole number of persons in each State, excluding Indians not taxed But when the right to vote at any election for the choice of electors for President and Vice President of the United States, Representatives in Congress, the Executive and Judicial officers of a State, or the members of the Legislature thereof, is denied to any of the male inhabitants of such State, being twenty-one years of age, and citizens of the United States, or in any way abridged, except for participation in rebellion, or other crime, the basis of representation therein shall be reduced in the proportion which the number of such male citizens shall bear to the whole number of male citizens twentyone years of age in such State Section 3.  No person shall be a Senator or Representative in Congress, or elector of President and Vice President, or hold any office, civil or military, under the United States, or under any State, who having previously taken an oath, as a member of Congress, or as an officer of the United States, or as a member of any State legislature, or as an executive or judicial officer of any State, to support the Constitution of the United States, shall have engaged in insurrection or rebellion against the same, or given aid or comfort to the enemies thereof But Congress may by a vote of two-thirds of each House, remove such disability Section 4.  The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void Section 5.  The Congress shall have power to enforce, by appropriate legislation, the provisions of this article Amendment XV [1870] Section 1. The right of citizens of the United States to vote shall not be denied or abridged by the United States or by any State on account of race, color, or previous condition of servitude Section 2.  The Congress shall have power to enforce this article by appropriate legislation Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix B  The Constitution of the United States  Amendment XVI [1913] The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration Amendment XVII [1913] Section 1.  The Senate of the United States shall be composed of two Senators from each State, elected by the people thereof, for six years; and each Senator shall have one vote The electors in each State shall have the qualifications requisite for electors of the most numerous branch of the State legislatures Section 2. When vacancies happen in the representation of any State in the Senate, the executive authority of such State shall issue writs of election to fill such vacancies: Provided, That the legislature of any State may empower the executive thereof to make temporary appointments until the people fill the vacancies by election as the legislature may direct Section 3.  This amendment shall not be so construed as to affect the election or term of any Senator chosen before it becomes valid as part of the Constitution Amendment XVIII [1919] Section 1. After one year from the ratification of this article the manufacture, sale, or transportation of intoxicating liquors within, the importation thereof into, or the exportation thereof from the United States and all territory subject to the jurisdiction thereof for beverage purposes is hereby prohibited Section 2. The Congress and the several States shall have concurrent power to enforce this article by appropriate legislation Section 3. This article shall be inoperative unless it shall have been ratified as an amendment to the Constitution by the legislatures of the several States, as provided in the Constitution, within seven years from the date of the submission hereof to the States by the Congress A–11 of the years in which such terms would have ended if this article had not been ratified; and the terms of their successors shall then begin Section 2. The Congress shall assemble at least once in every year, and such meeting shall begin at noon on the 3d day of January, unless they shall by law appoint a different day Section 3.  If, at the time fixed for the beginning of the term of the President, the President elect shall have died, the Vice President elect shall become President If the President shall not have been chosen before the time fixed for the beginning of his term, or if the President elect shall have failed to qualify, then the Vice President elect shall act as President until a President shall have qualified; and the Congress may by law provide for the case wherein neither a President elect nor a Vice President elect shall have qualified, declaring who shall then act as President, or the manner in which one who is to act shall be selected, and such person shall act accordingly until a President or Vice President shall have qualified Section 4.  The Congress may by law provide for the case of the death of any of the persons from whom the House of Representatives may choose a President whenever the right of choice shall have devolved upon them, and for the case of the death of any of the persons from whom the Senate may choose a Vice President whenever the right of choice shall have devolved upon them Section 5.  Sections and shall take effect on the 15th day of October following the ratification of this article Section 6.  This article shall be inoperative unless it shall have been ratified as an amendment to the Constitution by the legislatures of three-fourths of the several States within seven years from the date of its submission Amendment XXI [1933] Section 1. The eighteenth article of amendment to the Constitution of the United States is hereby repealed Amendment XIX [1920] Section 2. The transportation or importation into any State, Territory, or possession of the United States for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited Section 2.  Congress shall have power to enforce this article by appropriate legislation Section 3.  This article shall be inoperative unless it shall have been ratified as an amendment to the Constitution by conventions in the several States, as provided in the Constitution, within seven years from the date of the submission hereof to the States by the Congress Section 1. The right of citizens of the United States to vote shall not be denied or abridged by the United States or by any State on account of sex Amendment XX [1933] Section 1.  The terms of the President and Vice President shall end at noon on the 20th day of January, and the terms of Senators and Representatives at noon on the 3d day of January, Amendment XXII [1951] Section 1. No person shall be elected to the office of the President more than twice, and no person who has held Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–12  Appendix B  The Constitution of the United States the office of President, or acted as President, for more than two years of a term to which some other person was elected President shall be elected to the office of President more than once But this Article shall not apply to any person holding the office of President when this Article was proposed by the Congress, and shall not prevent any person who may be holding the office of President, or acting as President, during the term within which this Article becomes operative from holding the office of President or acting as President during the remainder of such term Section 2.  This article shall be inoperative unless it shall have been ratified as an amendment to the Constitution by the legislatures of three-fourths of the several States within seven years from the date of its submission to the States by the Congress Amendment XXIII [1961] Section 1.  The District constituting the seat of Government of the United States shall appoint in such manner as the Congress may direct: A number of electors of President and Vice President equal to the whole number of Senators and Representatives in Congress to which the District would be entitled if it were a State, but in no event more than the least populous state; they shall be in addition to those appointed by the states, but they shall be considered, for the purposes of the election of President and Vice President, to be electors appointed by a state; and they shall meet in the District and perform such duties as provided by the twelfth article of amendment Section 2.  The Congress shall have power to enforce this article by appropriate legislation Amendment XXIV [1964] Section 1. The right of citizens of the United States to vote in any primary or other election for President or Vice President, for electors for President or Vice President, or for Senator or Representative in Congress, shall not be denied or abridged by the United States, or any State by reason of failure to pay any poll tax or other tax who shall take office upon confirmation by a majority vote of both Houses of Congress Section 3. Whenever the President transmits to the President pro tempore of the Senate and the Speaker of the House of Representatives his written declaration that he is unable to discharge the powers and duties of his office, and until he transmits to them a written declaration to the contrary, such powers and duties shall be discharged by the Vice President as Acting President Section 4. Whenever the Vice President and a majority of either the principal officers of the executive departments or of such other body as Congress may by law provide, transmit to the President pro tempore of the Senate and the Speaker of the House of Representatives their written declaration that the President is unable to discharge the powers and duties of his office, the Vice President shall immediately assume the powers and duties of the office as Acting President Thereafter, when the President transmits to the President pro tempore of the Senate and the Speaker of the House of Representatives his written declaration that no inability exists, he shall resume the powers and duties of his office unless the Vice President and a majority of either the principal officers of the executive department or of such other body as Congress may by law provide, transmit within four days to the President pro tempore of the Senate and the Speaker of the House of Representatives their written declaration that the President is unable to discharge the powers and duties of his office Thereupon Congress shall decide the issue, assembling within forty-eight hours for that purpose if not in session If the Congress, within twenty-one days after receipt of the latter written declaration, or, if Congress is not in session, within twenty-one days after Congress is required to assemble, determines by two-thirds vote of both Houses that the President is unable to discharge the powers and duties of his office, the Vice President shall continue to discharge the same as Acting President; otherwise, the President shall resume the powers and duties of his office Amendment XXVI [1971] Section 2.  The Congress shall have power to enforce this article by appropriate legislation Section 1.  The right of citizens of the United States, who are eighteen years of age or older, to vote shall not be denied or abridged by the United States or by any State on account of age Amendment XXV [1967] Section 2.  The Congress shall have power to enforce this article by appropriate legislation Section 2.  Whenever there is a vacancy in the office of the Vice President, the President shall nominate a Vice President No law, varying the compensation for the services of the Senators and Representatives, shall take effect, until an election of Representatives shall have intervened Section 1. In case of the removal of the President from office or of his death or resignation, the Vice President shall become President Amendment XXVII [1992] Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it appendix C Articles and 2A of the Uniform Commercial Code (Adopted in fifty-two jurisdictions—all fifty States, although Louisiana has adopted only Articles 1, 3, 4, 7, 8, and 9; the District of Columbia; and the Virgin Islands.) contract, principal and agent, estoppel, fraud, misrepresentation, duress, coercion, mistake, bankruptcy, and other validating or invalidating cause, supplement its provisions The Code consists of the following articles: § 1–104.  Construction Against Implicit Repeal This Act being a general act intended as a unified coverage of its subject matter, no part of it shall be deemed to be impliedly repealed by subsequent legislation if such construction can reasonably be avoided Article General Provisions Sales 2A Leases Negotiable Instruments Bank Deposits and Collections 4A Funds Transfers Letters of Credit Repealer of Article 6—Bulk Transfers and [Revised] Article 6—Bulk Sales Warehouse Receipts, Bills of Lading and Other Documents of Title Investment Securities Secured Transactions 10 Effective Date and Repealer 11 Effective Date and Transition Provisions Article 1: GENERAL PROVISIONS Part 1—General Provisions § 1–101.  Short Titles (a)  This [Act] may be cited as Uniform Commercial Code (b) This article may be cited as Uniform Commercial CodeUniform Provisions § 1–102.  Scope of Article This article applies to a transaction to the extent that it is governed by another article of [the Uniform Commercial Code] § 1–103.  Construction of [Uniform Commercial Code] to Promote Its Purpose and Policies; Applicability of Supplemental Principles of Law (a) [The Uniform Commercial Code] must be liberally construed and applied to promote its underlying purposes and policies, which are: (1) to simplify, clarify, and modernize the law governing commercial transactions; (2)  to permit the continued expansion of commercial practices through custom, usage, and agreement of the parties; and (3) to make uniform the law among the various jurisdictions (b) Unless displaced by the particular provisions of [the Uniform Commercial Code], the principles of law and equity, including the law merchant and the law relative to capacity to Copyright 2013 by the American Law Institute and the National Conference of ­ Commissioners on Uniform State Laws Reproduced with the permission of the ­Permanent Editorial Board for the Uniform Commercial Code All rights reserved § 1–105. Severability If any provision or clause of [the Uniform Commercial Code] or its application to any person or circumstance is held invalid, the invalidity does not affect other provisions or applications of [the Uniform Commercial Code] which can be given effect without the invalid provision or application, and to this end the provisions of [the Uniform Commercial Code] are severable § 1–106.  Use of Singular and Plural; Gender In [the Uniform Commercial Code], unless the statutory context otherwise requires: (1)  words in the singular number include the plural, and those in the plural include the singular; and (2)  words of any gender also refer to any other gender § 1–107.  Section Captions Section captions are part of [the Uniform Commercial Code] § 1–108.  Relation to Electronic Signatures in Global and National Commerce Act This article modifies, limits, and supersedes the Federal Electronic Signatures in Global and National Commerce Act, 15 U.S.C Sections 7001 et seq., except that nothing in this article modifies, limits, or supersedes Section 7001(c) of that act or authorizes electronic delivery of any of the notices described in Section 7003(b) of that Act Part 2—General Definitions and Principles of Interpretation § 1–201.  General Definitions Subject to additional definitions contained in the subsequent Articles of this Act which are applicable to specific Articles or Parts thereof, and unless the context otherwise requires, in this Act: (1) “Action”, in the sense of a judicial proceeding, includes recoupment, counterclaim, set-off, suit in equity, and any other proceedings in which rights are determined (2) “Aggrieved party” means a party entitled to resort to a remedy (3)  “Agreement”, as distinguished from “contract”, means the bargain of the parties in fact, as found in their language or by implication from other circumstances, including course of performance, course of dealing, or usage of trade as provided in Section 1–303 (4) “Bank” means a person engaged in the business of banking and includes a savings bank, savings and loan association, credit union, and trust company A–13 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–14  Appendix c  Articles and 2A of the Uniform Commercial Code (5) “Bearer” means a person in control of a negotiable electronic document of title or a person in possession of a negotiable instrument, negotiable tangible document of title, or certificated security that is payable to bearer or indorsed in blank (6) “Bill of lading” means a document of title evidencing the receipt of goods for shipment issued by a person engaged in the business of directly or indirectly transporting or forwarding goods The term does not include a warehouse receipt (7)  “Branch” includes a separately incorporated foreign branch of a bank (8) “Burden of establishing” a fact means the burden of persuading the trier of fact that the existence of the fact is more ­probable than its nonexistence (9) “Buyer in ordinary course of business” means a person that buys goods in good faith, without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person, other than a pawnbroker, in the business of selling goods of that kind A person buys goods in the ordinary course if the sale to the person comports with the usual or customary practices in the kind of business in which the seller is engaged or with the seller’s own usual or customary practices A person that sells oil, gas, or other minerals at the wellhead or minehead is a person in the business of selling goods of that kind A buyer in ordinary course of business may buy for cash, by exchange of other property, or on secured or unsecured credit, and may acquire goods or documents of title under a pre-existing contract for sale Only a buyer that takes possession of the goods or has a right to recover the goods from the seller under Article may be a buyer in ordinary course of business A person that acquires goods in a transfer in bulk or as security for or in total or partial satisfaction of a money debt is not a buyer in ordinary course of business (10) “Conspicuous”, with reference to a term, means so written, displayed, or presented that a reasonable person against which it is to operate ought to have noticed it Whether a term is “conspicuous” or not is a decision for the court Conspicuous terms include the following: (A)  a heading in capitals equal to or greater in size than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same or lesser size; and (B) language in the body of a record or display in larger type than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same size, or set off from surrounding text of the same size by symbols or other marks that call attention to the language (11) “Consumer” means an individual who enters into a transaction primarily for personal, family, or household purposes (12) “Contract”, as distinguished from “agreement”, means the total legal obligation that results from the parties’ agreement as determined by [the Uniform Commercial Code] as supplemented by any other laws (13)  “Creditor” includes a general creditor, a secured creditor, a lien creditor and any representative of creditors, including an assignee for the benefit of creditors, a trustee in bankruptcy, a receiver in equity and an executor or administrator of an insolvent debtor’s or assignor’s estate (14) “Defendant” includes a person in the position of defendant in a counterclaim, cross-action, or third-party claim (15) “Delivery” with respect to an electronic document of title means voluntary transfer of control and with respect to an instrument, a tangible document of title, or chattel paper means voluntary transfer of possession (16) “Document of title” means a record (i) that in regular course of business or financing is treated as adequately evidencing that the person in possession or control of the record is entitled to receive, control, hold, and dispose of the record and the goods the record covers and (ii) that purports to be issued by or addressed to a bailee and to cover goods in the bailee’s possession which are either identified or are fungible portions of an identified mass The term includes a bill of lading, transport document, dock warrant, dock receipt, warehouse receipt, and order for delivery of goods An electronic document of title means a document of title evidenced by a record consisting of information stored in an electronic medium A tangible document of title means a document of title evidenced by a record consisting of information that is inscribed on a tangible medium (17) “Fault” means a default, breach, or wrongful act or omission (18)  “Fungible goods” means: (A)  goods of which any unit, by nature or usage of trade, is the equivalent of any other like unit; or (B)  goods that by agreement are treated as equivalent (19)  “Genuine” means free of forgery or counterfeiting (20) “Good faith,” except as otherwise provided in Article 5, means honesty in fact and the observance of reasonable commercial standards of fair dealing (21)  “Holder” means: (A) the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is the person in possession; (B) the person in possession of a negotiable tangible document of title if the goods are deliverable either to bearer or to the order of the person in possession; or (C)  the person in control of a negotiable electronic document of title (22) “Insolvency proceeding” includes an assignment for the benefit of creditors or other proceeding intended to liquidate or rehabilitate the estate of the person involved (23)  “Insolvent” means: (A) having generally ceased to pay debts in the ordinary course of business other than as a result of bona fide dispute; (B)  being unable to pay debts as they become due; or (C) being insolvent within the meaning of federal bankruptcy law (24) “Money” means a medium of exchange currently authorized or adopted by a domestic or foreign government The term includes a monetary unit of account established by an intergovernmental organization or by agreement between two or more countries (25)  “Organization” means a person other than an ­individual (26)  “Party”, as distinguished from “third party”, means a person that has engaged in a transaction or made an agreement subject to [the Uniform Commercial Code] (27)  “Person” means an individual, corporation, business trust, estate, trust, partnership, limited liability company, association, Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  joint venture, government, governmental subdivision, agency, or instrumentality, public corporation, or any other legal or commercial entity (28)  “Present value” means the amount as of a date certain of one or more sums payable in the future, discounted to the date certain by use of either an interest rate specified by the parties if that rate is not manifestly unreasonable at the time the transaction is entered into or, if an interest rate is not so specified, a commercially reasonable rate that takes into account the facts and circumstances at the time the transaction is entered into (29)  “Purchase” means taking by sale, lease, discount, negotiation, mortgage, pledge, lien, security interest, issue or reissue, gift, or any other voluntary transaction creating an interest in property (30)  “Purchaser” means a person that takes by purchase (31)  “Record” means information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form (32)  “Remedy” means any remedial right to which an aggrieved party is entitled with or without resort to a ­tribunal (33) “Representative” means a person empowered to act for another, including an agent, an officer of a corporation or association, and a trustee, executor, or administrator of an estate (34)  “Right” includes remedy (35)  “Security interest” means an interest in personal property or fixtures which secures payment or performance of an obligation “Security interest” includes any interest of a consignor and a buyer of accounts, chattel paper, a payment intangible, or a promissory note in a transaction that is subject to Article “Security interest” does not include the special property interest of a buyer of goods on identification of those goods to a contract for sale under Section 2–401, but a buyer may also acquire a “security interest” by complying with Article Except as otherwise provided in Section 2–505, the right of a seller or lessor of goods under Article or 2A to retain or acquire possession of the goods is not a “security interest”, but a seller or lessor may also acquire a “security interest” by complying with Article The retention or reservation of title by a seller of goods notwithstanding shipment or delivery to the buyer under Section 2–401 is limited in effect to a reservation of a “security interest.” Whether a transaction in the form of a lease creates a “security interest” is determined pursuant to Section 1–203 (36) “Send” in connection with a writing, record, or notice means: (A) to deposit in the mail or deliver for transmission by any other usual means of communication with postage or cost of transmission provided for and properly addressed and, in the case of an instrument, to an address specified thereon or otherwise agreed, or if there be none to any address reasonable under the circumstances; or (B)  in any other way to cause to be received any record or notice within the time it would have arrived if properly sent (37)  “Signed” includes using any symbol executed or adopted with present intention to adopt or accept a ­writing (38)  “State” means a State of the United States, the District of Columbia, Puerto Rico, the United States Virgin Islands, or any A–15 territory or insular possession subject to the jurisdiction of the United States (39) “Surety” includes a guarantor or other secondary obligor (40) “Term” means a portion of an agreement that relates to a particular matter (41)  “Unauthorized signature” means a signature made without actual, implied, or apparent authority The term includes a forgery (42) “Warehouse receipt” means a document of title issued by a person engaged in the business of storing goods for hire (43)  “Writing” includes printing, typewriting, or any other intentional reduction to tangible form “Written” has a corresponding meaning As amended in 2003 § 1–202.  Notice; Knowledge (a) Subject to subsection (f), a person has “notice” of a fact if the person: (1) has actual knowledge of it; (2) has received a notice or notification of it; or (3) from all the facts and circumstances known to the person at the time in question, has reason to know that it exists (b) “Knowledge” means actual knowledge “Knows” has a corresponding meaning (c) “Discover”, “learn”, or words of similar import refer to knowledge rather than to reason to know (d) A person “notifies” or “gives” a notice or notification to another person by taking such steps as may be reasonably required to inform the other person in ordinary course, whether or not the other person actually comes to know of it (e) Subject to subsection (f), a person “receives” a notice or notification when: (1) it comes to that person’s attention; or (2) it is duly delivered in a form reasonable under the circumstances at the place of business through which the contract was made or at another location held out by that person as the place for receipt of such communications (f) Notice, knowledge, or a notice or notification received by an organization is effective for a particular transaction from the time it is brought to the attention of the individual conducting that transaction and, in any event, from the time it would have been brought to the individual’s attention if the organization had exercised due diligence An organization exercises due diligence if it maintains reasonable routines for communicating significant information to the person conducting the transaction and there is reasonable compliance with the routines Due diligence does not require an individual acting for the organization to communicate information unless the communication is part of the individual’s regular duties or the individual has reason to know of the transaction and that the transaction would be materially affected by the information § 1–203.  Lease Distinguished from Security Interest (a) Whether a transaction in the form of a lease creates a lease or security interest is determined by the facts of each case (b) A transaction in the form of a lease creates a security interest if the consideration that the lessee is to pay the lessor for the right to possession and use of the goods is an obligation for Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–16  Appendix c  Articles and 2A of the Uniform Commercial Code the term of the lease and is not subject to termination by the lessee, and: (1) the original term of the lease is equal to or greater than the remaining economic life of the goods; (2) the lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become the owner of the goods; (3) the lessee has an option to renew the lease for the remaining economic life of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease agreement; or (4) the lessee has an option to become the owner of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease agreement (c) A transaction in the form of a lease does not create a security interest merely because: (1) the present value of the consideration the lessee is obligated to pay the lessor for the right to possession and use of the goods is substantially equal to or is greater than the fair market value of the goods at the time the lease is entered into; (2) the lessee assumes risk of loss of the goods; (3) the lessee agrees to pay, with respect to the goods, taxes, insurance, filing, recording, or registration fees, or service or maintenance costs; (4) the lessee has an option to renew the lease or to become the owner of the goods; (5) the lessee has an option to renew the lease for a fixed rent that is equal to or greater than the reasonably predictable fair market rent for the use of the goods for the term of the renewal at the time the option is to be performed; or (6) the lessee has an option to become the owner of the goods for a fixed price that is equal to or greater than the reasonably predictable fair market value of the goods at the time the option is to be performed (d) Additional consideration is nominal if it is less than the lessee’s reasonably predictable cost of performing under the lease agreement if the option is not exercised Additional consideration is not nominal if: (1) when the option to renew the lease is granted to the lessee, the rent is stated to be the fair market rent for the use of the goods for the term of the renewal determined at the time the option is to be performed; or (2) when the option to become the owner of the goods is granted to the lessee, the price is stated to be the fair market value of the goods determined at the time the option is to be performed (e) The “remaining economic life of the goods” and “reasonably predictable” fair market rent, fair market value, or cost of performing under the lease agreement must be determined with reference to the facts and circumstances at the time the transaction is entered into § 1–204.  Value Except as otherwise provided in Articles 3, 4, [and] 5, [and 6], a person gives value for rights if the person acquires them: (1) in return for a binding commitment to extend credit or for the extension of immediately available credit, whether or not drawn upon and whether or not a charge-back is provided for in the event of difficulties in collection; (2) as security for, or in total or partial satisfaction of, a preexisting claim; (3) by accepting delivery under a preexisting contract for purchase; or (4) in return for any consideration sufficient to support a simple contract § 1–205.  Reasonable Time; Seasonableness (a)  Whether a time for taking an action required by [the Uniform Commercial Code] is reasonable depends on the nature, purpose, and circumstances of the action (b) An action is taken seasonably if it is taken at or within the time agreed or, if no time is agreed, at or within a reasonable time § 1–206. Presumptions Whenever [the Uniform Commercial Code] creates a “presumption” with respect to a fact, or provides that a fact is “presumed,” the trier of fact must find the existence of the fact unless and until evidence is introduced that supports a finding of its nonexistence Part 3—Territorial Applicability and General Rules § 1–301.  Territorial Applicability; Parties’ Power to Choose Applicable Law (a) In this section: (1) “Domestic transaction” means a transaction other than an international transaction (2) “International transaction” means a transaction that bears a reasonable relation to a country other than the United States (b) This section applies to a transaction to the extent that it is governed by another article of the [Uniform Commercial Code] (c) Except as otherwise provided in this section: (1) an agreement by parties to a domestic transaction that any or all of their rights and obligations are to be determined by the law of this State or of another State is effective, whether or not the transaction bears a relation to the State designated; and (2) an agreement by parties to an international transaction that any or all of their rights and obligations are to be determined by the law of this State or of another State or country is effective, whether or not the transaction bears a relation to the State or country designated (d) In the absence of an agreement effective under subsection (c), and except as provided in subsections (e) and (g), the rights and obligations of the parties are determined by the law that would be selected by application of this State’s conflict of laws principles (e) If one of the parties to a transaction is a consumer, the following rules apply: (1) An agreement referred to in subsection (c) is not effective unless the transaction bears a reasonable relation to the State or country designated (2) Application of the law of the State or country determined pursuant to subsection (c) or (d) may not deprive Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  the consumer of the protection of any rule of law governing a matter within the scope of this section, which both is protective of consumers and may not be varied by agreement: (A) of the State or country in which the consumer principally resides, unless subparagraph (B) applies; or (B) if the transaction is a sale of goods, of the State or country in which the consumer both makes the contract and take delivery of those goods, if such State or country is not the State or country in which the consumer principally resides (f) An agreement otherwise effective under subsection (c) is not effective to the extent that application of the law of the State or country designated would be contrary to a fundamental policy of the State or country whose law would govern in the absence of agreement under subsection (d) (g) To the extent that [the Uniform Commercial Code] governs a transaction, if one of the following provisions of [the Uniform Commercial Code] specifies the applicable law, that provision governs and a contrary agreement is effective only to the extent permitted by the law so specified: (1) Section 2–402; (2) Sections 2A–105 and 2A–106; (3) Section 4–102; (4) Section 4A–507; (5) Section 5–116; [(6) Section 6–103;] (7) Section 8–110; (8) Sections 9–301 through 9–307 § 1–302.  Variation by Agreement (a) Except as otherwise provided in subsection (b) or elsewhere in [the Uniform Commercial Code], the effect of provisions of [the Uniform Commercial Code] may be varied by agreement (b) The obligations of good faith, diligence, reasonableness, and care prescribed by [the Uniform Commercial Code] may not be disclaimed by agreement The parties, by agreement, may determine the standards by which the performance of those obligations is to be measured if those standards are not manifestly unreasonable Whenever [the Uniform Commercial Code] requires an action to be taken within a reasonable time, a time that is not manifestly unreasonable may be fixed by agreement (c) The presence in certain provisions of [the Uniform Commercial Code] of the phrase “unless otherwise agreed”, or words of similar import, does not imply that the effect of other provisions may not be varied by agreement under this section § 1–303.  Course of Performance, Course of Dealing, and Usage of Trade (a) A “course of performance” is a sequence of conduct between the parties to a particular transaction that exists if: (1) the agreement of the parties with respect to the transaction involves repeated occasions for performance by a party; and (2) the other party, with knowledge of the nature of the performance and opportunity for objection to it, accepts the performance or acquiesces in it without objection (b) A “course of dealing” is a sequence of conduct concerning previous transactions between the parties to a particular transaction that is fairly to be regarded as establishing a common basis of understanding for interpreting their expressions and other conduct (c) A “usage of trade” is any practice or method of dealing having such regularity of observance in a place, vocation, or trade as to justify an expectation that it will be observed with respect to the transaction in question The existence and scope of such a usage A–17 must be proved as facts If it is established that such a usage is embodied in a trade code or similar record, the interpretation of the record is a question of law (d) A course of performance or course of dealing between the parties or usage of trade in the vocation or trade in which they are engaged or of which they are or should be aware is relevant in ascertaining the meaning of the parties’ agreement, may give particular meaning to specific terms of the agreement, and may supplement or qualify the terms of the agreement A usage of trade applicable in the place in which part of the performance under the agreement is to occur may be so utilized as to that part of the performance (e) Except as otherwise provided in subsection (f), the express terms of an agreement and any applicable course of performance, course of dealing, or usage of trade must be construed whenever reasonable as consistent with each other If such a construction is unreasonable: (1) express terms prevail over course of performance, course of dealing, and usage of trade; (2) course of performance prevails over course of dealing and usage of trade; and (3) course of dealing prevails over usage of trade (f) Subject to Section 2–209 and Section 2A–208, a course of performance is relevant to show a waiver or modification of any term inconsistent with the course of ­performance (g) Evidence of a relevant usage of trade offered by one party is not admissible unless that party has given the other party notice that the court finds sufficient to prevent unfair surprise to the other party § 1–304.  Obligation of Good Faith Every contract or duty within [the Uniform Commercial Code] imposes an obligation of good faith in its performance and ­enforcement § 1–305.  Remedies to be Liberally Administered (a) The remedies provided by [the Uniform Commercial Code] must be liberally administered to the end that the aggrieved party may be put in as good a position as if the other party had fully performed but neither consequential or special damages nor penal damages may be had except as specifically provided in [the Uniform Commercial Code] or by other rule of law (b) Any right or obligation declared by [the Uniform Commercial Code] is enforceable by action unless the provision declaring it specifies a different and limited effect § 1–306.  Waiver or Renunciation of Claim or Right After Breach A claim or right arising out of an alleged breach may be discharged in whole or in part without consideration by agreement of the aggrieved party in an authenticated record § 1–307.  Prima Facie Evidence by Third-Party Documents A document in due form purporting to be a bill of lading, policy or certificate of insurance, official weigher’s or inspector’s certificate, consular invoice, or any other document authorized or required by the contract to be issued by a third party is prima facie evidence of its own authenticity and genuineness and of the facts stated in the document by the third party Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–18  Appendix c  Articles and 2A of the Uniform Commercial Code § 1–308.  Performance or Acceptance Under Reservation of Rights (a) A party that with explicit reservation of rights performs or promises performance or assents to performance in a manner demanded or offered by the other party does not thereby prejudice the rights reserved Such words as “without prejudice,” “under protest,” or the like are sufficient (b) Subsection (a) does not apply to an accord and satisfaction § 1–309.  Option to Accelerate at Will A term providing that one party or that party’s successor in interest may accelerate payment or performance or require collateral or additional collateral “at will” or when the party “deems itself insecure,” or words of similar import, means that the party has power to so only if that party in good faith believes that the prospect of payment or performance is impaired The burden of establishing lack of good faith is on the party against which the power has been exercised § 1–310.  Subordinated Obligations An obligation may be issued as subordinated to performance of another obligation of the person obligated, or a creditor may subordinate its right to performance of an obligation by agreement with either the person obligated or another creditor of the person obligated Subordination does not create a security interest as against either the common debtor or a subordinated creditor Article 2:  SALES Part 1—Short Title, General Construction and Subject Matter § 2–101.  Short Title This Article shall be known and may be cited as Uniform Commercial Code—Sales § 2–102.  Scope; Certain Security and Other Transactions Excluded From This Article Unless the context otherwise requires, this Article applies to transactions in goods; it does not apply to any transaction which although in the form of an unconditional contract to sell or present sale is intended to operate only as a security transaction nor does this Article impair or repeal any statute regulating sales to consumers, farmers or other specified classes of buyers § 2–103.  Definitions and Index of Definitions (1) In this Article unless the context otherwise requires (a) “Buyer” means a person who buys or contracts to buy goods (b) “Good faith” in the case of a merchant means honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade (c) “Receipt” of goods means taking physical possession of them (d)  “Seller” means a person who sells or contracts to sell goods (2) Other definitions applying to this Article or to specified Parts thereof, and the sections in which they appear are: “Acceptance” Section 2–606 “Banker’s credit” Section 2–325 “Between merchants” Section 2–104 “Cancellation” Section 2–106(4) “Commercial unit” Section 2–105 “Confirmed credit” Section 2–325 “Conforming to contract” Section 2–106 “Contract for sale” Section 2–106 “Cover” Section 2–712 “Entrusting” Section 2–403 “Financing agency” Section 2–104 “Future goods” Section 2–105 “Goods” Section 2–105 “Identification” Section 2–501 “Installment contract” Section 2–612 “Letter of Credit” Section 2–325 “Lot” Section 2–105 “Merchant” Section 2–104 “Overseas” Section 2–323 “Person in position of seller” Section 2–707 “Present sale” Section 2–106 “Sale” Section 2–106 “Sale on approval” Section 2–326 “Sale or return” Section 2–326 “Termination” Section 2–106 (3)  The following definitions in other Articles apply to this Article: “Check” Section 3–104 “Consignee” Section 7–102 “Consignor” Section 7–102 “Consumer goods” Section 9–109 “Dishonor” Section 3–507 “Draft” Section 3–104 (4) In addition Article contains general definitions and principles of construction and interpretation applicable throughout this Article As amended in 1994 and 1999 § 2–104.  Definitions: “Merchant”; “Between Merchants”; “Financing Agency” (1) “Merchant” means a person who deals in goods of the kind or otherwise by his occupation holds himself out as having knowledge or skill peculiar to the practices or goods involved in the transaction or to whom such knowledge or skill may be attributed by his employment of an agent or broker or other intermediary who by his occupation holds himself out as having such knowledge or skill (2) “Financing agency” means a bank, finance company or other person who in the ordinary course of business makes advances against goods or documents of title or who by arrangement with either the seller or the buyer intervenes in ordinary course to make or collect payment due or claimed under the contract for sale, as by purchasing or paying the seller’s draft or making advances against it or by merely taking it for collection whether or not documents of title accompany the draft “Financing agency” includes also a bank or other person who similarly intervenes between persons who are in the position of seller and buyer in respect to the goods (Section 2–707) (3) “Between merchants” means in any transaction with respect to which both parties are chargeable with the knowledge or skill of merchants Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  § 2–105.  Definitions: Transferability; “Goods”; “Future” Goods; “Lot”; “Commercial Unit” (1) “Goods” means all things (including specially manufactured goods) which are movable at the time of identification to the contract for sale other than the money in which the price is to be paid, investment securities (Article 8) and things in action “Goods” also includes the unborn young of animals and growing crops and other identified things attached to realty as described in the section on goods to be severed from realty (Section 2–107) (2) Goods must be both existing and identified before any interest in them can pass Goods which are not both existing and identified are “future” goods A purported present sale of future goods or of any interest therein operates as a contract to sell (3) There may be a sale of a part interest in existing identified goods (4) An undivided share in an identified bulk of fungible goods is sufficiently identified to be sold although the quantity of the bulk is not determined Any agreed proportion of such a bulk or any quantity thereof agreed upon by number, weight or other measure may to the extent of the seller’s interest in the bulk be sold to the buyer who then becomes an owner in common (5) “Lot” means a parcel or a single article which is the subject matter of a separate sale or delivery, whether or not it is sufficient to perform the contract (6) “Commercial unit” means such a unit of goods as by commercial usage is a single whole for purposes of sale and division of which materially impairs its character or value on the market or in use A commercial unit may be a single article (as a machine) or a set of articles (as a suite of furniture or an assortment of sizes) or a quantity (as a bale, gross, or carload) or any other unit treated in use or in the relevant market as a single whole § 2–106.  Definitions: “Contract”; “Agreement”; “Contract for Sale”; “Sale”; “Present Sale”; “Conforming” to Contract; “Termination”; “Cancellation” (1) In this Article unless the context otherwise requires “contract” and “agreement” are limited to those relating to the present or future sale of goods “Contract for sale” includes both a present sale of goods and a contract to sell goods at a future time A “sale” consists in the passing of title from the seller to the buyer for a price (Section 2–401) A “present sale” means a sale which is accomplished by the making of the contract (2) Goods or conduct including any part of a performance are “conforming” or conform to the contract when they are in accordance with the obligations under the contract (3) “Termination” occurs when either party pursuant to a power created by agreement or law puts an end to the contract otherwise than for its breach On “termination” all obligations which are still executory on both sides are discharged but any right based on prior breach or per­for­mance survives (4)  “Cancellation” occurs when either party puts an end to the contract for breach by the other and its effect is the same as that of “termination” except that the cancelling party also retains any remedy for breach of the whole contract or any unperformed balance § 2–107.  Goods to Be Severed From Realty: Recording (1)  A contract for the sale of minerals or the like (including oil and gas) or a structure or its materials to be removed from A–19 realty is a contract for the sale of goods within this Article if they are to be severed by the seller but until severance a purported present sale thereof which is not effective as a transfer of an interest in land is effective only as a contract to sell (2) A contract for the sale apart from the land of growing crops or other things attached to realty and capable of severance without material harm thereto but not described in subsection (1) or of timber to be cut is a contract for the sale of goods within this Article whether the subject matter is to be severed by the buyer or by the seller even though it forms part of the realty at the time of contracting, and the parties can by identification effect a present sale before severance (3) The provisions of this section are subject to any third party rights provided by the law relating to realty records, and the contract for sale may be executed and recorded as a document transferring an interest in land and shall then constitute notice to third parties of the buyer’s rights under the contract for sale As amended in 1972 Part 2—Form, Formation and Readjustment of Contract § 2–201.  Formal Requirements; Statute of Frauds (1) Except as otherwise provided in this section a contract for the sale of goods for the price of $500 or more is not enforceable by way of action or defense unless there is some writing sufficient to indicate that a contract for sale has been made between the parties and signed by the party against whom enforcement is sought or by his authorized agent or broker A writing is not insufficient because it omits or incorrectly states a term agreed upon but the contract is not enforceable under this paragraph beyond the quantity of goods shown in such writing (2) Between merchants if within a reasonable time a writing in confirmation of the contract and sufficient against the sender is received and the party receiving it has reason to know its contents, its satisfies the requirements of subsection (1) against such party unless written notice of objection to its contents is given within ten days after it is received (3) A contract which does not satisfy the requirements of subsection (1) but which is valid in other respects is enforceable (a)  if the goods are to be specially manufactured for the buyer and are not suitable for sale to others in the ordinary course of the seller’s business and the seller, before notice of repudiation is received and under circumstances which reasonably indicate that the goods are for the buyer, has made either a substantial beginning of their manufacture or commitments for their procurement; or (b) if the party against whom enforcement is sought admits in his pleading, testimony or otherwise in court that a contract for sale was made, but the contract is not enforceable under this provision beyond the quantity of goods admitted; or (c) with respect to goods for which payment has been made and accepted or which have been received and accepted (Sec 2–606) § 2–202.  Final Written Expression: Parol or Extrinsic Evidence Terms with respect to which the confirmatory memoranda of the parties agree or which are otherwise set forth in a writing intended by the parties as a final expression of their agreement with respect to such terms as are included therein may Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–20  Appendix c  Articles and 2A of the Uniform Commercial Code not be contradicted by evidence of any prior agreement or of a ­contemporaneous oral agreement but may be explained or ­supplemented (a) by course of dealing or usage of trade (Section 1–205) or by course of performance (Section 2–208); and (b)  by evidence of consistent additional terms unless the court finds the writing to have been intended also as a complete and exclusive statement of the terms of the agreement § 2–203.  Seals Inoperative The affixing of a seal to a writing evidencing a contract for sale or an offer to buy or sell goods does not constitute the writing a sealed instrument and the law with respect to sealed instruments does not apply to such a contract or offer § 2–204.  Formation in General (1) A contract for sale of goods may be made in any manner sufficient to show agreement, including conduct by both parties which recognizes the existence of such a contract (2)  An agreement sufficient to constitute a contract for sale may be found even though the moment of its making is undetermined (3) Even though one or more terms are left open a contract for sale does not fail for indefiniteness if the parties have intended to make a contract and there is a reasonably certain basis for giving an appropriate remedy § 2–205.  Firm Offers An offer by a merchant to buy or sell goods in a signed writing which by its terms gives assurance that it will be held open is not revocable, for lack of consideration, during the time stated or if no time is stated for a reasonable time, but in no event may such period of irrevocability exceed three months; but any such term of assurance on a form supplied by the offeree must be separately signed by the offeror § 2–206.  Offer and Acceptance in Formation of Contract (1)  Unless other unambiguously indicated by the language or circumstances (a) an offer to make a contract shall be construed as inviting acceptance in any manner and by any medium reasonable in the circumstances; (b) an order or other offer to buy goods for prompt or current shipment shall be construed as inviting acceptance either by a prompt promise to ship or by the prompt or current shipment of conforming or nonconforming goods, but such a shipment of non-­conforming goods does not constitute an acceptance if the seller seasonably notifies the buyer that the shipment is offered only as an accommodation to the buyer (2)  Where the beginning of a requested performance is a reasonable mode of acceptance an offeror who is not notified of acceptance within a reasonable time may treat the offer as having lapsed before acceptance § 2–207.  Additional Terms in Acceptance or Confirmation (1) A definite and seasonable expression of acceptance or a written confirmation which is sent within a reasonable time operates as an acceptance even though it states terms additional to or different from those offered or agreed upon, unless acceptance is expressly made conditional on assent to the additional or different terms (2) The additional terms are to be construed as proposals for addition to the contract Between merchants such terms become part of the contract unless: (a) the offer expressly limits acceptance to the terms of the offer; (b) they materially alter it; or (c) notification of objection to them has already been given or is given within a reasonable time after notice of them is received (3) Conduct by both parties which recognizes the existence of a contract is sufficient to establish a contract for sale although the writings of the parties not otherwise establish a contract In such case the terms of the particular contract consist of those terms on which the writings of the parties agree, together with any supplementary terms incorporated under any other provisions of this Act § 2–208.  Course of Performance or Practical Construction (1) Where the contract for sale involves repeated occasions for performance by either party with knowledge of the nature of the performance and opportunity for objection to it by the other, any course of performance accepted or acquiesced in without objection shall be relevant to determine the meaning of the agreement (2)  The express terms of the agreement and any such course of performance, as well as any course of dealing and usage of trade, shall be construed whenever reasonable as consistent with each other; but when such construction is unreasonable, express terms shall control course of perform­ance and course of performance shall control both course of dealing and usage of trade (Section 1–205) (3) Subject to the provisions of the next section on modification and waiver, such course of performance shall be relevant to show a waiver or modification of any term inconsistent with such course of performance § 2–209.  Modification, Rescission and Waiver (1) An agreement modifying a contract within this Article needs no consideration to be binding (2) A signed agreement which excludes modification or rescission except by a signed writing cannot be otherwise modified or rescinded, but except as between merchants such a requirement on a form supplied by the merchant must be separately signed by the other party (3)  The requirements of the statute of frauds section of this Article (Section 2–201) must be satisfied if the contract as modified is within its provisions (4) Although an attempt at modification or rescission does not satisfy the requirements of subsection (2) or (3) it can operate as a waiver (5) A party who has made a waiver affecting an executory portion of the contract may retract the waiver by reasonable notification received by the other party that strict performance will be required of any term waived, unless the retraction would be unjust in view of a material change of position in reliance on the waiver Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  § 2–210.  Delegation of Performance; Assignment of Rights (1) A party may perform his duty through a delegate unless otherwise agreed or unless the other party has a substantial interest in having his original promisor perform or control the acts required by the contract No delegation of per­for­mance relieves the party delegating of any duty to perform or any liability for breach (2) Except as otherwise provided in Section 9–406, unless otherwise agreed, all rights of either seller or buyer can be assigned except where the assignment would materially change the duty of the other party, or increase materially the burden or risk imposed on him by his contract, or impair materially his chance of obtaining return performance A right to damages for breach of the whole contract or a right arising out of the assignor’s due performance of his entire obligation can be assigned despite agreement otherwise (3)  The creation, attachment, perfection, or enforcement of a security interest in the seller’s interest under a contract is not a transfer that materially changes the duty of or increases materially the burden or risk imposed on the buyer or impairs materially the buyer’s chance of obtaining return performance within the purview of subsection (2) unless, and then only to the extent that, enforcement actually results in a delegation of material performance of the seller Even in that event, the creation, attachment, perfection, and enforcement of the security interest remain effective, but (i) the seller is liable to the buyer for damages caused by the delegation to the extent that the damages could not reasonably by prevented by the buyer, and (ii) a court having jurisdiction may grant other appropriate relief, including cancellation of the contract for sale or an injunction against enforcement of the security interest or consummation of the enforcement (4) Unless the circumstances indicate the contrary a prohibition of assignment of “the contract” is to be construed as barring only the delegation to the assignee of the assignor’s performance (5) An assignment of “the contract” or of “all my rights under the contract” or an assignment in similar general terms is an assignment of rights and unless the language or the circumstances (as in an assignment for security) indicate the contrary, it is a delegation of performance of the duties of the assignor and its acceptance by the assignee constitutes a promise by him to perform those duties This promise is enforceable by either the assignor or the other party to the original contract (6) The other party may treat any assignment which delegates performance as creating reasonable grounds for insecurity and may without prejudice to his rights against the assignor demand assurances from the assignee (Section 2–609) As amended in 1999 Part 3—General Obligation and Construction of Contract § 2–301.  General Obligations of Parties The obligation of the seller is to transfer and deliver and that of the buyer is to accept and pay in accordance with the ­contract § 2–302.  Unconscionable Contract or Clause (1) If the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made the court may refuse to enforce the contract, or it may A–21 enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result (2) When it is claimed or appears to the court that the contract or any clause thereof may be unconscionable the parties shall be afforded a reasonable opportunity to present evidence as to its commercial setting, purpose and effect to aid the court in making the determination § 2–303.  Allocations or Division of Risks Where this Article allocates a risk or a burden as between the parties “unless otherwise agreed”, the agreement may not only shift the allocation but may also divide the risk or burden § 2–304.  Price Payable in Money, Goods, Realty, or Otherwise (1) The price can be made payable in money or otherwise If it is payable in whole or in part in goods each party is a seller of the goods which he is to transfer (2) Even though all or part of the price is payable in an interest in realty the transfer of the goods and the seller’s obligations with reference to them are subject to this Article, but not the transfer of the interest in realty or the transferor’s obligations in connection therewith § 2–305.  Open Price Term (1) The parties if they so intend can conclude a contract for sale even though the price is not settled In such a case the price is a reasonable price at the time for delivery if (a) nothing is said as to price; or (b) the price is left to be agreed by the parties and they fail to agree; or (c) the price is to be fixed in terms of some agreed market or other standard as set or recorded by a third person or agency and it is not so set or recorded (2) A price to be fixed by the seller or by the buyer means a price for him to fix in good faith (3) When a price left to be fixed otherwise than by agreement of the parties fails to be fixed through fault of one party the other may at his option treat the contract as cancelled or himself fix a reasonable price (4) Where, however, the parties intend not to be bound unless the price be fixed or agreed and it is not fixed or agreed there is no contract In such a case the buyer must return any goods already received or if unable so to must pay their reasonable value at the time of delivery and the seller must return any portion of the price paid on account § 2–306.  Output, Requirements and Exclusive Dealings (1) A term which measures the quantity by the output of the seller or the requirements of the buyer means such actual output or requirements as may occur in good faith, except that no quantity unreasonably disproportionate to any stated estimate or in the absence of a stated estimate to any normal or otherwise comparable prior output or requirements may be tendered or demanded (2)  A lawful agreement by either the seller or the buyer for exclusive dealing in the kind of goods concerned imposes unless otherwise agreed an obligation by the seller to use best efforts to supply the goods and by the buyer to use best efforts to promote their sale Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–22  Appendix c  Articles and 2A of the Uniform Commercial Code § 2–307.  Delivery in Single Lot or Several Lots Unless otherwise agreed all goods called for by a contract for sale must be tendered in a single delivery and payment is due only on such tender but where the circumstances give either party the right to make or demand delivery in lots the price if it can be apportioned may be demanded for each lot § 2–308.  Absence of Specified Place for Delivery Unless otherwise agreed (a)  the place for delivery of goods is the seller’s place of business or if he has none his residence; but (b) in a contract for sale of identified goods which to the knowledge of the parties at the time of contracting are in some other place, that place is the place for their delivery; and (c) documents of title may be delivered through customary banking channels § 2–309.  Absence of Specific Time Provisions; Notice of Termination (1) The time for shipment or delivery or any other action under a contract if not provided in this Article or agreed upon shall be a reasonable time (2)  Where the contract provides for successive perfor­mances but is indefinite in duration it is valid for a reasonable time but unless otherwise agreed may be terminated at any time by either party (3)  Termination of a contract by one party except on the happening of an agreed event requires that reasonable notification be received by the other party and an agreement dispensing with notification is invalid if its operation would be unconscionable § 2–310.  Open Time for Payment or Running of Credit; Authority to Ship Under Reservation Unless otherwise agreed (a) payment is due at the time and place at which the buyer is to receive the goods even though the place of shipment is the place of delivery; and (b) if the seller is authorized to send the goods he may ship them under reservation, and may tender the documents of title, but the buyer may inspect the goods after their arrival before payment is due unless such inspection is inconsistent with the terms of the contract (Section 2–513); and (c) if delivery is authorized and made by way of documents of title otherwise than by subsection (b) then payment is due at the time and place at which the buyer is to receive the documents regardless of where the goods are to be received; and (d)  where the seller is required or authorized to ship the goods on credit the credit period runs from the time of shipment but post-dating the invoice or delaying its dispatch will correspondingly delay the starting of the credit period § 2–311.  Options and Cooperation Respecting Performance (1) An agreement for sale which is otherwise sufficiently definite (subsection (3) of Section 2–204) to be a contract is not made invalid by the fact that it leaves particulars of performance to be specified by one of the parties Any such specification must be made in good faith and within limits set by commercial reasonableness (2)  Unless otherwise agreed specifications relating to assortment of the goods are at the buyer’s option and except as otherwise provided in subsections (1)(c) and (3) of Section 2–319 specifications or arrangements relating to shipment are at the seller’s option (3) Where such specification would materially affect the other party’s performance but is not seasonably made or where one party’s cooperation is necessary to the agreed performance of the other but is not seasonably forthcoming, the other party in addition to all other remedies (a)  is excused for any resulting delay in his own performance; and (b)  may also either proceed to perform in any reasonable manner or after the time for a material part of his own performance treat the failure to specify or to cooperate as a breach by failure to deliver or accept the goods § 2–312.  Warranty of Title and Against Infringement; Buyer’s Obligation Against Infringement (1) Subject to subsection (2) there is in a contract for sale a warranty by the seller that (a) the title conveyed shall be good, and its transfer rightful; and (b) the goods shall be delivered free from any security interest or other lien or encumbrance of which the buyer at the time of contracting has no knowledge (2) A warranty under subsection (1) will be excluded or modified only by specific language or by circumstances which give the buyer reason to know that the person selling does not claim title in himself or that he is purporting to sell only such right or title as he or a third person may have (3) Unless otherwise agreed a seller who is a merchant regularly dealing in goods of the kind warrants that the goods shall be delivered free of the rightful claim of any third person by way of infringement or the like but a buyer who furnishes specifications to the seller must hold the seller harmless against any such claim which arises out of compliance with the specifications § 2–313.  Express Warranties by Affirmation, Promise, Description, Sample (1) Express warranties by the seller are created as ­follows: (a)  Any affirmation of fact or promise made by the seller to the buyer which relates to the goods and becomes part of the basis of the bargain creates an express warranty that the goods shall conform to the affirmation or promise (b) Any description of the goods which is made part of the basis of the bargain creates an express warranty that the goods shall conform to the description (c) Any sample or model which is made part of the basis of the bargain creates an express warranty that the whole of the goods shall conform to the sample or model (2) It is not necessary to the creation of an express warranty that the seller use formal words such as “warrant” or “guarantee” or that he have a specific intention to make a warranty, but Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  an affirmation merely of the value of the goods or a statement purporting to be merely the seller’s opinion or commendation of the goods does not create a warranty § 2–314.  Implied Warranty: Merchantability; Usage of Trade (1)  Unless excluded or modified (Section 2–316), a warranty that the goods shall be merchantable is implied in a contract for their sale if the seller is a merchant with respect to goods of that kind Under this section the serving for value of food or drink to be consumed either on the premises or elsewhere is a sale (2) Goods to be merchantable must be at least such as (a) pass without objection in the trade under the contract description; and (b) in the case of fungible goods, are of fair average quality within the description; and (c) are fit for the ordinary purposes for which such goods are used; and (d) run, within the variations permitted by the agreement, of even kind, quality and quantity within each unit and among all units involved; and (e) are adequately contained, packaged, and labeled as the agreement may require; and (f) conform to the promises or affirmations of fact made on the container or label if any (3) Unless excluded or modified (Section 2–316) other implied warranties may arise from course of dealing or usage of trade § 2–315.  Implied Warranty: Fitness for Particular Purpose Where the seller at the time of contracting has reason to know any particular purpose for which the goods are required and that the buyer is relying on the seller’s skill or judgment to select or furnish suitable goods, there is unless excluded or modified under the next section an implied warranty that the goods shall be fit for such ­purpose § 2–316.  Exclusion or Modification of Warranties (1) Words or conduct relevant to the creation of an express warranty and words or conduct tending to negate or limit warranty shall be construed wherever reasonable as consistent with each other; but subject to the provisions of this Article on parol or extrinsic evidence (Section 2–202) negation or limitation is inoperative to the extent that such construction is unreasonable (2) Subject to subsection (3), to exclude or modify the implied warranty of merchantability or any part of it the language must mention merchantability and in case of a writing must be conspicuous, and to exclude or modify any implied warranty of fitness the exclusion must be by a writing and conspicuous Language to exclude all implied warranties of fitness is sufficient if it states, for example, that “There are no warranties which extend beyond the description on the face hereof.” (3) Notwithstanding subsection (2) (a) unless the circumstances indicate otherwise, all implied warranties are excluded by expressions like “as is”, “with all faults” or other language which in common understanding A–23 calls the buyer’s attention to the exclusion of warranties and makes plain that there is no implied warranty; and (b)  when the buyer before entering into the contract has examined the goods or the sample or model as fully as he desired or has refused to examine the goods there is no implied warranty with regard to defects which an examination ought in the circumstances to have revealed to him; and (c) an implied warranty can also be excluded or modified by course of dealing or course of performance or usage of trade (4)  Remedies for breach of warranty can be limited in accordance with the provisions of this Article on liquidation or limitation of damages and on contractual modification of remedy (Sections 2–718 and 2–719) § 2–317.  Cumulation and Conflict of Warranties Express or Implied Warranties whether express or implied shall be construed as consistent with each other and as cumulative, but if such construction is unreasonable the intention of the parties shall determine which warranty is dominant In ascertaining that intention the following rules apply: (a)  Exact or technical specifications displace an inconsistent sample or model or general language of description (b) A sample from an existing bulk displaces inconsistent general language of description (c)  Express warranties displace inconsistent implied warranties other than an implied warranty of fitness for a particular purpose § 2–318.  Third Party Beneficiaries of Warranties Express or Implied Note: If this Act is introduced in the Congress of the United States this section should be omitted (States to select one alternative.) Alternative A A seller’s warranty whether express or implied extends to any natural person who is in the family or household of his buyer or who is a guest in his home if it is reasonable to expect that such person may use, consume or be affected by the goods and who is injured in person by breach of the warranty A seller may not exclude or limit the operation of this section Alternative B A seller’s warranty whether express or implied extends to any natural person who may reasonably be expected to use, consume or be affected by the goods and who is injured in person by breach of the warranty A seller may not exclude or limit the operation of this section Alternative C A seller’s warranty whether express or implied extends to any person who may reasonably be expected to use, consume or be affected by the goods and who is injured by breach of the warranty A seller may not exclude or limit the operation of this section with respect to injury to the person of an individual to whom the warranty extends As amended 1966 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–24  Appendix c  Articles and 2A of the Uniform Commercial Code § 2–319.  F.O.B and F.A.S Terms (1) Unless otherwise agreed the term F.O.B (which means “free on board”) at a named place, even though used only in connection with the stated price, is a delivery term under which (a) when the term is F.O.B the place of shipment, the seller must at that place ship the goods in the manner provided in this Article (Section 2–504) and bear the expense and risk of putting them into the possession of the carrier; or (b)  when the term is F.O.B the place of destination, the seller must at his own expense and risk transport the goods to that place and there tender delivery of them in the manner provided in this Article (Section 2–503); (c) when under either (a) or (b) the term is also F.O.B vessel, car or other vehicle, the seller must in addition at his own expense and risk load the goods on board If the term is F.O.B vessel the buyer must name the vessel and in an appropriate case the seller must comply with the provisions of this Article on the form of bill of lading (Section 2–323) (2) Unless otherwise agreed the term F.A.S vessel (which means “free alongside”) at a named port, even though used only in connection with the stated price, is a delivery term under which the seller must (a) at his own expense and risk deliver the goods alongside the vessel in the manner usual in that port or on a dock designated and provided by the buyer; and (b) obtain and tender a receipt for the goods in exchange for which the carrier is under a duty to issue a bill of lading (3) Unless otherwise agreed in any case falling within subsection (1)(a) or (c) or subsection (2) the buyer must seasonably give any needed instructions for making delivery, including when the term is F.A.S or F.O.B the loading berth of the vessel and in an appropriate case its name and sailing date The seller may treat the failure of needed instructions as a failure of cooperation under this Article (Section 2–311) He may also at his option move the goods in any reasonable manner preparatory to delivery or shipment (4)  Under the term F.O.B vessel or F.A.S unless otherwise agreed the buyer must make payment against tender of the required documents and the seller may not tender nor the buyer demand delivery of the goods in substitution for the documents § 2–320.  C.I.F and C & F Terms (1)  The term C.I.F means that the price includes in a lump sum the cost of the goods and the insurance and freight to the named destination The term C & F or C.F means that the price so includes cost and freight to the named destination (2) Unless otherwise agreed and even though used only in connection with the stated price and destination, the term C.I.F destination or its equivalent requires the seller at his own expense and risk to (a) put the goods into the possession of a carrier at the port for shipment and obtain a negotiable bill or bills of lading covering the entire transportation to the named destination; and (b)  load the goods and obtain a receipt from the carrier (which may be contained in the bill of lading) showing that the freight has been paid or provided for; and (c) obtain a policy or certificate of insurance, including any war risk insurance, of a kind and on terms then current at the port of shipment in the usual amount, in the currency of the contract, shown to cover the same goods covered by the bill of lading and providing for payment of loss to the order of the buyer or for the account of whom it may concern; but the seller may add to the price the amount of the premium for any such war risk insurance; and (d) prepare an invoice of the goods and procure any other documents required to effect shipment or to comply with the contract; and (e) forward and tender with commercial promptness all the documents in due form and with any indorsement necessary to perfect the buyer’s rights (3) Unless otherwise agreed the term C & F or its equivalent has the same effect and imposes upon the seller the same obligations and risks as a C.I.F term except the obli­gation as to insurance (4)  Under the term C.I.F or C & F unless otherwise agreed the buyer must make payment against tender of the required documents and the seller may not tender nor the buyer demand delivery of the goods in substitution for the documents § 2–321.  C.I.F or C & F.: “Net Landed Weights”; “Payment on Arrival”; Warranty of Condition on Arrival Under a contract containing a term C.I.F or C & F (1) Where the price is based on or is to be adjusted according to “net landed weights”, “delivered weights”, “out turn” quantity or quality or the like, unless otherwise agreed the seller must reasonably estimate the price The payment due on tender of the documents called for by the contract is the amount so estimated, but after final adjustment of the price a settlement must be made with commercial promptness (2) An agreement described in subsection (1) or any warranty of quality or condition of the goods on arrival places upon the seller the risk of ordinary deterioration, shrinkage and the like in transportation but has no effect on the place or time of identification to the contract for sale or delivery or on the passing of the risk of loss (3)  Unless otherwise agreed where the contract provides for payment on or after arrival of the goods the seller must before payment allow such preliminary inspection as is feasible; but if the goods are lost delivery of the documents and payment are due when the goods should have arrived § 2–322.  Delivery “Ex-Ship” (1)  Unless otherwise agreed a term for delivery of goods “exship” (which means from the carrying vessel) or in equivalent language is not restricted to a particular ship and requires delivery from a ship which has reached a place at the named port of destination where goods of the kind are usually discharged (2) Under such a term unless otherwise agreed (a) the seller must discharge all liens arising out of the carriage and furnish the buyer with a direction which puts the carrier under a duty to deliver the goods; and (b) the risk of loss does not pass to the buyer until the goods leave the ship’s tackle or are otherwise properly unloaded Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  § 2–323.  Form of Bill of Lading Required in Overseas Shipment; “Overseas” (1)  Where the contract contemplates overseas shipment and contains a term C.I.F or C & F or F.O.B vessel, the seller unless otherwise agreed must obtain a negotiable bill of lading stating that the goods have been loaded on board or, in the case of a term C.I.F or C & F., received for shipment (2) Where in a case within subsection (1) a bill of lading has been issued in a set of parts, unless otherwise agreed if the documents are not to be sent from abroad the buyer may demand tender of the full set; otherwise only one part of the bill of lading need be tendered Even if the agreement expressly requires a full set (a) due tender of a single part is acceptable within the provisions of this Article on cure of improper delivery (subsection (1) of Section 2–508); and (b) even though the full set is demanded, if the documents are sent from abroad the person tendering an incomplete set may nevertheless require payment upon furnishing an indemnity which the buyer in good faith deems adequate (3)  A shipment by water or by air or a contract contemplating such shipment is “overseas” insofar as by usage of trade or agreement it is subject to the commercial, financing or shipping practices characteristic of international deep water commerce § 2–324.  “No Arrival, No Sale” Term Under a term “no arrival, no sale” or terms of like meaning, unless otherwise agreed, (a) the seller must properly ship conforming goods and if they arrive by any means he must tender them on arrival but he assumes no obligation that the goods will arrive unless he has caused the non-arrival; and (b) where without fault of the seller the goods are in part lost or have so deteriorated as no longer to conform to the contract or arrive after the contract time, the buyer may proceed as if there had been casualty to identified goods (Section 2–613) § 2–325.  “Letter of Credit” Term; “Confirmed Credit” (1) Failure of the buyer seasonably to furnish an agreed letter of credit is a breach of the contract for sale (2) The delivery to seller of a proper letter of credit s­ uspends the buyer’s obligation to pay If the letter of credit is dishonored, the seller may on seasonable notification to the buyer require payment directly from him (3)  Unless otherwise agreed the term “letter of credit” or “banker’s credit” in a contract for sale means an irrevocable credit issued by a financing agency of good repute and, where the shipment is overseas, of good international repute The term “confirmed credit” means that the credit must also carry the direct obligation of such an agency which does business in the seller’s financial market § 2–326.  Sale on Approval and Sale or Return; Rights of Creditors (1) Unless otherwise agreed, if delivered goods may be returned by the buyer even though they conform to the contract, the transaction is (a) a “sale on approval” if the goods are delivered primarily for use, and A–25 (b)  a “sale or return” if the goods are delivered primarily for resale (2) Goods held on approval are not subject to the claims of the buyer’s creditors until acceptance; goods held on sale or return are subject to such claims while in the buyer’s possession (3) Any “or return” term of a contract for sale is to be treated as a separate contract for sale within the statute of frauds section of this Article (Section 2–201) and as contradicting the sale aspect of the contract within the provisions of this Article or on parol or extrinsic evidence (Section 2–202) As amended in 1999 § 2–327.  Special Incidents of Sale on Approval and Sale or Return (1) Under a sale on approval unless otherwise agreed (a)  although the goods are identified to the contract the risk of loss and the title not pass to the buyer until acceptance; and (b) use of the goods consistent with the purpose of trial is not acceptance but failure seasonably to notify the seller of election to return the goods is acceptance, and if the goods conform to the contract acceptance of any part is acceptance of the whole; and (c) after due notification of election to return, the return is at the seller’s risk and expense but a merchant buyer must follow any reasonable instructions (2) Under a sale or return unless otherwise agreed (a) the option to return extends to the whole or any commercial unit of the goods while in substantially their original condition, but must be exercised seasonably; and (b) the return is at the buyer’s risk and expense § 2–328.  Sale by Auction (1) In a sale by auction if goods are put up in lots each lot is the subject of a separate sale (2)  A sale by auction is complete when the auctioneer so announces by the fall of the hammer or in other customary manner Where a bid is made while the hammer is falling in acceptance of a prior bid the auctioneer may in his discretion reopen the bidding or declare the goods sold under the bid on which the hammer was falling (3) Such a sale is with reserve unless the goods are in explicit terms put up without reserve In an auction with reserve the auctioneer may withdraw the goods at any time until he announces completion of the sale In an auction without reserve, after the auctioneer calls for bids on an article or lot, that article or lot cannot be withdrawn unless no bid is made within a reasonable time In either case a bidder may retract his bid until the auctioneer’s announcement of completion of the sale, but a bidder’s retraction does not revive any previous bid (4)  If the auctioneer knowingly receives a bid on the seller’s behalf or the seller makes or procures such as bid, and notice has not been given that liberty for such bidding is reserved, the buyer may at his option avoid the sale or take the goods at the price of the last good faith bid prior to the completion of the sale This subsection shall not apply to any bid at a forced sale Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–26  Appendix c  Articles and 2A of the Uniform Commercial Code Part 4—Title, Creditors and Good Faith Purchasers § 2–401.  Passing of Title; Reservation for Security; Limited Application of This Section Each provision of this Article with regard to the rights, obligations and remedies of the seller, the buyer, purchasers or other third parties applies irrespective of title to the goods except where the provision refers to such title Insofar as situations are not covered by the other provisions of this Article and matters concerning title became mate­rial the following rules apply: (1)  Title to goods cannot pass under a contract for sale prior to their identification to the contract (Section 2–501), and unless otherwise explicitly agreed the buyer acquires by their identification a special property as limited by this Act Any retention or reservation by the seller of the title (property) in goods shipped or delivered to the buyer is limited in effect to a reservation of a security interest Subject to these provisions and to the provisions of the Article on Secured Transactions (Article 9), title to goods passes from the seller to the buyer in any manner and on any conditions explicitly agreed on by the parties (2) Unless otherwise explicitly agreed title passes to the buyer at the time and place at which the seller completes his performance with reference to the physical delivery of the goods, despite any reservation of a security interest and even though a document of title is to be delivered at a different time or place; and in particular and despite any reservation of a security interest by the bill of lading (a) if the contract requires or authorizes the seller to send the goods to the buyer but does not require him to deliver them at destination, title passes to the buyer at the time and place of shipment; but (b)  if the contract requires delivery at destination, title passes on tender there (3)  Unless otherwise explicitly agreed where delivery is to be made without moving the goods, (a) if the seller is to deliver a document of title, title passes at the time when and the place where he delivers such documents; or (b) if the goods are at the time of contracting already identified and no documents are to be delivered, title passes at the time and place of contracting (4) A rejection or other refusal by the buyer to receive or retain the goods, whether or not justified, or a justified revocation of acceptance revests title to the goods in the seller Such revesting occurs by operation of law and is not a “sale” § 2–402.  Rights of Seller’s Creditors Against Sold Goods (1) Except as provided in subsections (2) and (3), rights of unsecured creditors of the seller with respect to goods which have been identified to a contract for sale are subject to the buyer’s rights to recover the goods under this Article (Sections 2–502 and 2–716) (2) A creditor of the seller may treat a sale or an identification of goods to a contract for sale as void if as against him a retention of possession by the seller is fraudulent under any rule of law of the state where the goods are situated, except that retention of possession in good faith and current course of trade by a merchant-seller for a commercially reasonable time after a sale or identification is not fraudulent (3) Nothing in this Article shall be deemed to impair the rights of creditors of the seller (a)  under the provisions of the Article on Secured Transactions (Article 9); or (b) where identification to the contract or delivery is made not in current course of trade but in satisfaction of or as security for a pre-existing claim for money, security or the like and is made under circumstances which under any rule of law of the state where the goods are situated would apart from this Article constitute the transaction a fraudulent transfer or voidable preference § 2–403.  Power to Transfer; Good Faith Purchase of Goods; “Entrusting” (1) A purchaser of goods acquires all title which his transferor had or had power to transfer except that a purchaser of a limited interest acquires rights only to the extent of the interest purchased A person with voidable title has power to transfer a good title to a good faith purchaser for value When goods have been delivered under a transaction of purchase the purchaser has such power even though (a) the transferor was deceived as to the identity of the purchaser, or (b) the delivery was in exchange for a check which is later dishonored, or (c)  it was agreed that the transaction was to be a “cash sale”, or (d) the delivery was procured through fraud punishable as larcenous under the criminal law (2) Any entrusting of possession of goods to a merchant who deals in goods of that kind gives him power to transfer all rights of the entruster to a buyer in ordinary course of business (3) “Entrusting” includes any delivery and any acquiescence in retention of possession regardless of any condition expressed between the parties to the delivery or acquiescence and regardless of whether the procurement of the entrusting or the possessor’s disposition of the goods have been such as to be larcenous under the criminal law (4) The rights of other purchasers of goods and of lien creditors are governed by the Articles on Secured Transactions (Article 9), Bulk Transfers (Article 6) and Documents of Title (Article 7) As amended in 1988 Part 5—Performance § 2–501.  Insurable Interest in Goods; Manner of Identification of Goods (1) The buyer obtains a special property and an insurable interest in goods by identification of existing goods as goods to which the contract refers even though the goods so identified are non-conforming and he has an option to return or reject them Such identification can be made at any time and in any manner explicitly agreed to by the parties In the absence of explicit agreement identification occurs (a) when the contract is made if it is for the sale of goods already existing and identified; (b) if the contract is for the sale of future goods other than those described in paragraph (c), when goods are shipped, Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  marked or otherwise designated by the seller as goods to which the contract refers; (c) when the crops are planted or otherwise become growing crops or the young are conceived if the contract is for the sale of unborn young to be born within twelve months after contracting or for the sale of crops to be harvested within twelve months or the next normal harvest season after contracting whichever is longer (2) The seller retains an insurable interest in goods so long as title to or any security interest in the goods remains in him and where the identification is by the seller alone he may until default or insolvency or notification to the buyer that the identification is final substitute other goods for those identified (3) Nothing in this section impairs any insurable interest recognized under any other statute or rule of law § 2–502.  Buyer’s Right to Goods on Seller’s Insolvency (1)  Subject to subsections (2) and (3) and even though the goods have not been shipped a buyer who has paid a part or all of the price of goods in which he has a special property under the provisions of the immediately preceding section may on making and keeping good a tender of any unpaid portion of their price recover them from the seller if: (a) in the case of goods bought for personal, family, or household purposes, the seller repudiates or fails to deliver as required by the contract; or (b) in all cases, the seller becomes insolvent within ten days after receipt of the first installment on their price (2)  The buyer’s right to recover the goods under subsection (1)(a) vests upon acquisition of a special property, even if the seller had not then repudiated or failed to deliver (3)  If the identification creating his special property has been made by the buyer he acquires the right to recover the goods only if they conform to the contract for sale As amended in 1999 § 2–503.  Manner of Seller’s Tender of Delivery (1) Tender of delivery requires that the seller put and hold conforming goods at the buyer’s disposition and give the buyer any notification reasonably necessary to enable him to take delivery The manner, time and place for tender are determined by the agreement and this Article, and in particular (a) tender must be at a reasonable hour, and if it is of goods they must be kept available for the period reasonably necessary to enable the buyer to take possession; but (b) unless otherwise agreed the buyer must furnish facilities reasonably suited to the receipt of the goods (2) Where the case is within the next section respecting shipment tender requires that the seller comply with its ­provisions (3) Where the seller is required to deliver at a particular destination tender requires that he comply with subsection (1) and also in any appropriate case tender documents as described in subsections (4) and (5) of this section (4) Where goods are in the possession of a bailee and are to be delivered without being moved (a) tender requires that the seller either tender a negotiable document of title covering such goods or procure acknowledgment by the bailee of the buyer’s right to possession of the goods; but A–27 (b)  tender to the buyer of a non-negotiable document of title or of a written direction to the bailee to deliver is sufficient tender unless the buyer seasonably objects, and receipt by the bailee of notification of the buyer’s rights fixes those rights as against the bailee and all third persons; but risk of loss of the goods and of any failure by the bailee to honor the non-­negotiable document of title or to obey the direction remains on the seller until the buyer has had a reasonable time to present the document or direction, and a refusal by the bailee to honor the document or to obey the direction defeats the tender (5) Where the contract requires the seller to deliver ­documents (a)  he must tender all such documents in correct form, except as provided in this Article with respect to bills of lading in a set (subsection (2) of Section 2–323); and (b)  tender through customary banking channels is sufficient and dishonor of a draft accompanying the documents constitutes non-acceptance or rejection § 2–504.  Shipment by Seller Where the seller is required or authorized to send the goods to the buyer and the contract does not require him to deliver them at a particular destination, then unless otherwise agreed he must (a)  put the goods in the possession of such a carrier and make such a contract for their transportation as may be reasonable having regard to the nature of the goods and other circumstances of the case; and (b) obtain and promptly deliver or tender in due form any document necessary to enable the buyer to obtain possession of the goods or otherwise required by the agreement or by usage of trade; and (c) promptly notify the buyer of the shipment Failure to notify the buyer under paragraph (c) or to make a proper contract under paragraph (a) is a ground for rejection only if material delay or loss ensues § 2–505.  Seller’s Shipment under Reservation (1) Where the seller has identified goods to the contract by or before shipment: (a) his procurement of a negotiable bill of lading to his own order or otherwise reserves in him a security interest in the goods His procurement of the bill to the order of a financing agency or of the buyer indicates in addition only the seller’s expectation of transferring that interest to the person named (b) a non-negotiable bill of lading to himself or his nominee reserves possession of the goods as security but except in a case of conditional delivery (subsection (2) of Section 2–507) a non-negotiable bill of lading naming the buyer as consignee reserves no security interest even though the seller retains possession of the bill of lading (2) When shipment by the seller with reservation of a security interest is in violation of the contract for sale it constitutes an improper contract for transportation within the preceding section but impairs neither the rights given to the buyer by shipment and identification of the goods to the contract nor the seller’s powers as a holder of a negotiable document Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–28  Appendix c  Articles and 2A of the Uniform Commercial Code § 2–506.  Rights of Financing Agency (1) A financing agency by paying or purchasing for value a draft which relates to a shipment of goods acquires to the extent of the payment or purchase and in addition to its own rights under the draft and any document of title securing it any rights of the shipper in the goods including the right to stop delivery and the shipper’s right to have the draft honored by the buyer (2)  The right to reimbursement of a financing agency which has in good faith honored or purchased the draft under commitment to or authority from the buyer is not impaired by subsequent discovery of defects with reference to any relevant document which was apparently regular on its face § 2–507.  Effect of Seller’s Tender; Delivery on Condition (1) Tender of delivery is a condition to the buyer’s duty to accept the goods and, unless otherwise agreed, to his duty to pay for them Tender entitles the seller to acceptance of the goods and to payment according to the contract (2) Where payment is due and demanded on the delivery to the buyer of goods or documents of title, his right as against the seller to retain or dispose of them is conditional upon his making the payment due § 2–508.  Cure by Seller of Improper Tender or Delivery; Replacement (1) Where any tender or delivery by the seller is rejected because non-conforming and the time for performance has not yet expired, the seller may seasonably notify the buyer of his intention to cure and may then within the contract time make a conforming delivery (2) Where the buyer rejects a non-conforming tender which the seller had reasonable grounds to believe would be acceptable with or without money allowance the seller may if he seasonably notifies the buyer have a further reasonable time to substitute a conforming tender § 2–509.  Risk of Loss in the Absence of Breach (1) Where the contract requires or authorizes the seller to ship the goods by carrier (a) if it does not require him to deliver them at a particular destination, the risk of loss passes to the buyer when the goods are duly delivered to the carrier even though the shipment is under reservation (Section 2–505); but (b) if it does require him to deliver them at a particular destination and the goods are there duly tendered while in the possession of the carrier, the risk of loss passes to the buyer when the goods are there duly so tendered as to enable the buyer to take ­delivery (2) Where the goods are held by a bailee to be delivered without being moved, the risk of loss passes to the buyer (a) on his receipt of a negotiable document of title covering the goods; or (b) on acknowledgment by the bailee of the buyer’s right to possession of the goods; or (c) after his receipt of a non-negotiable document of title or other written direction to deliver, as provided in subsection (4)(b) of Section 2–503 (3)  In any case not within subsection (1) or (2), the risk of loss passes to the buyer on his receipt of the goods if the seller is a merchant; otherwise the risk passes to the buyer on tender of delivery (4) The provisions of this section are subject to contrary agreement of the parties and to the provisions of this Article on sale on approval (Section 2–327) and on effect of breach on risk of loss (Section 2–510) § 2–510.  Effect of Breach on Risk of Loss (1) Where a tender or delivery of goods so fails to conform to the contract as to give a right of rejection the risk of their loss remains on the seller until cure or acceptance (2)  Where the buyer rightfully revokes acceptance he may to the extent of any deficiency in his effective insurance coverage treat the risk of loss as having rested on the seller from the beginning (3) Where the buyer as to conforming goods already identified to the contract for sale repudiates or is otherwise in breach before risk of their loss has passed to him, the seller may to the extent of any deficiency in his effective insurance coverage treat the risk of loss as resting on the buyer for a commercially reasonable time § 2–511.  Tender of Payment by Buyer; Payment by Check (1) Unless otherwise agreed tender of payment is a condition to the seller’s duty to tender and complete any delivery (2) Tender of payment is sufficient when made by any means or in any manner current in the ordinary course of business unless the seller demands payment in legal ­tender and gives any extension of time reasonably necessary to procure it (3)  Subject to the provisions of this Act on the effect of an instrument on an obligation (Section 3–310), payment by check is conditional and is defeated as between the parties by dishonor of the check on due presentment As amended in 1994 § 2–512.  Payment by Buyer Before Inspection (1)  Where the contract requires payment before inspection non-conformity of the goods does not excuse the buyer from so making payment unless (a) the non-conformity appears without inspection; or (b)  despite tender of the required documents the circumstances would justify injunction against honor under this Act (Section 5–109(b)) (2) Payment pursuant to subsection (1) does not constitute an acceptance of goods or impair the buyer’s right to inspect or any of his remedies As amended in 1995 § 2–513.  Buyer’s Right to Inspection of Goods (1) Unless otherwise agreed and subject to subsection (3), where goods are tendered or delivered or identified to the contract for sale, the buyer has a right before payment or acceptance to inspect them at any reasonable place and time and in any reasonable manner When the seller is required or authorized to send the goods to the buyer, the inspection may be after their arrival (2) Expenses of inspection must be borne by the buyer but may be recovered from the seller if the goods not conform and are rejected Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  (3) Unless otherwise agreed and subject to the provisions of this Article on C.I.F contracts (subsection (3) of Section 2–321), the buyer is not entitled to inspect the goods before payment of the price when the contract ­provides (a) for delivery “C.O.D.” or on other like terms; or (b)  for payment against documents of title, except where such payment is due only after the goods are to become available for inspection (4) A place or method of inspection fixed by the parties is presumed to be exclusive but unless otherwise expressly agreed it does not postpone identification or shift the place for delivery or for passing the risk of loss If compliance becomes impossible, inspection shall be as provided in this section unless the place or method fixed was clearly intended as an indispensable condition failure of which avoids the contract § 2–514.  When Documents Deliverable on Acceptance; When on Payment Unless otherwise agreed documents against which a draft is drawn are to be delivered to the drawee on acceptance of the draft if it is payable more than three days after presentment; otherwise, only on payment § 2–515.  Preserving Evidence of Goods in Dispute In furtherance of the adjustment of any claim or dispute (a) either party on reasonable notification to the other and for the purpose of ascertaining the facts and preserving evidence has the right to inspect, test and sample the goods including such of them as may be in the possession or control of the other; and (b) the parties may agree to a third party inspection or survey to determine the conformity or condition of the goods and may agree that the findings shall be binding upon them in any subsequent litigation or adjustment Part 6—Breach, Repudiation and Excuse § 2–601.  Buyer’s Rights on Improper Delivery Subject to the provisions of this Article on breach in installment contracts (Section 2–612) and unless otherwise agreed under the sections on contractual limitations of remedy (Sections 2–718 and 2–719), if the goods or the tender of delivery fail in any respect to conform to the contract, the buyer may (a) reject the whole; or (b) accept the whole; or (c) accept any commercial unit or units and reject the rest § 2–602.  Manner and Effect of Rightful Rejection (1) Rejection of goods must be within a reasonable time after their delivery or tender It is ineffective unless the buyer seasonably notifies the seller (2) Subject to the provisions of the two following sections on rejected goods (Sections 2–603 and 2–604), (a) after rejection any exercise of ownership by the buyer with respect to any commercial unit is wrongful as against the seller; and (b) if the buyer has before rejection taken physical possession of goods in which he does not have a security interest under the provisions of this Article (subsection (3) of Section 2–711), he is under a duty after rejection to hold A–29 them with reasonable care at the seller’s disposition for a time sufficient to permit the seller to remove them; but (c)  the buyer has no further obligations with regard to goods rightfully rejected (3) The seller’s rights with respect to goods wrongfully rejected are governed by the provisions of this Article on Seller’s remedies in general (Section 2–703) § 2–603.  Merchant Buyer’s Duties as to Rightfully Rejected Goods (1) Subject to any security interest in the buyer (subsection (3) of Section 2–711), when the seller has no agent or place of business at the market of rejection a merchant buyer is under a duty after rejection of goods in his possession or control to follow any reasonable instructions received from the seller with respect to the goods and in the absence of such instructions to make reasonable efforts to sell them for the seller’s account if they are perishable or threaten to decline in value speedily Instructions are not reasonable if on demand indemnity for expenses is not forthcoming (2) When the buyer sells goods under subsection (1), he is entitled to reimbursement from the seller or out of the proceeds for reasonable expenses of caring for and selling them, and if the expenses include no selling commission then to such commission as is usual in the trade or if there is none to a reasonable sum not exceeding ten per cent on the gross proceeds (3)  In complying with this section the buyer is held only to good faith and good faith conduct hereunder is neither acceptance nor conversion nor the basis of an action for damages § 2–604.  Buyer’s Options as to Salvage of Rightfully Rejected Goods Subject to the provisions of the immediately preceding section on perishables if the seller gives no instructions within a reasonable time after notification of rejection the buyer may store the rejected goods for the seller’s account or reship them to him or resell them for the seller’s account with reimbursement as provided in the preceding section Such action is not acceptance or ­conversion § 2–605.  Waiver of Buyer’s Objections by Failure to Particularize (1)  The buyer’s failure to state in connection with rejection a particular defect which is ascertainable by reasonable inspection precludes him from relying on the unstated defect to justify rejection or to establish breach (a)  where the seller could have cured it if stated season­ ably; or (b) between merchants when the seller has after rejection made a request in writing for a full and final written statement of all defects on which the buyer proposes to rely (2)  Payment against documents made without reservation of rights precludes recovery of the payment for defects apparent on the face of the documents § 2–606.  What Constitutes Acceptance of Goods (1) Acceptance of goods occurs when the buyer (a) after a reasonable opportunity to inspect the goods signifies to the seller that the goods are conforming or that he will take or retain them in spite of their nonconformity; or Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–30  Appendix c  Articles and 2A of the Uniform Commercial Code (b)  fails to make an effective rejection (subsection (1) of Section 2–602), but such acceptance does not occur until the buyer has had a reasonable opportunity to inspect them; or (c)  does any act inconsistent with the seller’s ownership; but if such act is wrongful as against the seller it is an acceptance only if ratified by him (2) Acceptance of a part of any commercial unit is acceptance of that entire unit § 2–607.  Effect of Acceptance; Notice of Breach; Burden of Establishing Breach After Acceptance; Notice of Claim or Litigation to Person Answerable Over (1)  The buyer must pay at the contract rate for any goods accepted (2) Acceptance of goods by the buyer precludes rejection of the goods accepted and if made with knowledge of a non-conformity cannot be revoked because of it unless the acceptance was on the reasonable assumption that the non-conformity would be seasonably cured but acceptance does not of itself impair any other remedy provided by this Article for non-conformity (3) Where a tender has been accepted (a) the buyer must within a reasonable time after he discovers or should have discovered any breach notify the seller of breach or be barred from any remedy; and (b) if the claim is one for infringement or the like (subsection (3) of Section 2–312) and the buyer is sued as a result of such a breach he must so notify the seller within a reasonable time after he receives notice of the litigation or be barred from any remedy over for liability established by the litigation (4)  The burden is on the buyer to establish any breach with respect to the goods accepted (5) Where the buyer is sued for breach of a warranty or other obligation for which his seller is answerable over (a) he may give his seller written notice of the litigation If the notice states that the seller may come in and defend and that if the seller does not so he will be bound in any action against him by his buyer by any determination of fact common to the two litigations, then unless the seller after seasonable receipt of the notice does come in and defend he is so bound (b) if the claim is one for infringement or the like (subsection (3) of Section 2–312) the original seller may demand in writing that his buyer turn over to him control of the litigation including settlement or else be barred from any remedy over and if he also agrees to bear all expense and to satisfy any adverse judgment, then unless the buyer after seasonable receipt of the demand does turn over control the buyer is so barred (6)  The provisions of subsections (3), (4) and (5) apply to any obligation of a buyer to hold the seller harmless against infringement or the like (subsection (3) of Section 2–312) § 2–608.  Revocation of Acceptance in Whole or in Part (1) The buyer may revoke his acceptance of a lot or commercial unit whose non-conformity substantially impairs its value to him if he has accepted it (a)  on the reasonable assumption that its noncon­form­ity would be cured and it has not been seasonably cured; or (b)  without discovery of such non-conformity if his acceptance was reasonably induced either by the difficulty of discovery before acceptance or by the seller’s assurances (2)  Revocation of acceptance must occur within a reasonable time after the buyer discovers or should have discovered the ground for it and before any substantial change in condition of the goods which is not caused by their own defects It is not effective until the buyer notifies the seller of it (3) A buyer who so revokes has the same rights and duties with regard to the goods involved as if he had rejected them § 2–609.  Right to Adequate Assurance of Performance (1) A contract for sale imposes an obligation on each party that the other’s expectation of receiving due performance will not be impaired When reasonable grounds for insecurity arise with respect to the performance of either party the other may in writing demand adequate assurance of due performance and until he receives such assurance may if commercially reasonable suspend any performance for which he has not already received the agreed return (2) Between merchants the reasonableness of grounds for insecurity and the adequacy of any assurance offered shall be determined according to commercial standards (3) Acceptance of any improper delivery or payment does not prejudice the party’s right to demand adequate assurance of future performance (4) After receipt of a justified demand failure to provide within a reasonable time not exceeding thirty days such assurance of due performance as is adequate under the circumstances of the particular case is a repudiation of the ­contract § 2–610.  Anticipatory Repudiation When either party repudiates the contract with respect to a performance not yet due the loss of which will substantially impair the value of the contract to the other, the aggrieved party may (a) for a commercially reasonable time await performance by the repudiating party; or (b)  resort to any remedy for breach (Section 2–703 or Section 2–711), even though he has notified the repudiating party that he would await the latter’s performance and has urged retraction; and (c) in either case suspend his own performance or proceed in accordance with the provisions of this Article on the seller’s right to identify goods to the contract notwithstanding breach or to salvage unfinished goods (Section 2–704) § 2–611.  Retraction of Anticipatory Repudiation (1) Until the repudiating party’s next performance is due he can retract his repudiation unless the aggrieved party has since the repudiation cancelled or materially changed his position or otherwise indicated that he considers the repudiation final (2)  Retraction may be by any method which clearly indicates to the aggrieved party that the repudiating party intends to perform, but must include any assurance justifiably demanded under the provisions of this Article (Section 2–609) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  (3) Retraction reinstates the repudiating party’s rights under the contract with due excuse and allowance to the aggrieved party for any delay occasioned by the repudiation § 2–612.  “Installment Contract”; Breach (1) An “installment contract” is one which requires or authorizes the delivery of goods in separate lots to be separately accepted, even though the contract contains a clause “each delivery is a separate contract” or its ­equivalent (2) The buyer may reject any installment which is non-­conforming if the non-conformity substantially impairs the value of that installment and cannot be cured or if the non-conformity is a defect in the required documents; but if the non-conformity does not fall within subsection (3) and the seller gives adequate assurance of its cure the buyer must accept that installment (3)  Whenever non-conformity or default with respect to one or more installments substantially impairs the value of the whole contract there is a breach of the whole But the aggrieved party reinstates the contract if he accepts a non-­conforming installment without seasonably notifying of cancellation or if he brings an action with respect only to past installments or demands performance as to future installments § 2–613.  Casualty to Identified Goods Where the contract requires for its performance goods identified when the contract is made, and the goods suffer casualty without fault of either party before the risk of loss passes to the buyer, or in a proper case under a “no arrival, no sale” term (Section 2–324) then (a) if the loss is total the contract is avoided; and (b) if the loss is partial or the goods have so deteriorated as no longer to conform to the contract the buyer may nevertheless demand inspection and at his option either treat the contract as voided or accept the goods with due allowance from the contract price for the deterioration or the deficiency in quantity but without further right against the seller § 2–614.  Substituted Performance (1)  Where without fault of either party the agreed berthing, loading, or unloading facilities fail or an agreed type of carrier becomes unavailable or the agreed manner of delivery otherwise becomes commercially impracticable but a commercially reasonable substitute is available, such substitute performance must be tendered and accepted (2) If the agreed means or manner of payment fails because of domestic or foreign governmental regulation, the seller may withhold or stop delivery unless the buyer provides a means or manner of payment which is commercially a substantial equivalent If delivery has already been taken, payment by the means or in the manner provided by the regulation discharges the buyer’s obligation unless the regulation is discriminatory, oppressive or predatory § 2–615.  Excuse by Failure of Presupposed Conditions Except so far as a seller may have assumed a greater obli­ gation and subject to the preceding section on substituted performance: (a) Delay in delivery or non-delivery in whole or in part by a seller who complies with paragraphs (b) and (c) is not a breach of his duty under a contract for sale if performance A–31 as agreed has been made impracticable by the occurrence of a contingency the nonoccurrence of which was a basic assumption on which the contract was made or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid (b)  Where the causes mentioned in paragraph (a) affect only a part of the seller’s capacity to perform, he must allocate production and deliveries among his customers but may at his option include regular customers not then under contract as well as his own requirements for further manufacture He may so allocate in any manner which is fair and reasonable (c) The seller must notify the buyer seasonably that there will be delay or non-delivery and, when allocation is required under paragraph (b), of the estimated quota thus made available for the buyer § 2–616.  Procedure on Notice Claiming Excuse (1) Where the buyer receives notification of a material or indefinite delay or an allocation justified under the preceding section he may by written notification to the seller as to any delivery concerned, and where the prospective deficiency substantially impairs the value of the whole contract under the provisions of this Article relating to breach of installment contracts (Section 2–612), then also as to the whole, (a)  terminate and thereby discharge any unexecuted portion of the contract; or (b)  modify the contract by agreeing to take his available quota in substitution (2) If after receipt of such notification from the seller the buyer fails so to modify the contract within a reasonable time not exceeding thirty days the contract lapses with respect to any deliveries affected (3) The provisions of this section may not be negated by agreement except in so far as the seller has assumed a greater obligation under the preceding section Part 7—Remedies § 2–701.  Remedies for Breach of Collateral Contracts Not Impaired Remedies for breach of any obligation or promise collateral or ancillary to a contract for sale are not impaired by the provisions of this Article § 2–702.  Seller’s Remedies on Discovery of Buyer’s Insolvency (1) Where the seller discovers the buyer to be insolvent he may refuse delivery except for cash including payment for all goods theretofore delivered under the contract, and stop delivery under this Article (Section 2–705) (2) Where the seller discovers that the buyer has received goods on credit while insolvent he may reclaim the goods upon demand made within ten days after the receipt, but if misrepresentation of solvency has been made to the particular seller in writing within three months before delivery the ten day limitation does not apply Except as provided in this subsection the seller may not base a right to reclaim goods on the buyer’s fraudulent or innocent misrepresentation of solvency or of intent to pay Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–32  Appendix c  Articles and 2A of the Uniform Commercial Code (3) The seller’s right to reclaim under subsection (2) is subject to the rights of a buyer in ordinary course or other good faith purchaser under this Article (Section 2–403) Successful reclamation of goods excludes all other remedies with respect to them § 2–703.  Seller’s Remedies in General Where the buyer wrongfully rejects or revokes acceptance of goods or fails to make a payment due on or before delivery or repudiates with respect to a part or the whole, then with respect to any goods directly affected and, if the breach is of the whole contract (Section 2–612), then also with respect to the whole undelivered balance, the aggrieved seller may (a) withhold delivery of such goods; (b)  stop delivery by any bailee as hereafter provided (Section 2–705); (c) proceed under the next section respecting goods still unidentified to the contract; (d)  resell and recover damages as hereafter provided (Section 2–706); (e) recover damages for non-acceptance (Section 2–708) or in a proper case the price (Section 2–709); (f) cancel § 2–704.  Seller’s Right to Identify Goods to the Contract Notwithstanding Breach or to Salvage Unfinished Goods (1) An aggrieved seller under the preceding section may (a) identify to the contract conforming goods not already identified if at the time he learned of the breach they are in his possession or control; (b) treat as the subject of resale goods which have demonstrably been intended for the particular contract even though those goods are unfinished (2) Where the goods are unfinished an aggrieved seller may in the exercise of reasonable commercial judgment for the purposes of avoiding loss and of effective realization either complete the manufacture and wholly identify the goods to the contract or cease manufacture and resell for scrap or salvage value or proceed in any other reasonable manner § 2–705.  Seller’s Stoppage of Delivery in Transit or Otherwise (1) The seller may stop delivery of goods in the possession of a carrier or other bailee when he discovers the buyer to be insolvent (Section 2–702) and may stop delivery of carload, truckload, planeload or larger shipments of express or freight when the buyer repudiates or fails to make a payment due before delivery or if for any other reason the seller has a right to withhold or reclaim the goods (2) As against such buyer the seller may stop delivery until (a) receipt of the goods by the buyer; or (b)  acknowledgment to the buyer by any bailee of the goods except a carrier that the bailee holds the goods for the buy­er; or (c) such acknowledgment to the buyer by a carrier by reshipment or as warehouseman; or (d) negotiation to the buyer of any negotiable document of title covering the goods (3) (a) To stop delivery the seller must so notify as to enable the bailee by reasonable diligence to prevent delivery of the goods (b) After such notification the bailee must hold and deliver the goods according to the directions of the seller but the seller is liable to the bailee for any ensuing charges or ­damages (c)  If a negotiable document of title has been issued for goods the bailee is not obliged to obey a notification to stop until surrender of the document (d) A carrier who has issued a non-negotiable bill of lading is not obliged to obey a notification to stop received from a person other than the consignor § 2–706.  Seller’s Resale Including Contract for Resale (1) Under the conditions stated in Section 2–703 on seller’s remedies, the seller may resell the goods concerned or the undelivered balance thereof Where the resale is made in good faith and in a commercially reasonable manner the seller may recover the difference between the resale price and the contract price together with any incidental damages allowed under the provisions of this Article (Section 2–710), but less expenses saved in consequence of the buyer’s breach (2) Except as otherwise provided in subsection (3) or unless otherwise agreed resale may be at public or private sale including sale by way of one or more contracts to sell or of identification to an existing contract of the seller Sale may be as a unit or in parcels and at any time and place and on any terms but every aspect of the sale including the method, manner, time, place and terms must be commercially reasonable The resale must be reasonably identified as referring to the broken contract, but it is not necessary that the goods be in existence or that any or all of them have been identified to the contract before the breach (3) Where the resale is at private sale the seller must give the buyer reasonable notification of his intention to resell (4) Where the resale is at public sale (a) only identified goods can be sold except where there is a recognized market for a public sale of futures in goods of the kind; and (b) it must be made at a usual place or market for public sale if one is reasonably available and except in the case of goods which are perishable or threaten to decline in value speedily the seller must give the buyer reasonable notice of the time and place of the resale; and (c)  if the goods are not to be within the view of those attending the sale the notification of sale must state the place where the goods are located and provide for their reasonable inspection by prospective bidders; and (d) the seller may buy (5)  A purchaser who buys in good faith at a resale takes the goods free of any rights of the original buyer even though the seller fails to comply with one or more of the requirements of this section (6)  The seller is not accountable to the buyer for any profit made on any resale A person in the position of a seller (Section 2–707) or a buyer who has rightfully rejected or justifiably revoked acceptance must account for any excess over the amount of his security interest, as hereinafter defined (subsection (3) of Section 2–711) § 2–707.  “Person in the Position of a Seller” (1) A “person in the position of a seller” includes as against a principal an agent who has paid or become responsible for the price of Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  goods on behalf of his principal or anyone who otherwise holds a security interest or other right in goods similar to that of a seller (2) A person in the position of a seller may as provided in this Article withhold or stop delivery (Section 2–705) and resell (Section 2–706) and recover incidental damages (Section 2–710) § 2–708.  Seller’s Damages for NonAcceptance or Repudiation (1) Subject to subsection (2) and to the provisions of this Article with respect to proof of market price (Section 2–723), the measure of damages for non-acceptance or repudiation by the buyer is the difference between the market price at the time and place for tender and the unpaid contract price together with any incidental damages provided in this Article (Section 2–710), but less expenses saved in consequence of the buyer’s breach (2) If the measure of damages provided in subsection (1) is inadequate to put the seller in as good a position as perform­ance would have done then the measure of damages is the profit (including reasonable overhead) which the seller would have made from full performance by the buyer, together with any incidental damages provided in this Article (Section 2–710), due allowance for costs reasonably incurred and due credit for payments or proceeds of resale § 2–709.  Action for the Price (1) When the buyer fails to pay the price as it becomes due the seller may recover, together with any incidental damages under the next section, the price (a) of goods accepted or of conforming goods lost or damaged within a commercially reasonable time after risk of their loss has passed to the buyer; and (b) of goods identified to the contract if the seller is unable after reasonable effort to resell them at a reasonable price or the circumstances reasonably indicate that such effort will be unavailing (2)  Where the seller sues for the price he must hold for the buyer any goods which have been identified to the contract and are still in his control except that if resale becomes possible he may resell them at any time prior to the collection of the judgment The net proceeds of any such resale must be credited to the buyer and payment of the judgment entitles him to any goods not resold (3)  After the buyer has wrongfully rejected or revoked acceptance of the goods or has failed to make a payment due or has repudiated (Section 2–610), a seller who is held not entitled to the price under this section shall nevertheless be awarded damages for non-acceptance under the preceding section § 2–710.  Seller’s Incidental Damages Incidental damages to an aggrieved seller include any commercially reasonable charges, expenses or commissions incurred in stopping delivery, in the transportation, care and custody of goods after the buyer’s breach, in connection with return or resale of the goods or otherwise resulting from the breach § 2–711.  Buyer’s Remedies in General; Buyer’s Security Interest in Rejected Goods (1) Where the seller fails to make delivery or repudiates or the buyer rightfully rejects or justifiably revokes acceptance then A–33 with respect to any goods involved, and with respect to the whole if the breach goes to the whole contract (Section 2–612), the buyer may cancel and whether or not he has done so may in addition to recovering so much of the price as has been paid (a) “cover” and have damages under the next section as to all the goods affected whether or not they have been identified to the contract; or (b) recover damages for non-delivery as provided in this Article (Section 2–713) (2) Where the seller fails to deliver or repudiates the buyer may also (a) if the goods have been identified recover them as provided in this Article (Section 2–502); or (b) in a proper case obtain specific performance or replevy the goods as provided in this Article (Section 2–716) (3) On rightful rejection or justifiable revocation of acceptance a buyer has a security interest in goods in his possession or control for any payments made on their price and any expenses reasonably incurred in their inspection, receipt, transportation, care and custody and may hold such goods and resell them in like manner as an aggrieved seller (Section 2–706) § 2–712.  “Cover”; Buyer’s Procurement of Substitute Goods (1) After a breach within the preceding section the buyer may “cover” by making in good faith and without unreasonable delay any reasonable purchase of or contract to purchase goods in substitution for those due from the seller (2) The buyer may recover from the seller as damages the difference between the cost of cover and the contract price together with any incidental or consequential damages as hereinafter defined (Section 2–715), but less expenses saved in consequence of the seller’s breach (3) Failure of the buyer to effect cover within this section does not bar him from any other remedy § 2–713.  Buyer’s Damages for Non-Delivery or Repudiation (1)  Subject to the provisions of this Article with respect to proof of market price (Section 2–723), the measure of damages for non-delivery or repudiation by the seller is the difference between the market price at the time when the buyer learned of the breach and the contract price together with any incidental and consequential damages provided in this Article (Section 2–715), but less expenses saved in consequence of the seller’s breach (2) Market price is to be determined as of the place for tender or, in cases of rejection after arrival or revocation of acceptance, as of the place of arrival § 2–714.  Buyer’s Damages for Breach in Regard to Accepted Goods (1) Where the buyer has accepted goods and given notification (subsection (3) of Section 2–607) he may recover as damages for any non-conformity of tender the loss resulting in the ordinary course of events from the seller’s breach as determined in any manner which is ­reasonable (2) The measure of damages for breach of warranty is the difference at the time and place of acceptance between the value Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–34  Appendix c  Articles and 2A of the Uniform Commercial Code of the goods accepted and the value they would have had if they had been as warranted, unless special circumstances show proximate damages of a different amount (3) In a proper case any incidental and consequential damages under the next section may also be recovered § 2–715.  Buyer’s Incidental and Consequential Damages (1) Incidental damages resulting from the seller’s breach include expenses reasonably incurred in inspection, receipt, transportation and care and custody of goods rightfully rejected, any commercially reasonable charges, expenses or commissions in connection with effecting cover and any other reasonable expense incident to the delay or other breach (2)  Consequential damages resulting from the seller’s breach include (a)  any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise; and (b) injury to person or property proximately resulting from any breach of warranty § 2–716.  Buyer’s Right to Specific Performance or Replevin (1)  Specific performance may be decreed where the goods are unique or in other proper circumstances (2) The decree for specific performance may include such terms and conditions as to payment of the price, damages, or other relief as the court may deem just (3) The buyer has a right of replevin for goods identified to the contract if after reasonable effort he is unable to effect cover for such goods or the circumstances reasonably indicate that such effort will be unavailing or if the goods have been shipped under reservation and satisfaction of the security interest in them has been made or tendered In the case of goods bought for personal, family, or household purposes, the buyer’s right of replevin vests upon acquisition of a special property, even if the seller had not then repudiated or failed to deliver As amended in 1999 § 2–717.  Deduction of Damages From the Price The buyer on notifying the seller of his intention to so may deduct all or any part of the damages resulting from any breach of the contract from any part of the price still due under the same contract § 2–718.  Liquidation or Limitation of Damages; Deposits (1)  Damages for breach by either party may be liquidated in the agreement but only at an amount which is reasonable in the light of the anticipated or actual harm caused by the breach, the difficulties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy A term fixing unreasonably large liquidated damages is void as a penalty (2)  Where the seller justifiably withholds delivery of goods because of the buyer’s breach, the buyer is entitled to restitution of any amount by which the sum of his payments exceeds (a)  the amount to which the seller is entitled by virtue of terms liquidating the seller’s damages in accordance with subsection (1), or (b)  in the absence of such terms, twenty per cent of the value of the total performance for which the buyer is obligated under the contract or $500, whichever is smaller (3) The buyer’s right to restitution under subsection (2) is subject to offset to the extent that the seller establishes (a)  a right to recover damages under the provisions of this Article other than subsection (1), and (b)  the amount or value of any benefits received by the buyer directly or indirectly by reason of the ­contract (4) Where a seller has received payment in goods their reasonable value or the proceeds of their resale shall be treated as payments for the purposes of subsection (2); but if the seller has notice of the buyer’s breach before reselling goods received in part performance, his resale is subject to the conditions laid down in this Article on resale by an aggrieved seller (Section 2–706) § 2–719.  Contractual Modification or Limitation of Remedy (1) Subject to the provisions of subsections (2) and (3) of this section and of the preceding section on liquidation and limitation of damages, (a)  the agreement may provide for remedies in addition to or in substitution for those provided in this Article and may limit or alter the measure of damages recoverable under this Article, as by limiting the buyer’s remedies to return of the goods and repayment of the price or to repair and replacement of nonconforming goods or parts; and (b)  resort to a remedy as provided is optional unless the remedy is expressly agreed to be exclusive, in which case it is the sole remedy (2) Where circumstances cause an exclusive or limited remedy to fail of its essential purpose, remedy may be had as provided in this Act (3) Consequential damages may be limited or excluded unless the limitation or exclusion is unconscionable Limitation of consequential damages for injury to the person in the case of consumer goods is prima facie unconscionable but limitation of damages where the loss is commercial is not § 2–720.  Effect of “Cancellation” or “Rescission” on Claims for Antecedent Breach Unless the contrary intention clearly appears, expressions of “cancellation” or “rescission” of the contract or the like shall not be construed as a renunciation or discharge of any claim in damages for an antecedent breach § 2–721.  Remedies for Fraud Remedies for material misrepresentation or fraud include all remedies available under this Article for non-­fraudulent breach Neither rescission or a claim for rescission of the contract for sale nor rejection or return of the goods shall bar or be deemed inconsistent with a claim for damages or other remedy Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  § 2–722.  Who Can Sue Third Parties for Injury to Goods Where a third party so deals with goods which have been identified to a contract for sale as to cause actionable injury to a party to that contract (a) a right of action against the third party is in either party to the contract for sale who has title to or a security interest or a special property or an insurable interest in the goods; and if the goods have been destroyed or converted a right of action is also in the party who either bore the risk of loss under the contract for sale or has since the injury assumed that risk as against the other; (b) if at the time of the injury the party plaintiff did not bear the risk of loss as against the other party to the contract for sale and there is no arrangement between them for disposition of the recovery, his suit or settlement is, subject to his own interest, as a fiduciary for the other party to the contract; (c) either party may with the consent of the other sue for the benefit of whom it may concern § 2–723.  Proof of Market Price: Time and Place (1) If an action based on anticipatory repudiation comes to trial before the time for performance with respect to some or all of the goods, any damages based on market price (Section 2–708 or Section 2–713) shall be determined according to the price of such goods prevailing at the time when the aggrieved party learned of the ­repudiation (2)  If evidence of a price prevailing at the times or places described in this Article is not readily available the price prevailing within any reasonable time before or after the time described or at any other place which in commercial judgment or under usage of trade would serve as a reasonable substitute for the one described may be used, making any proper allowance for the cost of transporting the goods to or from such other place (3)  Evidence of a relevant price prevailing at a time or place other than the one described in this Article offered by one party is not admissible unless and until he has given the other party such notice as the court finds sufficient to prevent unfair surprise § 2–724.  Admissibility of Market Quotations Whenever the prevailing price or value of any goods regularly bought and sold in any established commodity market is in issue, reports in official publications or trade journals or in newspapers or periodicals of general circulation published as the reports of such market shall be admissible in evidence The circumstances of the preparation of such a report may be shown to affect its weight but not its admissibility § 2–725.  Statute of Limitations in Contracts for Sale (1) An action for breach of any contract for sale must be commenced within four years after the cause of action has accrued By the original agreement the parties may reduce the period of limitation to not less than one year but may not extend it (2) A cause of action accrues when the breach occurs, regardless of the aggrieved party’s lack of knowledge of the breach A breach of warranty occurs when tender of delivery is made, except that where a warranty explicitly extends to future performance of the goods and discovery of the breach must await A–35 the time of such performance the cause of action accrues when the breach is or should have been discovered (3)  Where an action commenced within the time limited by subsection (1) is so terminated as to leave available a remedy by another action for the same breach such other action may be commenced after the expiration of the time limited and within six months after the termination of the first action unless the termination resulted from voluntary discontinuance or from dismissal for failure or neglect to prosecute (4) This section does not alter the law on tolling of the statute of limitations nor does it apply to causes of action which have accrued before this Act becomes effective Article 2A: LEASES Part 1—General Provisions § 2A–101.  Short Title This Article shall be known and may be cited as the Uniform Commercial Code—Leases § 2A–102.  Scope This Article applies to any transaction, regardless of form, that creates a lease § 2A–103.  Definitions and Index of Definitions (1)  In this Article unless the context otherwise requires: (a) “Buyer in ordinary course of business” means a person who in good faith and without knowledge that the sale to him [or her] is in violation of the ownership rights or security interest or leasehold interest of a third party in the goods buys in ordinary course from a person in the business of selling goods of that kind but does not include a pawnbroker “Buying” may be for cash or by exchange of other property or on secured or unsecured credit and includes receiving goods or documents of title under a preexisting contract for sale but does not include a transfer in bulk or as security for or in total or partial satisfaction of a money debt (b) “Cancellation” occurs when either party puts an end to the lease contract for default by the other party (c)  “Commercial unit” means such a unit of goods as by commercial usage is a single whole for purposes of lease and division of which materially impairs its character or value on the market or in use A commercial unit may be a single article, as a machine, or a set of articles, as a suite of furniture or a line of machinery, or a quantity, as a gross or carload, or any other unit treated in use or in the relevant market as a single whole (d) “Conforming” goods or performance under a lease contract means goods or performance that are in accordance with the obligations under the lease contract (e)  “Consumer lease” means a lease that a lessor regularly engaged in the business of leasing or selling makes to a lessee who is an individual and who takes under the lease primarily for a personal, family, or household purpose [, if the total payments to be made under the lease contract, excluding payments for options to renew or buy, not exceed $ ] Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–36  Appendix c  Articles and 2A of the Uniform Commercial Code (f) “Fault” means wrongful act, omission, breach, or default (g)  “Finance lease” means a lease with respect to which: (i) the lessor does not select, manufacture or supply the goods; (ii) the lessor acquires the goods or the right to possession and use of the goods in connection with the lease; and (iii) one of the following occurs: (A) the lessee receives a copy of the contract by which the lessor acquired the goods or the right to possession and use of the goods before signing the lease contract; (B) the lessee’s approval of the contract by which the lessor acquired the goods or the right to possession and use of the goods is a condition to effectiveness of the lease contract; (C) the lessee, before signing the lease contract, receives an accurate and complete statement designating the promises and warranties, and any disclaimers of warranties, limitations or modifications of remedies, or liquidated damages, including those of a third party, such as the manufacturer of the goods, provided to the lessor by the person supplying the goods in connection with or as part of the contract by which the lessor acquired the goods or the right to possession and use of the goods; or (D) if the lease is not a consumer lease, the lessor, before the lessee signs the lease contract, informs the lessee in writing (a) of the identity of the person supplying the goods to the lessor, unless the lessee has selected that person and directed the lessor to acquire the goods or the right to possession and use of the goods from that person, (b) that the lessee is entitled under this Article to any promises and warranties, including those of any third party, provided to the lessor by the person supplying the goods in connection with or as part of the contract by which the lessor acquired the goods or the right to possession and use of the goods, and (c) that the lessee may communicate with the person supplying the goods to the lessor and receive an accurate and complete statement of those promises and warranties, including any disclaimers and limitations of them or of ­remedies (h)  “Goods” means all things that are movable at the time of identification to the lease contract, or are fixtures (Section 2A–309), but the term does not include money, documents, instruments, accounts, chattel paper, general intangibles, or minerals or the like, including oil and gas, before extraction The term also includes the unborn young of animals (i) “Installment lease contract” means a lease contract that authorizes or requires the delivery of goods in separate lots to be separately accepted, even though the lease contract contains a clause “each delivery is a separate lease” or its ­equivalent (j) “Lease” means a transfer of the right to possession and use of goods for a term in return for consideration, but a sale, including a sale on approval or a sale or return, or retention or creation of a security interest is not a lease Unless the context clearly indicates otherwise, the term includes a sublease (k) “Lease agreement” means the bargain, with respect to the lease, of the lessor and the lessee in fact as found in their language or by implication from other circumstances including course of dealing or usage of trade or course of performance as provided in this Article Unless the context clearly indicates otherwise, the term includes a sublease agreement (l)  “Lease contract” means the total legal obligation that results from the lease agreement as affected by this Article and any other applicable rules of law Unless the context clearly indicates otherwise, the term includes a sublease contract (m) “Leasehold interest” means the interest of the lessor or the lessee under a lease contract (n) “Lessee” means a person who acquires the right to possession and use of goods under a lease Unless the context clearly indicates otherwise, the term includes a sublessee (o)  “Lessee in ordinary course of business” means a person who in good faith and without knowledge that the lease to him [or her] is in violation of the ownership rights or security interest or leasehold interest of a third party in the goods, leases in ordinary course from a person in the business of selling or leasing goods of that kind but does not include a pawnbroker “Leasing” may be for cash or by exchange of other property or on secured or unsecured credit and includes receiving goods or documents of title under a pre-existing lease contract but does not include a transfer in bulk or as security for or in total or partial satisfaction of a money debt (p) “Lessor” means a person who transfers the right to possession and use of goods under a lease Unless the context clearly indicates otherwise, the term includes a sublessor (q) “Lessor’s residual interest” means the lessor’s interest in the goods after expiration, termination, or cancellation of the lease contract (r)  “Lien” means a charge against or interest in goods to secure payment of a debt or performance of an obligation, but the term does not include a security interest (s) “Lot” means a parcel or a single article that is the subject matter of a separate lease or delivery, whether or not it is sufficient to perform the lease contract (t)  “Merchant lessee” means a lessee that is a merchant with respect to goods of the kind subject to the lease (u) “Present value” means the amount as of a date certain of one or more sums payable in the future, discounted to the date certain The discount is determined by the interest rate specified by the parties if the rate was not manifestly unreasonable at the time the transaction was entered into; otherwise, the discount is determined by a commercially reasonable rate that takes into account the facts and circumstances of each case at the time the transaction was entered into (v)  “Purchase” includes taking by sale, lease, mortgage, security interest, pledge, gift, or any other voluntary transaction creating an interest in goods Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  A–37 (w) “Sublease” means a lease of goods the right to possession and use of which was acquired by the lessor as a lessee under an existing lease (3) Failure to comply with an applicable law has only the effect specified therein As amended in 1990 (x)  “Supplier” means a person from whom a lessor buys or leases goods to be leased under a finance lease § 2A–105.  Territorial Application of Article to Goods Covered by Certificate of Title Subject to the provisions of Sections 2A–304(3) and 2A–305(3), with respect to goods covered by a certificate of title issued under a statute of this State or of another jurisdiction, compliance and the effect of compliance or noncompliance with a certificate of title statute are governed by the law (including the conflict of laws rules) of the jurisdiction issuing the certificate until the earlier of (a) surrender of the certificate, or (b) four months after the goods are removed from that jurisdiction and thereafter until a new certificate of title is issued by another jurisdiction (y) “Supply contract” means a contract under which a lessor buys or leases goods to be leased (z) “Termination” occurs when either party pursuant to a power created by agreement or law puts an end to the lease contract otherwise than for default (2) Other definitions applying to this Article and the sections in which they appear are: “Accessions” Section 2A–310(1) “Construction mortgage” Section 2A–309(1)(d) “Encumbrance” Section 2A–309(1)(e) “Fixtures” Section 2A–309(1)(a) “Fixture filing” Section 2A–309(1)(b) “Purchase money lease” Section 2A–309(1)(c) (3)  The following definitions in other Articles apply to this ­Article: “Accounts” Section 9–106 “Between merchants” Section 2–104(3) “Buyer” Section 2–103(1)(a) “Chattel paper” Section 9–105(1)(b) “Consumer goods” Section 9–109(1) “Document” Section 9–105(1)(f) “Entrusting” Section 2–403(3) “General intangibles” Section 9–106 “Good faith” Section 2–103(1)(b) “Instrument” Section 9–105(1)(i) “Merchant” Section 2–104(1) “Mortgage” Section 9–105(1)(j) “Pursuant to commitment” Section 9–105(1)(k) “Receipt” Section 2–103(1)(c) “Sale” Section 2–106(1) “Sale on approval” Section 2–326 “Sale or return” Section 2–326 “Seller” Section 2–103(1)(d) (4) In addition Article contains general definitions and principles of construction and interpretation applicable throughout this Article As amended in 1990 and 1999 § 2A–104.  Leases Subject to Other Law (1)  A lease, although subject to this Article, is also subject to any applicable: (a)  certificate of title statute of this State: (list any certificate of title statutes covering automobiles, trailers, mobile homes, boats, farm tractors, and the like); (b) certificate of title statute of another jurisdiction (Section 2A–105); or (c) consumer protection statute of this State, or final consumer protection decision of a court of this State existing on the effective date of this Article (2) In case of conflict between this Article, other than Sections 2A–105, 2A–304(3), and 2A–305(3), and a statute or decision referred to in subsection (1), the statute or decision controls § 2A–106.  Limitation on Power of Parties to Consumer Lease to Choose Applicable Law and Judicial Forum (1) If the law chosen by the parties to a consumer lease is that of a jurisdiction other than a jurisdiction in which the lessee resides at the time the lease agreement becomes enforceable or within 30 days thereafter or in which the goods are to be used, the choice is not enforceable (2)  If the judicial forum chosen by the parties to a consumer lease is a forum that would not otherwise have jurisdiction over the lessee, the choice is not enforceable § 2A–107.  Waiver or Renunciation of Claim or Right After Default Any claim or right arising out of an alleged default or breach of warranty may be discharged in whole or in part without consideration by a written waiver or renunciation signed and delivered by the aggrieved party § 2A–108.  Unconscionability (1) If the court as a matter of law finds a lease contract or any clause of a lease contract to have been unconscionable at the time it was made the court may refuse to enforce the lease contract, or it may enforce the remainder of the lease contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result (2) With respect to a consumer lease, if the court as a matter of law finds that a lease contract or any clause of a lease contract has been induced by unconscionable conduct or that unconscionable conduct has occurred in the collection of a claim arising from a lease contract, the court may grant appropriate relief (3) Before making a finding of unconscionability under subsection (1) or (2), the court, on its own motion or that of a party, shall afford the parties a reasonable opportunity to present evidence as to the setting, purpose, and effect of the lease contract or clause thereof, or of the conduct (4)  In an action in which the lessee claims unconscionability with respect to a consumer lease: (a)  If the court finds unconscionability under subsection (1) or (2), the court shall award reasonable attorney’s fees to the lessee (b) If the court does not find unconscionability and the lessee claiming unconscionability has brought or maintained Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–38  Appendix c  Articles and 2A of the Uniform Commercial Code an action he [or she] knew to be groundless, the court shall award reasonable attorney’s fees to the party against whom the claim is made (c) In determining attorney’s fees, the amount of the recovery on behalf of the claimant under subsections (1) and (2) is not controlling § 2A–109.  Option to Accelerate at Will (1) A term providing that one party or his [or her] successor in interest may accelerate payment or performance or require collateral or additional collateral “at will” or “when he [or she] deems himself [or herself] insecure” or in words of similar import must be construed to mean that he [or she] has power to so only if he [or she] in good faith believes that the prospect of payment or performance is impaired (2)  With respect to a consumer lease, the burden of establishing good faith under subsection (1) is on the party who exercised the power; otherwise the burden of establishing lack of good faith is on the party against whom the power has been exercised Part 2—Formation and Construction of Lease Contract § 2A–201.  Statute of Frauds (1)  A lease contract is not enforceable by way of action or defense unless: (a) the total payments to be made under the lease contract, excluding payments for options to renew or buy, are less than $1,000; or (b)  there is a writing, signed by the party against whom enforcement is sought or by that party’s author­ized agent, sufficient to indicate that a lease contract has been made between the parties and to describe the goods leased and the lease term (2)  Any description of leased goods or of the lease term is sufficient and satisfies subsection (1)(b), whether or not it is specific, if it reasonably identifies what is described (3) A writing is not insufficient because it omits or incorrectly states a term agreed upon, but the lease contract is not enforceable under subsection (1)(b) beyond the lease term and the quantity of goods shown in the ­writing (4) A lease contract that does not satisfy the requirements of subsection (1), but which is valid in other respects, is enforceable: (a) if the goods are to be specially manufactured or obtained for the lessee and are not suitable for lease or sale to others in the ordinary course of the lessor’s business, and the lessor, before notice of repudiation is received and under circumstances that reasonably indicate that the goods are for the lessee, has made either a substantial beginning of their manufacture or commitments for their procurement; (b) if the party against whom enforcement is sought admits in that party’s pleading, testimony or otherwise in court that a lease contract was made, but the lease contract is not enforceable under this provision beyond the quantity of goods admitted; or (c)  with respect to goods that have been received and accepted by the lessee (5) The lease term under a lease contract referred to in subsection (4) is: (a) if there is a writing signed by the party against whom enforcement is sought or by that party’s authorized agent specifying the lease term, the term so specified; (b) if the party against whom enforcement is sought admits in that party’s pleading, testimony, or otherwise in court a lease term, the term so admitted; or (c) a reasonable lease term § 2A–202.  Final Written Expression: Parol or Extrinsic Evidence Terms with respect to which the confirmatory memoranda of the parties agree or which are otherwise set forth in a writing intended by the parties as a final expression of their agreement with respect to such terms as are included therein may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement but may be explained or supplemented: (a) by course of dealing or usage of trade or by course of performance; and (b) by evidence of consistent additional terms unless the court finds the writing to have been intended also as a complete and exclusive statement of the terms of the agreement § 2A–203.  Seals Inoperative The affixing of a seal to a writing evidencing a lease contract or an offer to enter into a lease contract does not render the writing a sealed instrument and the law with respect to sealed instruments does not apply to the lease contract or offer § 2A–204.  Formation in General (1) A lease contract may be made in any manner sufficient to show agreement, including conduct by both parties which recognizes the existence of a lease contract (2) An agreement sufficient to constitute a lease contract may be found although the moment of its making is ­undetermined (3) Although one or more terms are left open, a lease contract does not fail for indefiniteness if the parties have intended to make a lease contract and there is a reasonably certain basis for giving an appropriate remedy § 2A–205.  Firm Offers An offer by a merchant to lease goods to or from another person in a signed writing that by its terms gives assurance it will be held open is not revocable, for lack of consideration, during the time stated or, if no time is stated, for a reasonable time, but in no event may the period of irrevocability exceed months Any such term of assurance on a form supplied by the offeree must be separately signed by the offeror § 2A–206.  Offer and Acceptance in Formation of Lease Contract (1) Unless otherwise unambiguously indicated by the language or circumstances, an offer to make a lease contract must be construed as inviting acceptance in any manner and by any medium reasonable in the circumstances (2) If the beginning of a requested performance is a reasonable mode of acceptance, an offeror who is not notified of acceptance within a reasonable time may treat the offer as having lapsed before acceptance Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  § 2A–207.  Course of Performance or Practical Construction (1) If a lease contract involves repeated occasions for performance by either party with knowledge of the nature of the performance and opportunity for objection to it by the other, any course of performance accepted or acquiesced in without objection is relevant to determine the meaning of the lease agreement (2)  The express terms of a lease agreement and any course of performance, as well as any course of dealing and usage of trade, must be construed whenever reasonable as consistent with each other; but if that construction is unreasonable, express terms control course of performance, course of performance controls both course of dealing and usage of trade, and course of dealing controls usage of trade (3) Subject to the provisions of Section 2A–208 on modification and waiver, course of performance is relevant to show a waiver or modification of any term inconsistent with the course of ­performance § 2A–208.  Modification, Rescission and Waiver (1) An agreement modifying a lease contract needs no consideration to be binding (2)  A signed lease agreement that excludes modification or rescission except by a signed writing may not be otherwise modified or rescinded, but, except as between merchants, such a requirement on a form supplied by a merchant must be separately signed by the other party (3) Although an attempt at modification or rescission does not satisfy the requirements of subsection (2), it may operate as a waiver (4) A party who has made a waiver affecting an executory portion of a lease contract may retract the waiver by reasonable notification received by the other party that strict performance will be required of any term waived, unless the retraction would be unjust in view of a material change of position in reliance on the waiver § 2A–209.  Lessee under Finance Lease as Beneficiary of Supply Contract (1)  The benefit of the supplier’s promises to the lessor under the supply contract and of all warranties, whether express or implied, including those of any third party provided in connection with or as part of the supply contract, extends to the lessee to the extent of the lessee’s leasehold interest under a finance lease related to the supply contract, but is subject to the terms warranty and of the supply contract and all defenses or claims arising therefrom (2)  The extension of the benefit of supplier’s promises and of warranties to the lessee (Section 2A–209(1)) does not: (i) modify the rights and obligations of the parties to the supply contract, whether arising therefrom or otherwise, or (ii) impose any duty or liability under the supply contract on the lessee (3) Any modification or rescission of the supply contract by the supplier and the lessor is effective between the supplier and the lessee unless, before the modification or rescission, the supplier has received notice that the lessee has entered into a finance lease related to the supply contract If the modification or rescission is effective between the supplier and the lessee, the lessor is deemed to have assumed, in addition to the obligations of the lessor to the lessee under the lease contract, A–39 promises of the supplier to the lessor and warranties that were so modified or rescinded as they existed and were available to the lessee before modification or rescission (4) In addition to the extension of the benefit of the supplier’s promises and of warranties to the lessee under subsection (1), the lessee retains all rights that the lessee may have against the supplier which arise from an agreement between the lessee and the supplier or under other law As amended in 1990 § 2A–210.  Express Warranties (1) Express warranties by the lessor are created as ­follows: (a) Any affirmation of fact or promise made by the lessor to the lessee which relates to the goods and becomes part of the basis of the bargain creates an express warranty that the goods will conform to the affirmation or promise (b) Any description of the goods which is made part of the basis of the bargain creates an express warranty that the goods will conform to the description (c) Any sample or model that is made part of the basis of the bargain creates an express warranty that the whole of the goods will conform to the sample or model (2) It is not necessary to the creation of an express warranty that the lessor use formal words, such as “warrant” or “guarantee,” or that the lessor have a specific intention to make a warranty, but an affirmation merely of the value of the goods or a statement purporting to be merely the lessor’s opinion or commendation of the goods does not create a warranty § 2A–211.  Warranties Against Interference and Against Infringement; Lessee’s Obligation Against Infringement (1) There is in a lease contract a warranty that for the lease term no person holds a claim to or interest in the goods that arose from an act or omission of the lessor, other than a claim by way of infringement or the like, which will interfere with the lessee’s enjoyment of its leasehold interest (2) Except in a finance lease there is in a lease contract by a lessor who is a merchant regularly dealing in goods of the kind a warranty that the goods are delivered free of the rightful claim of any person by way of infringement or the like (3)  A lessee who furnishes specifications to a lessor or a supplier shall hold the lessor and the supplier harmless against any claim by way of infringement or the like that arises out of compliance with the specifications § 2A–212.  Implied Warranty of Merchantability (1) Except in a finance lease, a warranty that the goods will be merchantable is implied in a lease contract if the lessor is a merchant with respect to goods of that kind (2) Goods to be merchantable must be at least such as (a) pass without objection in the trade under the description in the lease agreement; (b) in the case of fungible goods, are of fair average quality within the description; (c) are fit for the ordinary purposes for which goods of that type are used; (d) run, within the variation permitted by the lease agreement, of even kind, quality, and quantity within each unit and among all units involved; Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–40  Appendix c  Articles and 2A of the Uniform Commercial Code (e)  are adequately contained, packaged, and labeled as the lease agreement may require; and (f) conform to any promises or affirmations of fact made on the container or label (3) Other implied warranties may arise from course of dealing or usage of trade § 2A–213.  Implied Warranty of Fitness for Particular Purpose Except in a finance of lease, if the lessor at the time the lease contract is made has reason to know of any particular purpose for which the goods are required and that the lessee is relying on the lessor’s skill or judgment to select or furnish suitable goods, there is in the lease contract an implied warranty that the goods will be fit for that purpose § 2A–214.  Exclusion or Modification of Warranties (1)  Words or conduct relevant to the creation of an express warranty and words or conduct tending to negate or limit a warranty must be construed wherever reasonable as consistent with each other; but, subject to the provisions of Section 2A–202 on parol or extrinsic evidence, negation or ­limitation is inoperative to the extent that the construction is unreasonable (2) Subject to subsection (3), to exclude or modify the im­plied warranty of merchantability or any part of it the ­language must mention “merchantability”, be by a writing, and be conspicuous Subject to subsection (3), to exclude or modify any implied warranty of fitness the exclusion must be by a writing and be conspicuous Language to exclude all implied warranties of fitness is sufficient if it is in writing, is conspicuous and states, for example, “There is no warranty that the goods will be fit for a particular ­purpose” (3) Notwithstanding subsection (2), but subject to subsection (4), (a)  unless the circumstances indicate otherwise, all implied warranties are excluded by expressions like “as is” or “with all faults” or by other language that in common understanding calls the lessee’s attention to the exclusion of warranties and makes plain that there is no implied warranty, if in writing and ­conspicuous; (b) if the lessee before entering into the lease contract has examined the goods or the sample or model as fully as desired or has refused to examine the goods, there is no implied warranty with regard to defects that an examination ought in the circumstances to have revealed; and (c) an implied warranty may also be excluded or modified by course of dealing, course of performance, or usage of trade (4)  To exclude or modify a warranty against interference or against infringement (Section 2A–211) or any part of it, the language must be specific, be by a writing, and be conspicuous, unless the circumstances, including course of performance, course of dealing, or usage of trade, give the lessee reason to know that the goods are being leased subject to a claim or interest of any ­person § 2A–215.  Cumulation and Conflict of Warranties Express or Implied Warranties, whether express or implied, must be construed as consistent with each other and as cumulative, but if that construction is unreasonable, the intention of the parties determines which warranty is dominant In ascertaining that intention the following rules apply: (a)  Exact or technical specifications displace an inconsistent sample or model or general language of description (b) A sample from an existing bulk displaces inconsistent general language of description (c)  Express warranties displace inconsistent implied warranties other than an implied warranty of fitness for a particular purpose § 2A–216.  Third-Party Beneficiaries of Express and Implied Warranties Alternative A A warranty to or for the benefit of a lessee under this Article, whether express or implied, extends to any natural person who is in the family or household of the lessee or who is a guest in the lessee’s home if it is reasonable to expect that such person may use, consume, or be affected by the goods and who is injured in person by breach of the warranty This section does not displace principles of law and equity that extend a warranty to or for the benefit of a lessee to other persons The operation of this section may not be excluded, modified, or limited, but an exclusion, modification, or limitation of the warranty, including any with respect to rights and remedies, effective against the lessee is also effective against any beneficiary designated under this section Alternative B A warranty to or for the benefit of a lessee under this Article, whether express or implied, extends to any natural person who may reasonably be expected to use, consume, or be affected by the goods and who is injured in person by breach of the warranty This section does not displace principles of law and equity that extend a warranty to or for the benefit of a lessee to other persons The operation of this section may not be excluded, modified, or limited, but an exclusion, modification, or limitation of the warranty, including any with respect to rights and remedies, effective against the lessee is also effective against the beneficiary designated under this section Alternative C A warranty to or for the benefit of a lessee under this Article, whether express or implied, extends to any person who may reasonably be expected to use, consume, or be affected by the goods and who is injured by breach of the warranty The operation of this section may not be excluded, modified, or limited with respect to injury to the person of an individual to whom the warranty extends, but an exclusion, modification, or limitation of the warranty, including any with respect to rights and remedies, effective against the lessee is also effective against the beneficiary designated under this section § 2A–217.  Identification Identification of goods as goods to which a lease contract refers may be made at any time and in any manner explicitly agreed to by the parties In the absence of explicit agreement, identification occurs: (a) when the lease contract is made if the lease contract is for a lease of goods that are existing and identified; Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  (b)  when the goods are shipped, marked, or otherwise designated by the lessor as goods to which the lease contract refers, if the lease contract is for a lease of goods that are not existing and identified; or (c) when the young are conceived, if the lease contract is for a lease of unborn young of animals § 2A–218.  Insurance and Proceeds (1) A lessee obtains an insurable interest when existing goods are identified to the lease contract even though the goods identified are nonconforming and the lessee has an option to reject them (2)  If a lessee has an insurable interest only by reason of the lessor’s identification of the goods, the lessor, until default or insolvency or notification to the lessee that identification is final, may substitute other goods for those identified (3) Notwithstanding a lessee’s insurable interest under subsections (1) and (2), the lessor retains an insurable interest until an option to buy has been exercised by the lessee and risk of loss has passed to the lessee (4) Nothing in this section impairs any insurable interest recognized under any other statute or rule of law (5) The parties by agreement may determine that one or more parties have an obligation to obtain and pay for insurance covering the goods and by agreement may determine the beneficiary of the proceeds of the insurance § 2A–219.  Risk of Loss (1) Except in the case of a finance lease, risk of loss is retained by the lessor and does not pass to the lessee In the case of a finance lease, risk of loss passes to the lessee (2)  Subject to the provisions of this Article on the effect of default on risk of loss (Section 2A–220), if risk of loss is to pass to the lessee and the time of passage is not stated, the following rules apply: (a) If the lease contract requires or authorizes the goods to be shipped by carrier (i) and it does not require delivery at a particular destination, the risk of loss passes to the lessee when the goods are duly delivered to the carrier; but (ii) if it does require delivery at a particular destination and the goods are there duly tendered while in the possession of the carrier, the risk of loss passes to the lessee when the goods are there duly so tendered as to enable the lessee to take delivery (b) If the goods are held by a bailee to be delivered without being moved, the risk of loss passes to the lessee on acknowledgment by the bailee of the lessee’s right to possession of the goods (c) In any case not within subsection (a) or (b), the risk of loss passes to the lessee on the lessee’s receipt of the goods if the lessor, or, in the case of a finance lease, the supplier, is a merchant; otherwise the risk passes to the lessee on tender of delivery § 2A–220.  Effect of Default on Risk of Loss (1)  Where risk of loss is to pass to the lessee and the time of passage is not stated: (a) If a tender or delivery of goods so fails to conform to the lease contract as to give a right of rejection, the risk of their A–41 loss remains with the lessor, or, in the case of a finance lease, the supplier, until cure or acceptance (b) If the lessee rightfully revokes acceptance, he [or she], to the extent of any deficiency in his [or her] effective insurance coverage, may treat the risk of loss as having remained with the lessor from the ­beginning (2) Whether or not risk of loss is to pass to the lessee, if the lessee as to conforming goods already identified to a lease contract repudiates or is otherwise in default under the lease contract, the lessor, or, in the case of a finance lease, the supplier, to the extent of any deficiency in his [or her] effective insurance coverage may treat the risk of loss as resting on the lessee for a commercially reasonable time § 2A–221.  Casualty to Identified Goods If a lease contract requires goods identified when the lease contract is made, and the goods suffer casualty without fault of the lessee, the lessor or the supplier before delivery, or the goods suffer casualty before risk of loss passes to the lessee pursuant to the lease agreement or Section 2A–219, then: (a) if the loss is total, the lease contract is avoided; and (b) if the loss is partial or the goods have so deteriorated as to no longer conform to the lease contract, the lessee may nevertheless demand inspection and at his [or her] option either treat the lease contract as avoided or, except in a finance lease that is not a consumer lease, accept the goods with due allowance from the rent payable for the balance of the lease term for the deterioration or the deficiency in quantity but without further right against the ­lessor Part 3—Effect of Lease Contract § 2A–301.  Enforceability of Lease Contract Except as otherwise provided in this Article, a lease contract is effective and enforceable according to its terms between the parties, against purchasers of the goods and against creditors of the parties § 2A–302.  Title to and Possession of Goods Except as otherwise provided in this Article, each provision of this Article applies whether the lessor or a third party has title to the goods, and whether the lessor, the lessee, or a third party has possession of the goods, notwithstanding any statute or rule of law that possession or the absence of possession is fraudulent § 2A–303.  Alienability of Party’s Interest Under Lease Contract or of Lessor’s Residual Interest in Goods; Delegation of Performance; Transfer of Rights (1)  As used in this section, “creation of a security interest” includes the sale of a lease contract that is subject to Article 9, Secured Transactions, by reason of Section 9–109(a)(3) (2)  Except as provided in subsections (3) and Section 9–407, a provision in a lease agreement which (i) prohibits the voluntary or involuntary transfer, including a transfer by sale, sublease, creation or enforcement of a security interest, or attachment, levy, or other judicial pro­cess, of an interest of a party under the lease contract or of the lessor’s residual interest in the goods, or (ii) makes such a transfer an event of default, gives rise to the rights and remedies provided in subsection (4), Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–42  Appendix c  Articles and 2A of the Uniform Commercial Code but a transfer that is prohibited or is an event of default under the lease agreement is otherwise effective (3) A provision in a lease agreement which (i) prohibits a transfer of a right to damages for default with respect to the whole lease contract or of a right to payment arising out of the transferor’s due performance of the transferor’s entire obligation, or (ii) makes such a transfer an event of default, is not enforceable, and such a transfer is not a transfer that materially impairs the propsect of obtaining return performance by, materially changes the duty of, or materially increases the burden or risk imposed on, the other party to the lease contract within the purview of subsection (4) (4) Subject to subsection (3) and Section 9–407: (a) if a transfer is made which is made an event of default under a lease agreement, the party to the lease contract not making the transfer, unless that party waives the default or otherwise agrees, has the rights and remedies described in Section 2A–501(2); (b) if paragraph (a) is not applicable and if a transfer is made that (i) is prohibited under a lease agreement or (ii) materially impairs the prospect of obtaining return performance by, materially changes the duty of, or materially increases the burden or risk imposed on, the other party to the lease contract, unless the party not making the transfer agrees at any time to the transfer in the lease contract or otherwise, then, except as limited by contract, (i) the transferor is liable to the party not making the transfer for damages caused by the transfer to the extent that the damages could not reasonably be prevented by the party not making the transfer and (ii) a court having jurisdiction may grant other appropriate relief, including cancellation of the lease contract or an injunction against the transfer (5) A transfer of “the lease” or of “all my rights under the lease”, or a transfer in similar general terms, is a transfer of rights and, unless the language or the circumstances, as in a transfer for security, indicate the contrary, the transfer is a delegation of duties by the transferor to the transferee Acceptance by the transferee constitutes a promise by the transferee to perform those duties The promise is enforceable by either the transferor or the other party to the lease contract (6) Unless otherwise agreed by the lessor and the lessee, a delegation of performance does not relieve the transferor as against the other party of any duty to perform or of any liability for default (7) In a consumer lease, to prohibit the transfer of an interest of a party under the lease contract or to make a transfer an event of default, the language must be specific, by a writing, and conspicuous As amended in 1990 and 1999 § 2A–304.  Subsequent Lease of Goods by Lessor (1) Subject to Section 2A–303, a subsequent lessee from a lessor of goods under an existing lease contract obtains, to the extent of the leasehold interest transferred, the leasehold interest in the goods that the lessor had or had power to transfer, and except as provided in subsection (2) and Section 2A–527(4), takes subject to the existing lease contract A lessor with voidable title has power to transfer a good leasehold interest to a good faith subsequent lessee for value, but only to the extent set forth in the preceding sentence If goods have been delivered under a transaction of purchase the lessor has that power even though: (a) the lessor’s transferor was deceived as to the identity of the lessor; (b) the delivery was in exchange for a check which is later dishonored; (c)  it was agreed that the transaction was to be a “cash sale”; or (d) the delivery was procured through fraud punishable as larcenous under the criminal law (2) A subsequent lessee in the ordinary course of business from a lessor who is a merchant dealing in goods of that kind to whom the goods were entrusted by the existing lessee of that lessor before the interest of the subsequent lessee became enforceable against that lessor obtains, to the extent of the leasehold interest transferred, all of that lessor’s and the existing lessee’s rights to the goods, and takes free of the existing lease contract (3) A subsequent lessee from the lessor of goods that are subject to an existing lease contract and are covered by a certificate of title issued under a statute of this State or of another jurisdiction takes no greater rights than those provided both by this section and by the certificate of title statute As amended in 1990 § 2A–305.  Sale or Sublease of Goods by Lessee (1) Subject to the provisions of Section 2A–303, a buyer or sublessee from the lessee of goods under an existing lease contract obtains, to the extent of the interest transferred, the leasehold interest in the goods that the lessee had or had power to transfer, and except as provided in subsection (2) and Section 2A–511(4), takes subject to the existing lease contract A lessee with a voidable leasehold interest has power to transfer a good leasehold interest to a good faith buyer for value or a good faith sublessee for value, but only to the extent set forth in the preceding sentence When goods have been delivered under a transaction of lease the lessee has that power even though: (a) the lessor was deceived as to the identity of the ­lessee; (b) the delivery was in exchange for a check which is later dishonored; or (c) the delivery was procured through fraud punishable as larcenous under the criminal law (2)  A buyer in the ordinary course of business or a sublessee in the ordinary course of business from a lessee who is a merchant dealing in goods of that kind to whom the goods were entrusted by the lessor obtains, to the extent of the interest transferred, all of the lessor’s and lessee’s rights to the goods, and takes free of the existing lease contract (3) A buyer or sublessee from the lessee of goods that are subject to an existing lease contract and are covered by a certificate of title issued under a statute of this State or of another jurisdiction takes no greater rights than those provided both by this section and by the certificate of title statute § 2A–306.  Priority of Certain Liens Arising by Operation of Law If a person in the ordinary course of his [or her] business furnishes services or materials with respect to goods subject to a Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  lease contract, a lien upon those goods in the possession of that person given by statute or rule of law for those materials or services takes priority over any interest of the lessor or lessee under the lease contract or this Article unless the lien is created by statute and the statute provides otherwise or unless the lien is created by rule of law and the rule of law provides otherwise § 2A–307.  Priority of Liens Arising by Attachment or Levy on, Security Interests in, and Other Claims to Goods (1) Except as otherwise provided in Section 2A–306, a creditor of a lessee takes subject to the lease contract (2)  Except as otherwise provided in subsection (3) and in Sections 2A–306 and 2A–308, a creditor of a lessor takes subject to the lease contract unless the creditor holds a lien that attached to the goods before the lease contract became enforceable (3) Except as otherwise provided in Sections 9–317, 9–321, and 9–323, a lessee takes a leasehold interest subject to a security interest held by a creditor of the lessor As amended in 1990 and 1999 § 2A–308.  Special Rights of Creditors (1)  A creditor of a lessor in possession of goods subject to a lease contract may treat the lease contract as void if as against the creditor retention of possession by the lessor is fraudulent under any statute or rule of law, but retention of possession in good faith and current course of trade by the lessor for a commercially reasonable time after the lease contract becomes enforceable is not ­fraudulent (2)  Nothing in this Article impairs the rights of creditors of a lessor if the lease contract (a) becomes enforceable, not in current course of trade but in satisfaction of or as security for a pre-existing claim for money, security, or the like, and (b) is made under circumstances which under any statute or rule of law apart from this Article would constitute the transaction a fraudulent transfer or voidable preference (3) A creditor of a seller may treat a sale or an identification of goods to a contract for sale as void if as against the creditor retention of possession by the seller is fraudulent under any statute or rule of law, but retention of possession of the goods pursuant to a lease contract entered into by the seller as lessee and the buyer as lessor in connection with the sale or identification of the goods is not fraudulent if the buyer bought for value and in good faith § 2A–309.  Lessor’s and Lessee’s Rights When Goods Become Fixtures (1) In this section: (a)  goods are “fixtures” when they become so related to particular real estate that an interest in them arises under real estate law; (b)  a “fixture filing” is the filing, in the office where a mortgage on the real estate would be filed or recorded, of a financing statement covering goods that are or are to become fixtures and conforming to the requirements of Section 9–502(a) and (b); (c) a lease is a “purchase money lease” unless the lessee has possession or use of the goods or the right to possession or use of the goods before the lease agreement is enforceable; A–43 (d) a mortgage is a “construction mortgage” to the extent it secures an obligation incurred for the construction of an improvement on land including the acquisition cost of the land, if the recorded writing so indicates; and (e)  “encumbrance” includes real estate mortgages and other liens on real estate and all other rights in real estate that are not ownership interests (2) Under this Article a lease may be of goods that are fixtures or may continue in goods that become fixtures, but no lease exists under this Article of ordinary building materials incorporated into an improvement on land (3) This Article does not prevent creation of a lease of fixtures pursuant to real estate law (4) The perfected interest of a lessor of fixtures has priority over a conflicting interest of an encumbrancer or owner of the real estate if: (a) the lease is a purchase money lease, the conflicting interest of the encumbrancer or owner arises before the goods become fixtures, the interest of the lessor is perfected by a fixture filing before the goods become fixtures or within ten days thereafter, and the lessee has an interest of record in the real estate or is in possession of the real estate; or (b) the interest of the lessor is perfected by a fixture filing before the interest of the encumbrancer or owner is of record, the lessor’s interest has priority over any conflicting interest of a predecessor in title of the encumbrancer or owner, and the lessee has an interest of record in the real estate or is in possession of the real estate (5) The interest of a lessor of fixtures, whether or not perfected, has priority over the conflicting interest of an encumbrancer or owner of the real estate if: (a)  the fixtures are readily removable factory or office machines, readily removable equipment that is not primarily used or leased for use in the operation of the real estate, or readily removable replacements of domestic appliances that are goods subject to a consumer lease, and before the goods become fixtures the lease contract is enforceable; or (b)  the conflicting interest is a lien on the real estate obtained by legal or equitable proceedings after the lease contract is enforceable; or (c)  the encumbrancer or owner has consented in writing to the lease or has disclaimed an interest in the goods as fixtures; or (d) the lessee has a right to remove the goods as against the encumbrancer or owner If the lessee’s right to remove terminates, the priority of the interest of the lessor continues for a reasonable time (6)  Notwithstanding paragraph (4)(a) but otherwise subject to subsections (4) and (5), the interest of a lessor of fixtures, including the lessor’s residual interest, is subordinate to the conflicting interest of an encumbrancer of the real estate under a construction mortgage recorded before the goods become fixtures if the goods become fixtures before the completion of the construction To the extent given to refinance a construction mortgage, the conflicting interest of an encumbrancer of the real estate under a mortgage has this priority to the same extent as the encumbrancer of the real estate under the construction mortgage Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–44  Appendix c  Articles and 2A of the Uniform Commercial Code (7)  In cases not within the preceding subsections, priority between the interest of a lessor of fixtures, including the lessor’s residual interest, and the conflicting interest of an encumbrancer or owner of the real estate who is not the lessee is determined by the priority rules governing conflicting interests in real estate (8)  If the interest of a lessor of fixtures, including the lessor’s residual interest, has priority over all conflicting interests of all owners and encumbrancers of the real estate, the lessor or the lessee may (i) on default, expiration, termination, or cancellation of the lease agreement but subject to the agreement and this Article, or (ii) if necessary to enforce other rights and remedies of the lessor or lessee under this Article, remove the goods from the real estate, free and clear of all conflicting interests of all owners and encumbrancers of the real estate, but the lessor or lessee must reimburse any encumbrancer or owner of the real estate who is not the lessee and who has not otherwise agreed for the cost of repair of any physical injury, but not for any diminution in value of the real estate caused by the absence of the goods removed or by any necessity of replacing them A person entitled to reimbursement may refuse permission to remove until the party seeking removal gives adequate security for the performance of this obligation (9) Even though the lease agreement does not create a security interest, the interest of a lessor of fixtures, including the lessor’s residual interest, is perfected by filing a financing statement as a fixture filing for leased goods that are or are to become fixtures in accordance with the relevant provisions of the Article on Secured Transactions (Article 9) As amended in 1990 and 1999 § 2A–310.  Lessor’s and Lessee’s Rights When Goods Become Accessions (1) Goods are “accessions” when they are installed in or affixed to other goods (2)  The interest of a lessor or a lessee under a lease contract entered into before the goods became accessions is superior to all interests in the whole except as stated in subsection (4) (3)  The interest of a lessor or a lessee under a lease contract entered into at the time or after the goods became accessions is superior to all subsequently acquired interests in the whole except as stated in subsection (4) but is subordinate to interests in the whole existing at the time the lease contract was made unless the holders of such interests in the whole have in writing consented to the lease or disclaimed an interest in the goods as part of the whole (4)  The interest of a lessor or a lessee under a lease contract described in subsection (2) or (3) is subordinate to the ­interest of (a) a buyer in the ordinary course of business or a lessee in the ordinary course of business of any interest in the whole acquired after the goods became accessions; or (b) a creditor with a security interest in the whole perfected before the lease contract was made to the extent that the creditor makes subsequent advances without knowledge of the lease contract (5) When under subsections (2) or (3) and (4) a lessor or a lessee of accessions holds an interest that is superior to all interests in the whole, the lessor or the lessee may (a) on default, expiration, termination, or cancellation of the lease contract by the other party but subject to the provisions of the lease contract and this Article, or (b) if necessary to enforce his [or her] other rights and remedies under this Article, remove the goods from the whole, free and clear of all interests in the whole, but he [or she] must reimburse any holder of an interest in the whole who is not the lessee and who has not otherwise agreed for the cost of repair of any physical injury but not for any diminution in value of the whole caused by the absence of the goods removed or by any necessity for replacing them A person entitled to reimbursement may refuse permission to remove until the party seeking removal gives adequate security for the performance of this obligation § 2A–311.  Priority Subject to Subordination Nothing in this Article prevents subordination by agreement by any person entitled to priority As added in 1990 Part 4—Performance of Lease Contract: Repudiated, Substituted and Excused § 2A–401.  Insecurity: Adequate Assurance of Performance (1) A lease contract imposes an obligation on each party that the other’s expectation of receiving due performance will not be impaired (2) If reasonable grounds for insecurity arise with respect to the performance of either party, the insecure party may demand in writing adequate assurance of due perfor­mance Until the insecure party receives that assurance, if commercially reasonable the insecure party may suspend any performance for which he [or she] has not already received the agreed return (3) A repudiation of the lease contract occurs if assurance of due performance adequate under the circumstances of the particular case is not provided to the insecure party within a reasonable time, not to exceed 30 days after receipt of a demand by the other party (4) Between merchants, the reasonableness of grounds for insecurity and the adequacy of any assurance offered must be determined according to commercial standards (5) Acceptance of any nonconforming delivery or payment does not prejudice the aggrieved party’s right to demand adequate assurance of future performance § 2A–402.  Anticipatory Repudiation If either party repudiates a lease contract with respect to a performance not yet due under the lease contract, the loss of which performance will substantially impair the value of the lease contract to the other, the aggrieved party may: (a) for a commercially reasonable time, await retraction of repudiation and performance by the repudiating party; (b) make demand pursuant to Section 2A–401 and await assurance of future performance adequate under the circumstances of the particular case; or (c) resort to any right or remedy upon default under the lease contract or this Article, even though the aggrieved party has notified the repudiating party that the aggrieved party would await the repudiating party’s performance and assurance and has urged retraction In addition, whether or not the aggrieved Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  party is pursuing one of the foregoing remedies, the aggrieved party may suspend performance or, if the aggrieved party is the lessor, proceed in accordance with the provisions of this Article on the lessor’s right to identify goods to the lease contract notwithstanding default or to salvage unfinished goods (Section 2A–524) § 2A–403.  Retraction of Anticipatory Repudiation (1) Until the repudiating party’s next performance is due, the repudiating party can retract the repudiation unless, since the repudiation, the aggrieved party has cancelled the lease contract or materially changed the aggrieved party’s position or otherwise indicated that the aggrieved party considers the repudiation final (2)  Retraction may be by any method that clearly indicates to the aggrieved party that the repudiating party intends to perform under the lease contract and includes any assurance demanded under Section 2A–401 (3)  Retraction reinstates a repudiating party’s rights under a lease contract with due excuse and allowance to the aggrieved party for any delay occasioned by the ­repudiation § 2A–404.  Substituted Performance (1)  If without fault of the lessee, the lessor and the supplier, the agreed berthing, loading, or unloading facilities fail or the agreed type of carrier becomes unavailable or the agreed manner of delivery otherwise becomes commercially impracticable, but a commercially reasonable substitute is available, the substitute performance must be tendered and accepted (2) If the agreed means or manner of payment fails because of domestic or foreign governmental regulation: (a)  the lessor may withhold or stop delivery or cause the supplier to withhold or stop delivery unless the lessee provides a means or manner of payment that is commercially a substantial equivalent; and (b) if delivery has already been taken, payment by the means or in the manner provided by the regulation discharges the lessee’s obligation unless the regulation is discriminatory, oppressive, or predatory § 2A–405.  Excused Performance Subject to Section 2A–404 on substituted performance, the following rules apply: (a)  Delay in delivery or nondelivery in whole or in part by a lessor or a supplier who complies with paragraphs (b) and (c) is not a default under the lease contract if performance as agreed has been made impracticable by the occurrence of a contingency the nonoccurrence of which was a basic assumption on which the lease contract was made or by compliance in good faith with any applicable foreign or domestic governmental regulation or order, whether or not the regulation or order later proves to be invalid (b)  If the causes mentioned in paragraph (a) affect only part of the lessor’s or the supplier’s capacity to perform, he [or she] shall allocate production and deliveries among his [or her] customers but at his [or her] option may include regular customers not then under contract for sale or lease as well as his [or her] own requirements for further manufacture He [or she] may so allocate in any manner that is fair and reasonable A–45 (c) The lessor seasonably shall notify the lessee and in the case of a finance lease the supplier seasonably shall notify the lessor and the lessee, if known, that there will be delay or nondelivery and, if allocation is required under paragraph (b), of the estimated quota thus made available for the lessee § 2A–406.  Procedure on Excused Performance (1) If the lessee receives notification of a material or indefinite delay or an allocation justified under Section 2A–405, the lessee may by written notification to the lessor as to any goods involved, and with respect to all of the goods if under an installment lease contract the value of the whole lease contract is substantially impaired (Section 2A–510): (a) terminate the lease contract (Section 2A–505(2)); or (b) except in a finance lease that is not a consumer lease, modify the lease contract by accepting the available quota in substitution, with due allowance from the rent payable for the balance of the lease term for the deficiency but without further right against the lessor (2) If, after receipt of a notification from the lessor under Section 2A–405, the lessee fails so to modify the lease ­agreement within a reasonable time not exceeding 30 days, the lease contract lapses with respect to any deliveries affected § 2A–407.  Irrevocable Promises: Finance Leases (1) In the case of a finance lease that is not a consumer lease the lessee’s promises under the lease contract become irrevocable and independent upon the lessee’s acceptance of the goods (2)  A promise that has become irrevocable and inde­pend­ent under subsection (1): (a) is effective and enforceable between the parties, and by or against third parties including assignees of the parties, and (b)  is not subject to cancellation, termination, modification, repudiation, excuse, or substitution without the consent of the party to whom the promise runs (3) This section does not affect the validity under any other law of a covenant in any lease contract making the lessee’s promises irrevocable and independent upon the lessee’s acceptance of the goods As amended in 1990 Part 5—Default A. In General § 2A–501.  Default: Procedure (1) Whether the lessor or the lessee is in default under a lease contract is determined by the lease agreement and this Article (2) If the lessor or the lessee is in default under the lease contract, the party seeking enforcement has rights and remedies as provided in this Article and, except as limited by this Article, as provided in the lease agreement (3) If the lessor or the lessee is in default under the lease contract, the party seeking enforcement may reduce the party’s claim to judgment, or otherwise enforce the lease contract by self-help or any available judicial procedure or nonjudicial procedure, including administrative proceeding, arbitration, or the like, in accordance with this Article Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–46  Appendix c  Articles and 2A of the Uniform Commercial Code (4)  Except as otherwise provided in Section 1–106(1) or this Article or the lease agreement, the rights and remedies referred to in subsections (2) and (3) are cumulative (5) If the lease agreement covers both real property and goods, the party seeking enforcement may proceed under this Part as to the goods, or under other applicable law as to both the real property and the goods in accordance with that party’s rights and remedies in respect of the real property, in which case this Part does not apply As amended in 1990 § 2A–502.  Notice After Default Except as otherwise provided in this Article or the lease agreement, the lessor or lessee in default under the lease contract is not entitled to notice of default or notice of enforcement from the other party to the lease agreement § 2A–503.  Modification or Impairment of Rights and Remedies (1) Except as otherwise provided in this Article, the lease agreement may include rights and remedies for default in addition to or in substitution for those provided in this Article and may limit or alter the measure of damages recoverable under this Article (2) Resort to a remedy provided under this Article or in the lease agreement is optional unless the remedy is expressly agreed to be exclusive If circumstances cause an exclusive or limited remedy to fail of its essential purpose, or provision for an exclusive remedy is unconscionable, remedy may be had as provided in this Article (3)  Consequential damages may be liquidated under Section 2A–504, or may otherwise be limited, altered, or excluded unless the limitation, alteration, or exclusion is unconscionable Limitation, alteration, or exclusion of consequential damages for injury to the person in the case of consumer goods is prima facie unconscionable but limitation, alteration, or exclusion of damages where the loss is commercial is not prima facie unconscionable (4)  Rights and remedies on default by the lessor or the lessee with respect to any obligation or promise collateral or ancillary to the lease contract are not impaired by this Article As amended in 1990 § 2A–504.  Liquidation of Damages (1)  Damages payable by either party for default, or any other act or omission, including indemnity for loss or diminution of anticipated tax benefits or loss or damage to lessor’s residual interest, may be liquidated in the lease agreement but only at an amount or by a formula that is reasonable in light of the then anticipated harm caused by the default or other act or omission (2) If the lease agreement provides for liquidation of damages, and such provision does not comply with subsection (1), or such provision is an exclusive or limited remedy that circumstances cause to fail of its essential purpose, remedy may be had as provided in this Article (3) If the lessor justifiably withholds or stops delivery of goods because of the lessee’s default or insolvency (Section 2A–525 or 2A–526), the lessee is entitled to restitution of any amount by which the sum of his [or her] payments exceeds: (a) the amount to which the lessor is entitled by virtue of terms liquidating the lessor’s damages in accordance with subsection (1); or (b)  in the absence of those terms, 20 percent of the then present value of the total rent the lessee was obligated to pay for the balance of the lease term, or, in the case of a consumer lease, the lesser of such amount or $500 (4) A lessee’s right to restitution under subsection (3) is subject to offset to the extent the lessor establishes: (a) a right to recover damages under the provisions of this Article other than subsection (1); and (b) the amount or value of any benefits received by the lessee directly or indirectly by reason of the lease contract § 2A–505.  Cancellation and Termination and Effect of Cancellation, Termination, Rescission, or Fraud on Rights and Remedies (1)  On cancellation of the lease contract, all obligations that are still executory on both sides are discharged, but any right based on prior default or performance survives, and the cancelling party also retains any remedy for default of the whole lease contract or any unperformed balance (2) On termination of the lease contract, all obligations that are still executory on both sides are discharged but any right based on prior default or performance survives (3)  Unless the contrary intention clearly appears, expressions of “cancellation,” “rescission,” or the like of the lease contract may not be construed as a renunciation or discharge of any claim in damages for an antecedent default (4) Rights and remedies for material misrepresentation or fraud include all rights and remedies available under this Article for default (5) Neither rescission nor a claim for rescission of the lease contract nor rejection or return of the goods may bar or be deemed inconsistent with a claim for damages or other right or remedy § 2A–506.  Statute of Limitations (1) An action for default under a lease contract, including breach of warranty or indemnity, must be commenced within years after the cause of action accrued By the original lease contract the parties may reduce the period of limitation to not less than one year (2) A cause of action for default accrues when the act or omission on which the default or breach of warranty is based is or should have been discovered by the aggrieved party, or when the default occurs, whichever is later A cause of action for indemnity accrues when the act or omission on which the claim for indemnity is based is or should have been discovered by the indemnified party, whichever is later (3)  If an action commenced within the time limited by subsection (1) is so terminated as to leave available a remedy by another action for the same default or breach of warranty or indemnity, the other action may be commenced after the expiration of the time limited and within months after the termination of the first action unless the termination resulted from voluntary discontinuance or from dismissal for failure or neglect to prosecute (4) This section does not alter the law on tolling of the statute of limitations nor does it apply to causes of action that have accrued before this Article becomes effective Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  § 2A–507.  Proof of Market Rent: Time and Place (1) Damages based on market rent (Section 2A–519 or 2A–528) are determined according to the rent for the use of the goods concerned for a lease term identical to the remaining lease term of the original lease agreement and prevailing at the times specified in Sections 2A–519 and 2A–528 (2) If evidence of rent for the use of the goods concerned for a lease term identical to the remaining lease term of the original lease agreement and prevailing at the times or places described in this Article is not readily available, the rent prevailing within any reasonable time before or after the time described or at any other place or for a different lease term which in commercial judgment or under usage of trade would serve as a reasonable substitute for the one described may be used, making any proper allowance for the difference, including the cost of transporting the goods to or from the other place (3) Evidence of a relevant rent prevailing at a time or place or for a lease term other than the one described in this Article offered by one party is not admissible unless and until he [or she] has given the other party notice the court finds sufficient to prevent unfair surprise (4) If the prevailing rent or value of any goods regularly leased in any established market is in issue, reports in official publications or trade journals or in newspapers or periodicals of general circulation published as the reports of that market are admissible in evidence The circumstances of the preparation of the report may be shown to affect its weight but not its admissibility As amended in 1990 B. Default by Lessor § 2A–508.  Lessee’s Remedies (1)  If a lessor fails to deliver the goods in conformity to the lease contract (Section 2A–509) or repudiates the lease contract (Section 2A–402), or a lessee rightfully rejects the goods (Section 2A–509) or justifiably revokes acceptance of the goods (Section 2A–517), then with respect to any goods involved, and with respect to all of the goods if under an installment lease contract the value of the whole lease contract is substantially impaired (Section 2A–510), the lessor is in default under the lease contract and the lessee may: (a) cancel the lease contract (Section 2A–505(1)); (b)  recover so much of the rent and security as has been paid and is just under the circumstances; (c)  cover and recover damages as to all goods affected whether or not they have been identified to the lease contract (Sections 2A–518 and 2A–520), or recover damages for nondelivery (Sections 2A–519 and 2A–520); (d) exercise any other rights or pursue any other remedies provided in the lease contract (2) If a lessor fails to deliver the goods in conformity to the lease contract or repudiates the lease contract, the lessee may also: (a) if the goods have been identified, recover them (Section 2A–522); or (b) in a proper case, obtain specific performance or replevy the goods (Section 2A–521) (3) If a lessor is otherwise in default under a lease contract, the lessee may exercise the rights and pursue the remedies provided A–47 in the lease contract, which may include a right to cancel the lease, and in Section 2A–519(3) (4)  If a lessor has breached a warranty, whether express or implied, the lessee may recover damages (Section 2A–519(4)) (5) On rightful rejection or justifiable revocation of acceptance, a lessee has a security interest in goods in the lessee’s possession or control for any rent and security that has been paid and any expenses reasonably incurred in their inspection, receipt, transportation, and care and custody and may hold those goods and dispose of them in good faith and in a commercially reasonable manner, subject to Section 2A–527(5) (6) Subject to the provisions of Section 2A–407, a lessee, on notifying the lessor of the lessee’s intention to so, may deduct all or any part of the damages resulting from any default under the lease contract from any part of the rent still due under the same lease contract As amended in 1990 § 2A–509.  Lessee’s Rights on Improper Delivery; Rightful Rejection (1)  Subject to the provisions of Section 2A–510 on default in installment lease contracts, if the goods or the tender or delivery fail in any respect to conform to the lease contract, the lessee may reject or accept the goods or accept any commercial unit or units and reject the rest of the goods (2) Rejection of goods is ineffective unless it is within a reasonable time after tender or delivery of the goods and the lessee seasonably notifies the lessor § 2A–510.  Installment Lease Contracts: Rejection and Default (1) Under an installment lease contract a lessee may reject any delivery that is nonconforming if the nonconformity substantially impairs the value of that delivery and cannot be cured or the nonconformity is a defect in the required documents; but if the nonconformity does not fall within subsection (2) and the lessor or the supplier gives adequate assurance of its cure, the lessee must accept that delivery (2) Whenever nonconformity or default with respect to one or more deliveries substantially impairs the value of the installment lease contract as a whole there is a default with respect to the whole But, the aggrieved party reinstates the installment lease contract as a whole if the aggrieved party accepts a nonconforming delivery without seasonably notifying of cancellation or brings an action with respect only to past deliveries or demands perform­ance as to future deliveries § 2A–511.  Merchant Lessee’s Duties as to Rightfully Rejected Goods (1) Subject to any security interest of a lessee (Section 2A–508(5)), if a lessor or a supplier has no agent or place of business at the market of rejection, a merchant lessee, after rejection of goods in his [or her] possession or control, shall follow any reasonable instructions received from the lessor or the supplier with respect to the goods In the absence of those instructions, a merchant lessee shall make reasonable efforts to sell, lease, or otherwise dispose of the goods for the lessor’s account if they threaten to decline in value speedily Instructions are not reasonable if on demand indemnity for expenses is not forthcoming Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–48  Appendix c  Articles and 2A of the Uniform Commercial Code (2)  If a merchant lessee (subsection (1)) or any other lessee (Section 2A–512) disposes of goods, he [or she] is entitled to reimbursement either from the lessor or the supplier or out of the proceeds for reasonable expenses of caring for and disposing of the goods and, if the expenses include no disposition commission, to such commission as is usual in the trade, or if there is none, to a reasonable sum not exceeding 10 percent of the gross proceeds (3) In complying with this section or Section 2A–512, the lessee is held only to good faith Good faith conduct hereunder is neither acceptance or conversion nor the basis of an action for ­damages (4) A purchaser who purchases in good faith from a lessee pursuant to this section or Section 2A–512 takes the goods free of any rights of the lessor and the supplier even though the lessee fails to comply with one or more of the requirements of this Article § 2A–512.  Lessee’s Duties as to Rightfully Rejected Goods (1)  Except as otherwise provided with respect to goods that threaten to decline in value speedily (Section 2A–511) and subject to any security interest of a lessee (Section 2A–508(5)): (a) the lessee, after rejection of goods in the lessee’s possession, shall hold them with reasonable care at the lessor’s or the supplier’s disposition for a reasonable time after the lessee’s seasonable notification of rejection; (b) if the lessor or the supplier gives no instructions within a reasonable time after notification of rejection, the lessee may store the rejected goods for the lessor’s or the supplier’s account or ship them to the lessor or the supplier or dispose of them for the lessor’s or the supplier’s account with reimbursement in the manner provided in Section 2A–511; but (c)  the lessee has no further obligations with regard to goods rightfully rejected (2) Action by the lessee pursuant to subsection (1) is not acceptance or conversion § 2A–513.  Cure by Lessor of Improper Tender or Delivery; Replacement (1)  If any tender or delivery by the lessor or the supplier is rejected because nonconforming and the time for perfor­mance has not yet expired, the lessor or the supplier may s­ easonably notify the lessee of the lessor’s or the supplier’s intention to cure and may then make a conforming delivery within the time provided in the lease contract (2)  If the lessee rejects a nonconforming tender that the lessor or the supplier had reasonable grounds to believe would be acceptable with or without money allowance, the lessor or the supplier may have a further reasonable time to substitute a conforming tender if he [or she] seasonably notifies the lessee § 2A–514.  Waiver of Lessee’s Objections (1)  In rejecting goods, a lessee’s failure to state a particular defect that is ascertainable by reasonable inspection precludes the lessee from relying on the defect to justify rejection or to establish default: (a) if, stated seasonably, the lessor or the supplier could have cured it (Section 2A–513); or (b)  between merchants if the lessor or the supplier after rejection has made a request in writing for a full and final written statement of all defects on which the lessee proposes to rely (2) A lessee’s failure to reserve rights when paying rent or other consideration against documents precludes recovery of the payment for defects apparent on the face of the ­documents § 2A–515.  Acceptance of Goods (1) Acceptance of goods occurs after the lessee has had a reasonable opportunity to inspect the goods and (a) the lessee signifies or acts with respect to the goods in a manner that signifies to the lessor or the supplier that the goods are conforming or that the lessee will take or retain them in spite of their nonconformity; or (b)  the lessee fails to make an effective rejection of the goods (Section 2A–509(2)) (2) Acceptance of a part of any commercial unit is acceptance of that entire unit § 2A–516.  Effect of Acceptance of Goods; Notice of Default; Burden of Establishing Default after Acceptance; Notice of Claim or Litigation to Person Answerable Over (1) A lessee must pay rent for any goods accepted in accordance with the lease contract, with due allowance for goods rightfully rejected or not delivered (2)  A lessee’s acceptance of goods precludes rejection of the goods accepted In the case of a finance lease, if made with knowledge of a nonconformity, acceptance cannot be revoked because of it In any other case, if made with knowledge of a nonconformity, acceptance cannot be revoked because of it unless the acceptance was on the reasonable assumption that the nonconformity would be seasonably cured Acceptance does not of itself impair any other remedy provided by this Article or the lease agreement for nonconformity (3) If a tender has been accepted: (a)  within a reasonable time after the lessee discovers or should have discovered any default, the lessee shall notify the lessor and the supplier, if any, or be barred from any remedy against the party notified; (b) except in the case of a consumer lease, within a reasonable time after the lessee receives notice of litigation for infringement or the like (Section 2A–211) the lessee shall notify the lessor or be barred from any remedy over for liability established by the litigation; and (c) the burden is on the lessee to establish any default (4) If a lessee is sued for breach of a warranty or other obligation for which a lessor or a supplier is answerable over the following apply: (a) The lessee may give the lessor or the supplier, or both, written notice of the litigation If the notice states that the person notified may come in and defend and that if the person notified does not so that person will be bound in any action against that person by the lessee by any determination of fact common to the two litigations, then unless the person notified after seasonable receipt of the notice does come in and defend that person is so bound Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  (b) The lessor or the supplier may demand in writing that the lessee turn over control of the litigation including settlement if the claim is one for infringement or the like (Section 2A–211) or else be barred from any remedy over If the demand states that the lessor or the supplier agrees to bear all expense and to satisfy any adverse judgment, then unless the lessee after seasonable receipt of the demand does turn over control the lessee is so barred (5) Subsections (3) and (4) apply to any obligation of a lessee to hold the lessor or the supplier harmless against infringement or the like (Section 2A–211) As amended in 1990 § 2A–517.  Revocation of Acceptance of Goods (1) A lessee may revoke acceptance of a lot or commercial unit whose nonconformity substantially impairs its value to the lessee if the lessee has accepted it: (a) except in the case of a finance lease, on the reasonable assumption that its nonconformity would be cured and it has not been seasonably cured; or (b) without discovery of the nonconformity if the lessee’s acceptance was reasonably induced either by the lessor’s assurances or, except in the case of a finance lease, by the difficulty of discovery before acceptance (2) Except in the case of a finance lease that is not a consumer lease, a lessee may revoke acceptance of a lot or commercial unit if the lessor defaults under the lease contract and the default substantially impairs the value of that lot or commercial unit to the lessee (3) If the lease agreement so provides, the lessee may revoke acceptance of a lot or commercial unit because of other defaults by the lessor (4)  Revocation of acceptance must occur within a reasonable time after the lessee discovers or should have discovered the ground for it and before any substantial change in condition of the goods which is not caused by the nonconformity Revocation is not effective until the lessee notifies the lessor (5) A lessee who so revokes has the same rights and duties with regard to the goods involved as if the lessee had rejected them As amended in 1990 § 2A–518.  Cover; Substitute Goods (1)  After a default by a lessor under the lease contract of the type described in Section 2A–508(1), or, if agreed, after other default by the lessor, the lessee may cover by making any purchase or lease of or contract to purchase or lease goods in substitution for those due from the lessor (2) Except as otherwise provided with respect to damages liquidated in the lease agreement (Section 2A–504) or otherwise determined pursuant to agreement of the parties (Sections 1–102(3) and 2A–503), if a lessee’s cover is by lease agreement substantially similar to the original lease agreement and the new lease agreement is made in good faith and in a commercially reasonable manner, the lessee may recover from the lessor as damages (i) the pres­ent value, as of the date of the commencement of the term of the new lease agreement, of the rent under the new lease agreement applicable to that period of the new lease term which is comparable to the then remaining term of the original lease agreement minus the present value as A–49 of the same date of the total rent for the then remaining lease term of the original lease agreement, and (ii) any incidental or consequential damages, less expenses saved in consequence of the lessor’s default (3) If a lessee’s cover is by lease agreement that for any reason does not qualify for treatment under subsection (2), or is by purchase or otherwise, the lessee may recover from the lessor as if the lessee had elected not to cover and Section 2A–519 governs As amended in 1990 § 2A–519.  Lessee’s Damages for NonDelivery, Repudiation, Default, and Breach of Warranty in Regard to Accepted Goods (1) Except as otherwise provided with respect to damages liquidated in the lease agreement (Section 2A–504) or otherwise determined pursuant to agreement of the parties (Sections 1–102(3) and 2A–503), if a lessee elects not to cover or a lessee elects to cover and the cover is by lease agreement that for any reason does not qualify for treatment under Section 2A–518(2), or is by purchase or otherwise, the measure of damages for non-delivery or repudiation by the lessor or for rejection or revocation of acceptance by the lessee is the present value, as of the date of the default, of the then market rent minus the present value as of the same date of the original rent, computed for the remaining lease term of the original lease agreement, together with incidental and consequential damages, less expenses saved in consequence of the lessor’s default (2) Market rent is to be determined as of the place for tender or, in cases of rejection after arrival or revocation of acceptance, as of the place of arrival (3) Except as otherwise agreed, if the lessee has accepted goods and given notification (Section 2A–516(3)), the measure of damages for non-conforming tender or delivery or other default by a lessor is the loss resulting in the ordinary course of events from the lessor’s default as determined in any manner that is reasonable together with incidental and consequential damages, less expenses saved in consequence of the lessor’s default (4)  Except as otherwise agreed, the measure of damages for breach of warranty is the present value at the time and place of acceptance of the difference between the value of the use of the goods accepted and the value if they had been as warranted for the lease term, unless special circumstances show proximate damages of a different amount, together with incidental and consequential damages, less expenses saved in consequence of the lessor’s default or breach of warranty As amended in 1990 § 2A–520.  Lessee’s Incidental and Consequential Damages (1)  Incidental damages resulting from a lessor’s default include expenses reasonably incurred in inspection, receipt, transportation, and care and custody of goods rightfully rejected or goods the acceptance of which is justifiably revoked, any commercially r­easonable charges, expenses or commissions in connection with effecting cover, and any other reasonable expense incident to the default Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–50  Appendix c  Articles and 2A of the Uniform Commercial Code (2)  Consequential damages resulting from a lessor’s default include: (a)  any loss resulting from general or particular requirements and needs of which the lessor at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise; and (b) injury to person or property proximately resulting from any breach of warranty § 2A–521.  Lessee’s Right to Specific Performance or Replevin (1) Specific performance may be decreed if the goods are unique or in other proper circumstances (2)  A decree for specific performance may include any terms and conditions as to payment of the rent, damages, or other relief that the court deems just (3) A lessee has a right of replevin, detinue, sequestration, claim and delivery, or the like for goods identified to the lease contract if after reasonable effort the lessee is unable to effect cover for those goods or the circumstances reasonably indicate that the effort will be unavailing § 2A–522.  Lessee’s Right to Goods on Lessor’s Insolvency (1) Subject to subsection (2) and even though the goods have not been shipped, a lessee who has paid a part or all of the rent and security for goods identified to a lease contract (Section 2A–217) on making and keeping good a tender of any unpaid portion of the rent and security due under the lease contract may recover the goods identified from the lessor if the lessor becomes insolvent within 10 days after receipt of the first installment of rent and security (2) A lessee acquires the right to recover goods identified to a lease contract only if they conform to the lease ­contract C. Default by Lessee § 2A–523.  Lessor’s Remedies (1) If a lessee wrongfully rejects or revokes acceptance of goods or fails to make a payment when due or repudiates with respect to a part or the whole, then, with respect to any goods involved, and with respect to all of the goods if under an installment lease contract the value of the whole lease contract is substantially impaired (Section 2A–510), the lessee is in default under the lease contract and the lessor may: (a)  cancel the lease contract (Section 2A–505(1)); (b)  proceed respecting goods not identified to the lease contract (Section 2A–524); (c)  withhold delivery of the goods and take possession of goods previously delivered (Section 2A–525); (d)  stop delivery of the goods by any bailee (Section 2A–526); (e)  dispose of the goods and recover damages (Section 2A–527), or retain the goods and recover damages (Section 2A–528), or in a proper case recover rent (Section 2A–529) (f)  exercise any other rights or pursue any other remedies provided in the lease contract (2) If a lessor does not fully exercise a right or obtain a remedy to which the lessor is entitled under subsection (1), the lessor may recover the loss resulting in the ordinary course of events from the lessee’s default as determined in any reason- able manner, together with incidental damages, less expenses saved in consequence of the lessee’s default (3) If a lessee is otherwise in default under a lease contract, the lessor may exercise the rights and pursue the remedies provided in the lease contract, which may include a right to cancel the lease In addition, unless otherwise provided in the lease contract: (a) if the default substantially impairs the value of the lease contract to the lessor, the lessor may exercise the rights and pursue the remedies provided in subsections (1) or (2); or (b) if the default does not substantially impair the value of the lease contract to the lessor, the lessor may recover as provided in subsection (2) As amended in 1990 § 2A–524.  Lessor’s Right to Identify Goods to Lease Contract (1)  After default by the lessee under the lease contract of the type described in Section 2A–523(1) or 2A–523(3)(a) or, if agreed, after other default by the lessee, the lessor may: (a)  identify to the lease contract conforming goods not already identified if at the time the lessor learned of the default they were in the lessor’s or the supplier’s possession or control; and (b) dispose of goods (Section 2A–527(1)) that demonstrably have been intended for the particular lease contract even though those goods are ­unfinished (2)  If the goods are unfinished, in the exercise of reasonable commercial judgment for the purposes of avoiding loss and of effective realization, an aggrieved lessor or the supplier may either complete manufacture and wholly identify the goods to the lease contract or cease manufacture and lease, sell, or otherwise dispose of the goods for scrap or salvage value or proceed in any other reasonable manner As amended in 1990 § 2A–525.  Lessor’s Right to Possession of Goods (1) If a lessor discovers the lessee to be insolvent, the lessor may refuse to deliver the goods (2) After a default by the lessee under the lease contract of the type described in Section 2A–523(1) or 2A–523(3)(a) or, if agreed, after other default by the lessee, the lessor has the right to take possession of the goods If the lease contract so provides, the lessor may require the lessee to assemble the goods and make them available to the lessor at a place to be designated by the lessor which is reasonably convenient to both parties Without removal, the lessor may render unusable any goods employed in trade or business, and may dispose of goods on the lessee’s premises (Section 2A–527) (3) The lessor may proceed under subsection (2) without judicial process if that can be done without breach of the peace or the lessor may proceed by action As amended in 1990 § 2A–526.  Lessor’s Stoppage of Delivery in Transit or Otherwise (1) A lessor may stop delivery of goods in the possession of a carrier or other bailee if the lessor discovers the lessee to be insolvent and may stop delivery of carload, truckload, planeload, or larger shipments of express or freight if the lessee repu- Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix C  Articles and 2A of the Uniform Commercial Code  diates or fails to make a payment due before delivery, whether for rent, security or otherwise under the lease contract, or for any other reason the lessor has a right to withhold or take possession of the goods (2) In pursuing its remedies under subsection (1), the lessor may stop delivery until (a) receipt of the goods by the lessee; (b)  acknowledgment to the lessee by any bailee of the goods, except a carrier, that the bailee holds the goods for the lessee; or (c) such an acknowledgment to the lessee by a carrier via reshipment or as warehouseman (3)  (a) To stop delivery, a lessor shall so notify as to enable the bailee by reasonable diligence to prevent delivery of the goods (b) After notification, the bailee shall hold and deliver the goods according to the directions of the lessor, but the lessor is liable to the bailee for any ensuing charges or damages (c) A carrier who has issued a nonnegotiable bill of lading is not obliged to obey a notification to stop received from a person other than the consignor § 2A–527.  Lessor’s Rights to Dispose of Goods (1)  After a default by a lessee under the lease contract of the type described in Section 2A–523(1) or 2A–523(3)(a) or after the lessor refuses to deliver or takes possession of goods (Section 2A–525 or 2A–526), or, if agreed, after other default by a lessee, the lessor may dispose of the goods concerned or the undelivered balance thereof by lease, sale, or otherwise (2) Except as otherwise provided with respect to damages liquidated in the lease agreement (Section 2A–504) or otherwise determined pursuant to agreement of the parties (Sections 1–102(3) and 2A–503), if the disposition is by lease agreement substantially similar to the original lease agreement and the new lease agreement is made in good faith and in a commercially reasonable manner, the lessor may recover from the lessee as damages (i) accrued and unpaid rent as of the date of the commencement of the term of the new lease agreement, (ii) the present value, as of the same date, of the total rent for the then remaining lease term of the original lease agreement minus the pres­ent value, as of the same date, of the rent under the new lease agreement applicable to that period of the new lease term which is comparable to the then remaining term of the original lease agreement, and (iii) any incidental damages allowed under Section 2A–530, less expenses saved in consequence of the lessee’s default (3) If the lessor’s disposition is by lease agreement that for any reason does not qualify for treatment under subsection (2), or is by sale or otherwise, the lessor may recover from the lessee as if the lessor had elected not to dispose of the goods and Section 2A–528 governs (4)  A subsequent buyer or lessee who buys or leases from the lessor in good faith for value as a result of a disposition under this section takes the goods free of the original lease contract and any rights of the original lessee even though the lessor fails to comply with one or more of the requirements of this Article (5)  The lessor is not accountable to the lessee for any profit made on any disposition A lessee who has rightfully rejected or justifiably revoked acceptance shall account to the lessor for any excess over the amount of the lessee’s security interest (Section 2A–508(5)) A–51 As amended in 1990 § 2A–528.  Lessor’s Damages for Non-acceptance, Failure to Pay, Repudiation, or Other Default (1)  Except as otherwise provided with respect to damages liquidated in the lease agreement (Section 2A–504) or otherwise determined pursuant to agreement of the parties (Section 1–102(3) and 2A–503), if a lessor elects to retain the goods or a lessor elects to dispose of the goods and the disposition is by lease agreement that for any reason does not qualify for treatment under Section 2A–527(2), or is by sale or otherwise, the lessor may recover from the lessee as damages for a default of the type described in Section 2A–523(1) or 2A–523(3)(a), or if agreed, for other default of the lessee, (i) accrued and unpaid rent as of the date of the default if the lessee has never taken possession of the goods, or, if the lessee has taken possession of the goods, as of the date the lessor repossesses the goods or an earlier date on which the lessee makes a tender of the goods to the lessor, (ii) the pre­ sent value as of the date determined under clause (i) of the total rent for the then remaining lease term of the original lease agreement minus the present value as of the same date of the market rent as the place where the goods are located computed for the same lease term, and (iii) any incidental damages allowed under Section 2A–530, less expenses saved in consequence of the lessee’s default (2)  If the measure of damages provided in subsection (1) is inadequate to put a lessor in as good a position as performance would have, the measure of damages is the pres­ent value of the profit, including reasonable overhead, the lessor would have made from full performance by the lessee, together with any incidental damages allowed under Section 2A–530, due allowance for costs reasonably incurred and due credit for payments or proceeds of disposition As amended in 1990 § 2A–529.  Lessor’s Action for the Rent (1)  After default by the lessee under the lease contract of the type described in Section 2A–523(1) or 2A–523(3)(a) or, if agreed, after other default by the lessee, if the lessor complies with subsection (2), the lessor may recover from the lessee as damages: (a) for goods accepted by the lessee and not repossessed by or tendered to the lessor, and for conforming goods lost or damaged within a commercially reasonable time after risk of loss passes to the lessee (Section 2A–219), (i) accrued and unpaid rent as of the date of entry of judgment in favor of the lessor (ii) the present value as of the same date of the rent for the then remaining lease term of the lease agreement, and (iii) any incidental damages allowed under Section 2A–530, less expenses saved in consequence of the lessee’s default; and (b)  for goods identified to the lease contract if the lessor is unable after reasonable effort to dispose of them at a reasonable price or the circumstances reasonably indicate that effort will be unavailing, (i) accrued and unpaid rent as of the date of entry of judgment in favor of the lessor, (ii) the present value as of the same date of the rent for the then remaining lease term of the lease agreement, and (iii) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–52  Appendix c  Articles and 2A of the Uniform Commercial Code any incidental damages allowed under Section 2A–530, less expenses saved in consequence of the lessee’s default (2) Except as provided in subsection (3), the lessor shall hold for the lessee for the remaining lease term of the lease agreement any goods that have been identified to the lease contract and are in the lessor’s control (3) The lessor may dispose of the goods at any time before collection of the judgment for damages obtained pursuant to subsection (1) If the disposition is before the end of the remaining lease term of the lease agreement, the lessor’s recovery against the lessee for damages is governed by Section 2A–527 or Section 2A–528, and the lessor will cause an appropriate credit to be provided against a judgment for damages to the extent that the amount of the judgment exceeds the recovery available pursuant to Section 2A–527 or 2A–528 (4) Payment of the judgment for damages obtained pursuant to subsection (1) entitles the lessee to the use and possession of the goods not then disposed of for the remaining lease term of and in accordance with the lease agreement (5)  After default by the lessee under the lease contract of the type described in Section 2A–523(1) or Section 2A–523(3)(a) or, if agreed, after other default by the lessee, a lessor who is held not entitled to rent under this s­ection must nevertheless be awarded damages for non-acceptance under Sections 2A–527 and 2A–528 As amended in 1990 § 2A–530.  Lessor’s Incidental Damages Incidental damages to an aggrieved lessor include any commercially reasonable charges, expenses, or commissions incurred in stopping delivery, in the transportation, care and custody of goods after the lessee’s default, in connection with return or disposition of the goods, or otherwise resulting from the default § 2A–531.  Standing to Sue Third Parties for Injury to Goods (1) If a third party so deals with goods that have been identified to a lease contract as to cause actionable injury to a party to the lease contract (a) the lessor has a right of action against the third party, and (b) the lessee also has a right of action against the third party if the lessee: (i) has a security interest in the goods; (ii) has an insurable interest in the goods; or (iii)  bears the risk of loss under the lease contract or has since the injury assumed that risk as against the lessor and the goods have been converted or destroyed (2) If at the time of the injury the party plaintiff did not bear the risk of loss as against the other party to the lease contract and there is no arrangement between them for disposition of the recovery, his [or her] suit or settlement, subject to his [or her] own interest, is as a fiduciary for the other party to the lease contract (3) Either party with the consent of the other may sue for the benefit of whom it may concern § 2A–532.  Lessor’s Rights to Residual Interest In addition to any other recovery permitted by this Article or other law, the lessor may recover from the lessee an amount that will fully compensate the lessor for any loss of or damage to the lessor’s residual interest in the goods caused by the default of the lessee As added in 1990 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it appendix D Appendix D  The Sarbanes-Oxley Act (Excerpts and Explanatory Comments)  A–53 The Sarbanes-Oxley Act (Excerpts and Explanatory Comments) Note: The author’s explanatory comments appear in italics following the excerpt from each section Section 302 Corporate responsibility for financial reports1 (a) Regulations required The Commission shall, by rule, require, for each company filing periodic reports under section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C 78m, 78o(d)), that the principal executive officer or officers and the principal financial officer or officers, or persons performing similar functions, certify in each annual or quarterly report filed or submitted under either such section of such Act that— (1) the signing officer has reviewed the report; (2) based on the officer’s knowledge, the report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading; (3) based on such officer’s knowledge, the financial statements, and other financial information included in the report, fairly present in all material respects the financial condition and results of operations of the issuer as of, and for, the periods presented in the report; (4) the signing officers— (A) are responsible for establishing and maintaining internal controls; (B) have designed such internal controls to ensure that material information relating to the issuer and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared; (C) have evaluated the effectiveness of the issuer’s internal controls as of a date within 90 days prior to the report; and (D) have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation as of that date; (5) the signing officers have disclosed to the issuer’s auditors and the audit committee of the board of directors (or persons fulfilling the equivalent function)— (A) all significant deficiencies in the design or operation of internal controls which could adversely affect the issuer’s ability to record, process, summarize, and report financial data and have identified for the issuer’s auditors any material weaknesses in internal controls; and This section of the Sarbanes-Oxley Act is codified at 15 U.S.C Section 7241 (B) any fraud, whether or not material, that involves management or other employees who have a significant role in the issuer’s internal controls; and (6) the signing officers have indicated in the report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses (b) Foreign reincorporations have no effect Nothing in this section shall be interpreted or applied in any way to allow any issuer to lessen the legal force of the statement required under this section, by an issuer having reincorporated or having engaged in any other transaction that resulted in the transfer of the corporate domicile or offices of the issuer from inside the United States to outside of the United States (c) Deadline The rules required by subsection (a) of this section shall be effective not later than 30 days after July 30, 2002 * * * * Explanatory Comments: Section 302 requires the chief executive officer (CEO) and chief financial officer (CFO) of each public company to certify that they have reviewed the company’s quarterly and annual reports to be filed with the Securities and Exchange Commission (SEC) The CEO and CFO must certify that, based on their knowledge, the reports not contain any untrue statement of a material fact or any half-truth that would make the report misleading, and that the information contained in the reports fairly presents the company’s financial condition In addition, this section also requires the CEO and CFO to certify that they have created and designed an internal control system for their company and have recently evaluated that system to ensure that it is effectively providing them with relevant and accurate financial information If the signing officers have found any significant deficiencies or weaknesses in the company’s system or have discovered any evidence of fraud, they must have reported the situation, and any corrective actions they have taken, to the auditors and the audit committee Section 306 Insider trades during pension fund blackout periods2 (a) Prohibition of insider trading during pension fund blackout periods (1) In general Except to the extent otherwise provided by rule of the Commission pursuant to paragraph (3), it shall be unlawful for any director or executive officer of an issuer of any Codified at 15 U.S.C Section 7244 A–53 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–54  Appendix D  The Sarbanes-Oxley Act (Excerpts and Explanatory Comments) equity security (other than an exempted security), directly or indirectly, to purchase, sell, or otherwise acquire or transfer any equity security of the issuer (other than an exempted security) during any blackout period with respect to such equity security if such director or officer acquires such equity security in connection with his or her service or employment as a director or executive officer (2) Remedy (A) In general Any profit realized by a director or executive officer referred to in paragraph (1) from any purchase, sale, or other acquisition or transfer in violation of this subsection shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such director or executive officer in entering into the transaction (B) Actions to recover profits An action to recover profits in accordance with this subsection may be instituted at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer if the issuer fails or refuses to bring such action within 60 days after the date of request, or fails diligently to prosecute the action thereafter, except that no such suit shall be brought more than years after the date on which such profit was realized (3) Rulemaking authorized The Commission shall, in consultation with the Secretary of Labor, issue rules to clarify the application of this subsection and to prevent evasion thereof Such rules shall provide for the application of the requirements of paragraph (1) with respect to entities treated as a single employer with respect to an issuer under section 414(b), (c), (m), or (o) of Title 26 to the extent necessary to clarify the application of such requirements and to prevent evasion thereof Such rules may also provide for appropriate exceptions from the requirements of this subsection, including exceptions for purchases pursuant to an automatic dividend reinvestment program or purchases or sales made pursuant to an advance election (4) Blackout period For purposes of this subsection, the term “blackout period”, with respect to the equity securities of any issuer— (A) means any period of more than consecutive business days during which the ability of not fewer than 50 percent of the participants or beneficiaries under all individual account plans maintained by the issuer to purchase, sell, or otherwise acquire or transfer an interest in any equity of such issuer held in such an individual account plan is temporarily suspended by the issuer or by a fiduciary of the plan; and (B) does not include, under regulations which shall be prescribed by the Commission— (i) a regularly scheduled period in which the participants and beneficiaries may not purchase, sell, or otherwise acquire or transfer an interest in any equity of such issuer, if such period is— (I) incorporated into the individual account plan; and (II) timely disclosed to employees before becoming participants under the individual account plan or as a subsequent amendment to the plan; or (ii) any suspension described in subparagraph (A) that is imposed solely in connection with persons becoming participants or beneficiaries, or ceasing to be participants or beneficiaries, in an individual account plan by reason of a corporate merger, acquisition, divestiture, or similar transaction involving the plan or plan sponsor (5) Individual account plan For purposes of this subsection, the term “individual account plan” has the meaning provided in section 1002(34) of Title 29, except that such term shall not include a one-participant retirement plan (within the meaning of section 1021(i)(8)(B) of Title 29) (6) Notice to directors, executive officers, and the Commission In any case in which a director or executive officer is subject to the requirements of this subsection in connection with a blackout period (as defined in paragraph (4)) with respect to any equity securities, the issuer of such equity securities shall timely notify such director or officer and the Securities and Exchange Commission of such blackout period * * * * Explanatory Comments: Corporate pension funds typically prohibit employees from trading shares of the corporation during periods when the pension fund is undergoing significant change Before 2002, however, these blackout periods did not affect the corporation’s executives, who frequently received shares of the corporate stock as part of their compensation Section 306 was Congress’s solution to the basic unfairness of this situation This section of the act required the SEC to issue rules that prohibit any director or executive officer from trading during pension fund blackout periods (The SEC later issued these rules, entitled Regulation Blackout Trading Restriction, or Reg BTR.) Section 306 also provided shareholders with a right to file a shareholder’s derivative suit against officers and directors who have profited from trading during these blackout periods (provided that the corporation has failed to bring a suit) The officer or director can be forced to return to the corporation any profits received, regardless of whether the director or officer acted with bad intent Section 402 Periodical and other reports3 * * * * (i) Accuracy of financial reports Each financial report that contains financial statements, and that is required to be prepared in accordance with (or reconciled to) ­generally accepted accounting principles under this chapter and filed with the Commission shall reflect all material correcting adjustments that have been identified by a registered This section of the Sarbanes-Oxley Act amended some of the provisions of the 1934 Securities Exchange Act and added the paragraphs reproduced here at 15 U.S.C Section 78m Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix D  The Sarbanes-Oxley Act (Excerpts and Explanatory Comments)  public accounting firm in accordance with generally accepted accounting principles and the rules and regulations of the Commission (j) Off-balance sheet transactions Not later than 180 days after July 30, 2002, the Commission shall issue final rules providing that each annual and quarterly financial report required to be filed with the Commission shall disclose all material off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships of the issuer with unconsolidated entities or other persons, that may have a material current or future effect on financial condition, changes in financial condition, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenues or expenses (k) Prohibition on personal loans to executives (1) In general It shall be unlawful for any issuer (as defined in section 7201 of this title), directly or indirectly, including through any subsidiary, to extend or maintain credit, to arrange for the extension of credit, or to renew an extension of credit, in the form of a personal loan to or for any director or executive officer (or equivalent thereof) of that issuer An extension of credit maintained by the issuer on July 30, 2002, shall not be subject to the provisions of this subsection, provided that there is no material modification to any term of any such extension of credit or any renewal of any such extension of credit on or after July 30, 2002 (2) Limitation Paragraph (1) does not preclude any home improvement and manufactured home loans (as that term is defined in section 1464 of Title 12), consumer credit (as defined in section 1602 of this title), or any extension of credit under an open end credit plan (as defined in section 1602 of this title), or a charge card (as defined in section 1637(c)(4)(e) of this title), or any extension of credit by a broker or dealer registered under section 78o of this title to an employee of that broker or dealer to buy, trade, or carry securities, that is permitted under rules or regulations of the Board of Governors of the Federal Reserve System pursuant to section 78g of this title (other than an extension of credit that would be used to purchase the stock of that issuer), that is— (A) made or provided in the ordinary course of the consumer credit business of such issuer; (B) of a type that is generally made available by such issuer to the public; and (C) made by such issuer on market terms, or terms that are no more favorable than those offered by the issuer to the general public for such extensions of credit (3) Rule of construction for certain loans Paragraph (1) does not apply to any loan made or maintained by an insured depository institution (as defined in section 1813 of Title 12), if the loan is subject to the insider lending restrictions of section 375b of Title 12 (l) Real time issuer disclosures Each issuer reporting under subsection (a) of this section or section 78o(d) of this title shall disclose to the public on a rapid and current basis such additional information concerning A–55 material changes in the financial condition or operations of the issuer, in plain English, which may include trend and qualitative information and graphic presentations, as the Commission determines, by rule, is necessary or useful for the protection of investors and in the public interest Explanatory Comments: Before this act, many corporate executives typically received extremely large salaries, significant bonuses, and abundant stock options, even when the companies for which they worked were suffering Executives were also routinely given personal loans from corporate funds, many of which were never paid back The average large company during that period loaned almost $1 million a year to top executives, and some companies loaned hundreds of millions of dollars to their executives every year Section 402 amended the 1934 Securities Exchange Act to prohibit public companies from making personal loans to executive officers and directors There are a few exceptions to this prohibition, such as homeimprovement loans made in the ordinary course of business Note also that while loans are forbidden, outright gifts are not A corporation is free to give gifts to its executives, including cash, provided that these gifts are disclosed on its financial reports The idea is that corporate directors will be deterred from making substantial gifts to their executives by the disclosure requirement—particularly if the corporation’s financial condition is questionable—because making such gifts could be perceived as abusing their authority Section 403 Directors, officers, and principal stockholders4 (a) Disclosures required (1) Directors, officers, and principal stockholders required to file Every person who is directly or indirectly the beneficial owner of more than 10 percent of any class of any equity security (other than an exempted security) which is registered pursuant to section 78l of this title, or who is a director or an officer of the issuer of such security, shall file the statements required by this subsection with the Commission (and, if such security is registered on a national securities exchange, also with the exchange) (2) Time of filing The statements required by this subsection shall be filed— (A) at the time of the registration of such security on a national securities exchange or by the effective date of a registration statement filed pursuant to section 78l(g) of this title; (B) within 10 days after he or she becomes such beneficial owner, director, or officer; (C) if there has been a change in such ownership, or if such person shall have purchased or sold a securitybased swap agreement (as defined in section 206(b) of the Gramm-Leach-Bliley Act (15 U.S.C 78c note)) involving such equity security, before the end of the second business day following the day on which the subject transaction has been executed, or at such other This section of the Sarbanes-Oxley Act amended the disclosure provisions of the 1934 Securities Exchange Act, at 15 U.S.C Section 78p Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–56  Appendix D  The Sarbanes-Oxley Act (Excerpts and Explanatory Comments) time as the Commission shall establish, by rule, in any case in which the Commission determines that such 2-day period is not feasible (3) Contents of statements A statement filed— (A) under subparagraph (A) or (B) of paragraph (2) shall contain a statement of the amount of all equity securities of such issuer of which the filing person is the beneficial owner; and (B) under subparagraph (C) of such paragraph shall indicate ownership by the filing person at the date of filing, any such changes in such ownership, and such purchases and sales of the security-based swap agreements as have occurred since the most recent such filing under such subparagraph (4) Electronic filing and availability Beginning not later than year after July 30, 2002— (A) a statement filed under subparagraph (C) of paragraph (2) shall be filed electronically; (B) the Commission shall provide each such statement on a publicly accessible Internet site not later than the end of the business day following that filing; and (C) the issuer (if the issuer maintains a corporate website) shall provide that statement on that corporate website, not later than the end of the business day following that filing * * * * Explanatory Comments: This section dramatically shortens the time period provided in the Securities Exchange Act of 1934 for disclosing transactions by insiders The prior law stated that most transactions had to be reported within ten days of the beginning of the following month, although certain transactions did not have to be reported until the following fiscal year (within the first forty-five days) In several instances, some insider trading was not disclosed (and was therefore not discovered) until long after the transactions So Congress added this section to reduce the time period for making disclosures Under Section 403, most transactions by insiders must be electronically filed with the SEC within two business days Also, any company that maintains a Web site must post these SEC filings on its site by the end of the next business day Congress enacted this section in the belief that if insiders are required to file reports of their transactions promptly with the SEC, companies will more to police themselves and prevent insider trading Section 404 Management assessment of internal controls5 (a) Rules required The Commission shall prescribe rules requiring each annual report required by section 78m(a) or 78o(d) of this title to contain an internal control report, which shall— (1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and (2) contain an assessment, as of the end of the most recent fiscal year of the issuer, of the effectiveness of the internal Codified at 15 U.S.C Section 7262 control structure and procedures of the issuer for financial reporting (b) Internal control evaluation and reporting With respect to the internal control assessment required by subsection (a) of this section, each registered public accounting firm that prepares or issues the audit report for the issuer shall attest to, and report on, the assessment made by the management of the issuer An attestation made under this subsection shall be made in accordance with standards for attestation engagements issued or adopted by the Board Any such attestation shall not be the subject of a separate engagement * * * * Explanatory Comments: This section was enacted to prevent corporate executives from claiming they were ignorant of significant errors in their companies’ financial reports For instance, several CEOs testified before Congress that they simply had no idea that the corporations’ financial statements were off by billions of dollars Congress therefore passed Section 404, which requires each annual report to contain a description and assessment of the company’s internal control structure and financial reporting procedures The section also requires that an audit be conducted of the internal control assessment, as well as the financial statements contained in the report This section goes hand in hand with Section 302 (which, as discussed previously, requires various certifications attesting to the accuracy of the information in financial reports) Section 404 has been one of the more controversial and expensive provisions in the Sarbanes-Oxley Act because it requires companies to assess their own internal financial controls to make sure that their financial statements are reliable and accurate A corporation might need to set up a disclosure committee and a coordinator, establish codes of conduct for accounting and financial personnel, create documentation procedures, provide training, and outline the individuals who are responsible for performing each of the procedures Companies that were already well managed have not experienced substantial difficulty complying with this section Other companies, however, have spent millions of dollars setting up, documenting, and evaluating their internal financial control systems Although initially creating the internal financial control system is a one-timeonly expense, the costs of maintaining and evaluating it are ongoing Some corporations that spent considerable sums complying with Section 404 have been able to offset these costs by discovering and correcting inefficiencies or frauds within their systems Nevertheless, it is unlikely that any corporation will find compliance with this section to be inexpensive Section 802(a) Destruction, alteration, or falsification of records in Federal investigations and bankruptcy6 Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or Codified at 15 U.S.C Section 1519 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix D  The Sarbanes-Oxley Act (Excerpts and Explanatory Comments)  contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both Destruction of corporate audit records7 (a) (1) Any accountant who conducts an audit of an issuer of securities to which section 10A(a) of the Securities Exchange Act of 1934 (15 U.S.C 78j-1(a)) applies, shall maintain all audit or review workpapers for a period of years from the end of the fiscal period in which the audit or review was concluded (2) The Securities and Exchange Commission shall promulgate, within 180 days, after adequate notice and an opportunity for comment, such rules and regulations, as are reasonably necessary, relating to the retention of relevant records such as workpapers, documents that form the basis of an audit or review, memoranda, correspondence, communications, other documents, and records (including electronic records) which are created, sent, or received in connection with an audit or review and contain conclusions, opinions, analyses, or financial data relating to such an audit or review, which is conducted by any accountant who conducts an audit of an issuer of securities to which section 10A(a) of the Securities Exchange Act of 1934 (15 U.S.C 78j-1(a)) applies The Commission may, from time to time, amend or supplement the rules and regulations that it is required to promulgate under this section, after adequate notice and an opportunity for comment, in order to ensure that such rules and regulations adequately comport with the purposes of this section (b) Whoever knowingly and willfully violates subsection (a)(1), or any rule or regulation promulgated by the Securities and Exchange Commission under subsection (a)(2), shall be fined under this title, imprisoned not more than 10 years, or both (c) Nothing in this section shall be deemed to diminish or relieve any person of any other duty or obligation imposed by Federal or State law or regulation to maintain, or refrain from destroying, any document * * * * Explanatory Comments: Section 802(a) enacted two new statutes that punish those who alter or destroy documents The first statute is not specifically limited to securities fraud cases It provides that anyone who alters, destroys, or falsifies records in federal investigations or bankruptcy may be criminally prosecuted and sentenced to a fine or to up to twenty years in prison, or both The second statute requires auditors of public companies to keep all audit or review working papers for five years but expressly allows the SEC to amend or supplement these requirements as it sees fit The SEC has, in fact, amended this section by issuing a rule that requires auditors who audit reporting companies to retain working papers for seven years from the conclusion of the review Section 802(a) further provides that anyone who knowingly and willfully violates this statute is subject to criminal prosecution and can be sentenced to a fine, imprisoned for up to ten years, or both if convicted This portion of the Sarbanes-Oxley Act implicitly recognizes that persons who are under investigation often are tempted to respond by Codified at 15 U.S.C Section 1520 A–57 destroying or falsifying documents that might prove their complicity in wrongdoing The severity of the punishment should provide a strong incentive for these individuals to resist the temptation Section 804 Time limitations on the commencement of civil actions arising under Acts of Congress8 (a) Except as otherwise provided by law, a civil action arising under an Act of Congress enacted after the date of the enactment of this section may not be commenced later than years after the cause of action accrues (b) Notwithstanding subsection (a), a private right of action that involves a claim of fraud, deceit, manipulation, or contrivance in contravention of a regulatory requirement concerning the securities laws, as defined in section 3(a)(47) of the Securities Exchange Act of 1934 (15 U.S.C 78c(a)(47)), may be brought not later than the earlier of— (1) 2 years after the discovery of the facts constituting the violation; or (2) 5 years after such violation * * * * Explanatory Comments: Before the enactment of this section, Section 10(b) of the Securities Exchange Act of 1934 had no express statute of limitations The courts generally required plaintiffs to have filed suit within one year from the date that they should (using due diligence) have discovered that a fraud had been committed but no later than three years after the fraud occurred Section 804 extends this period by specifying that plaintiffs must file a lawsuit within two years after they discover (or should have discovered) a fraud but no later than five years after the fraud’s occurrence This provision has prevented the courts from dismissing numerous securities fraud lawsuits Section 806 Civil action to protect against retaliation in fraud cases9 (a) Whistleblower protection for employees of publicly traded companies.— No company with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C 78l), or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C 78o(d)), or any officer, employee, contractor, subcontractor, or agent of such company, may discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in the terms and conditions of employment because of any lawful act done by the employee— (1) to provide information, cause information to be provided, or otherwise assist in an investigation regarding any conduct which the employee reasonably believes constitutes a violation of section 1341, 1343, 1344, or 1348, any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud against shareholders, when the information or assistance is provided to or the investigation is conducted by— Codified at 28 U.S.C Section 1658 Codified at 18 U.S.C Section 1514A Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–58  Appendix D  The Sarbanes-Oxley Act (Excerpts and Explanatory Comments) (A) a Federal regulatory or law enforcement agency; (B) any Member of Congress or any committee of Congress; or (C) a person with supervisory authority over the employee (or such other person working for the employer who has the authority to investigate, discover, or terminate misconduct); or (2) to file, cause to be filed, testify, participate in, or otherwise assist in a proceeding filed or about to be filed (with any knowledge of the employer) relating to an alleged violation of section 1341, 1343, 1344, or 1348, any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud against shareholders (b) Enforcement action.— (1) In general.—A person who alleges discharge or other discrimination by any person in violation of subsection (a) may seek relief under subsection (c), by— (A) filing a complaint with the Secretary of Labor; or (B) if the Secretary has not issued a final decision within 180 days of the filing of the complaint and there is no showing that such delay is due to the bad faith of the claimant, bringing an action at law or equity for de novo review in the appropriate district court of the United States, which shall have jurisdiction over such an action without regard to the amount in controversy (2) Procedure.— (A) In general.—An action under paragraph (1)(A) shall be governed under the rules and procedures set forth in section 42121(b) of title 49, United States Code (B) Exception.—Notification made under section 42121(b)(1) of title 49, United States Code, shall be made to the person named in the complaint and to the employer (C) Burdens of proof.—An action brought under paragraph (1)(B) shall be governed by the legal burdens of proof set forth in section 42121(b) of title 49, United States Code (D) Statute of limitations.—An action under paragraph (1) shall be commenced not later than 90 days after the date on which the violation occurs (c) Remedies.— (1) In general.—An employee prevailing in any action under subsection (b)(1) shall be entitled to all relief necessary to make the employee whole (2) Compensatory damages.—Relief for any action under paragraph (1) shall include— (A) reinstatement with the same seniority status that the employee would have had, but for the discrimination; (B) the amount of back pay, with interest; and (C) compensation for any special damages sustained as a result of the discrimination, including litigation costs, expert witness fees, and reasonable attorney fees (d) Rights retained by employee.—Nothing in this section shall be deemed to diminish the rights, privileges, or remedies of any employee under any Federal or State law, or under any collective bargaining agreement Explanatory Comments: Section 806 is one of several provisions that were included in the Sarbanes-Oxley Act to encourage and protect whistleblowers—that is, employees who report their employer’s alleged violations of securities law to the authorities This section applies to employees, agents, and independent contractors who work for publicly traded companies or testify about such a company during an investigation It sets up an administrative procedure at the U.S Department of Labor for individuals who claim that their employer retaliated against them (fired or demoted them, for example) for blowing the whistle on the employer’s wrongful conduct It also allows the award of civil damages—including back pay, reinstatement, special damages, attorneys’ fees, and court costs—to employees who prove that they suffered retaliation Since this provision was enacted, whistleblowers have filed numerous complaints with the U.S Department of Labor under this section Section 807 Securities fraud10 Whoever knowingly executes, or attempts to execute, a scheme or artifice— (1) to defraud any person in connection with any security of an issuer with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C 78l) or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C 78o(d)); or (2) to obtain, by means of false or fraudulent pretenses, representations, or promises, any money or property in connection with the purchase or sale of any security of an issuer with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C 78l) or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C 78o(d)); shall be fined under this title, or imprisoned not more than 25 years, or both * * * * Explanatory Comments: Section 807 adds a new provision to the federal criminal code that addresses securities fraud Before 2002, federal securities law had already made it a crime—under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, both of which were discussed in Chapter 28—to intentionally defraud someone in connection with a purchase or sale of securities, but the offense was not listed in the federal criminal code Also, paragraph of Section 807 goes beyond what is prohibited under securities law by making it a crime to obtain by means of false or fraudulent pretenses any money or property from the purchase or sale of securities This new provision allows violators to be punished by up to twenty-five years in prison, a fine, or both Section 906 Failure of corporate officers to certify financial reports11 (a) Certification of periodic financial reports.—Each periodic report containing financial statements filed by an issuer with the Securities Exchange Commission pursuant to section 13(a) 10 Codified at 18 U.S.C Section 1348 11 Codified at 18 U.S.C Section 1350 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix D  The Sarbanes-Oxley Act (Excerpts and Explanatory Comments)  or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C 78m(a) or 78o(d)) shall be accompanied by a written statement by the chief executive officer and chief financial officer (or equivalent thereof) of the issuer (b) Content.—The statement required under subsection (a) shall certify that the periodic report containing the financial statements fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C 78m or 78o(d)) and that information contained in the periodic report fairly presents, in all material respects, the financial condition and results of operations of the issuer (c) Criminal penalties.—Whoever— (1) certifies any statement as set forth in subsections (a) and (b) of this section knowing that the periodic report accompanying the statement does not comport with all the requirements set forth in this section shall be fined not more than $1,000,000 or imprisoned not more than 10 years, or both; or (2) willfully certifies any statement as set forth in subsections (a) and (b) of this section knowing that the periodic A–59 report accompanying the statement does not comport with all the requirements set forth in this section shall be fined not more than $5,000,000, or imprisoned not more than 20 years, or both Explanatory Comments: As previously discussed, under Section 302 a corporation’s CEO and CFO are required to certify that they believe the quarterly and annual reports their company files with the SEC are accurate and fairly present the company’s financial condition Section 906 adds “teeth” to these requirements by authorizing criminal penalties for those officers who intentionally certify inaccurate SEC filings Knowing violations of the requirements are punishable by a fine of up to $1 million, ten years’ imprisonment, or both Willful violators may be fined up to $5 million, sentenced to up to twenty years’ imprisonment, or both Although the difference between a knowing and a willful violation is not entirely clear, the section is obviously intended to remind corporate officers of the serious consequences of certifying inaccurate reports to the SEC Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it appendix E Answers to the Issue Spotters Chapter 1.  Under what circumstances might a judge rely on case law to determine the intent and purpose of a statute? Case law includes courts’ interpretations of statutes, as well as constitutional provisions and administrative rules Statutes often codify common law rules For these reasons, a judge might rely on the common law as a guide to the intent and purpose of a statute 2.  Assuming that these convicted war criminals had not disobeyed any law of their country and had merely been following their government’s orders, what law had they violated? Explain At the time of the Nuremberg trials, “crimes against humanity” were new international crimes The laws criminalized such acts as murder, extermination, enslavement, deportation, and other inhumane acts committed against any civilian population These international laws derived their legitimacy from “natural law.” Natural law, which is the oldest and one of the most significant schools of jurisprudence, holds that governments and legal systems should reflect the moral and ethical ideals that are inherent in human nature Because natural law is universal and discoverable by reason, its adherents believe that all other law is derived from natural law Natural law therefore supersedes laws created by humans (national, or “positive,” law), and in a conflict between the two, national or positive law loses its legitimacy The defendants asserted that they had been acting in accordance with German law The judges dismissed these claims, reasoning that the defendants’ acts were commonly regarded as crimes and that the accused must have known that the acts would be considered criminal The judges clearly believed the tenets of natural law and expected that the defendants, too, should have been able to realize that their acts ran afoul of it The fact that the “positivist law” of Germany at the time required them to commit these acts is irrelevant Under natural law theory, the international court was justified in finding the defendants guilty of crimes against humanity Chapter 1.  Does the court in Sue’s state have jurisdiction over Tipton? What factors will the court consider? A corporation normally is subject to personal jurisdiction in the state in which it is incorporated, has its principal office, and/or is doing business Under the authority of a state long arm statute, a court can exercise personal jurisdiction over certain out-ofstate defendants based on activities that took place within the state Before a court can exercise jurisdiction, though, it must be demonstrated that the defendant had minimum contacts with the state to justify the jurisdiction The minimum-contacts requirement is usually met if the corporation advertises or sells its products within the state, or places its goods into the “stream of commerce” with the intent that the goods be sold in the state Therefore, a court will consider whether Tipton advertised or sold its product within Sue’s state The court may also look at whether the contract between Sue and Tipton was negotiated or signed within the state 2.  Tom can call his first witness What else might he do? Tom could file a motion for a directed verdict This motion asks the judge to direct a verdict for Tom on the ground that Sue presented no evidence that would justify granting Jan relief The judge grants the motion if there is insufficient evidence to raise an issue of fact Chapter 1.  If a dispute arises, is the arbitration clause enforceable? Why or why not? Maybe not The Federal Arbitration Act (FAA) promotes enforcement of arbitration clauses in contracts involving interstate commerce, which would include contracts with smartphone providers Nevertheless, because this agreement was presented on a take-it-or-leave it basis to a consumer, it is an adhesion contract that might be deemed unconscionable Sue, the consumer, had no opportunity to negotiate the terms of this consumer arbitration agreement Moreover, the smartphone provider’s terms required the consumer (Sue) to pay two-thirds of the costs of arbitration, which seems unfair Therefore, a court may conclude that the contract was unconscionable and refuse to enforce it (and the dispute would be litigated in court) 2.  If the dispute is not resolved, or if either party disagrees with the decision of the mediator or arbitrator, will a court hear the case? Explain Yes Submission of the dispute to mediation or nonbinding arbitration is mandatory, but compliance with a decision of the mediator or arbitrator is voluntary Chapter 1.  Are there ethical concerns about putting traumatized children on the news immediately after an event like this? Why or why not? In determining whether it is ethical to interview these children soon after a tragic event, it is important to analyze the competing interests and reasons behind the interviews The interviews may generate more viewers, which may lead to higher ratings and more advertising revenue for the company and its shareholders Alternatively, the value of the interview to the public or to any investigation may be minimal The children may not have accurate information and may be further traumatized by the interview process A–61 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–62  Appendix E  Answers to the Issue Spotters 2.  Is it ethical for Johnny to take a performanceenhancing drug that has not been banned? Why or why not? Maybe Individuals and businesses often face ethical dilemmas when the letter of the law seems clear but alternatives exist that may violate what is known as the spirit of the law or the purpose for the law In this case, the restrictions exist to stop athletes from performing better than they would naturally because of a foreign substance The list of banned substances may not be able to keep up with the advances in technology and science in developing performance enhancing drugs Some might argue that it is ethical for him to take anything that is not formally banned and that all competitors have the same ability to access and take those substances and therefore any advantage is eliminated Because there seems to be no unfair advantage, the purpose of the restriction is not frustrated There is an implicit assumption, however, that all performers have the connections and the resources to obtain the non-banned substance Because this assumption is not necessarily true, it is more likely an ethical violation to take the non-banned performance enhancing drugs, even if it is not technically against the rules Chapter 1.  Can a state, in the interest of energy conservation, ban all advertising by power utilities if conservation could be accomplished by less restrictive means? Why or why not? No Even if commercial speech is not related to illegal activities nor misleading, it may be restricted if a state has a substantial interest that cannot be achieved by less restrictive means In this case, the interest in energy conservation is substantial, but it could be achieved by less restrictive means That would be the utilities’ defense against the enforcement of this state law 2.  Is this a violation of equal protection if the only reason for the tax is to protect the local firms from outof-state competition? Explain Yes The tax would limit the liberty of some persons (out of state businesses), so it is subject to a review under the equal protection clause Protecting local businesses from out-of-state competition is not a legitimate government objective Thus, such a tax would violate the equal protection clause Chapter 1.  What safeguards promote the ALJ’s fairness? Under the Administrative Procedure Act (APA), the administrative law judge (ALJ) must be separate from the agency’s investigative and prosecutorial staff Ex parte communications between the ALJ and a party to a proceeding are prohibited Under the APA, an ALJ is exempt from agency discipline except on a showing of good cause 2.  Does the firm have any opportunity to express its opinion about the pending rule? Explain Yes Administrative rulemaking starts with the publication of a notice of the rulemaking in the Federal Register A public hear- ing is held at which proponents and opponents can offer evidence and question witnesses After the hearing, the agency considers what was presented at the hearing and drafts the final rule Chapter 1.  With respect to the gas station, has she committed a crime? If so, what is it? Yes With respect to the gas station, she has obtained goods by false pretenses She might also be charged with larceny and forgery, and most states have special statutes covering illegal use of credit cards 2.  Has Ben committed a crime? If so, what is it? Yes The Counterfeit Access Device and Computer Fraud and Abuse Act provides that a person who accesses a computer online, without permission, to obtain classified data—such as consumer credit files in a credit agency’s database—is subject to criminal prosecution The crime has two elements: accessing the computer without permission and taking data It is a felony if done for private financial gain Penalties include fines and imprisonment for up to twenty years The victim of the theft can also bring a civil suit against the criminal to obtain damages and other relief Chapter 1.  Under what circumstances would a U.S court enforce the judgment of the Ecuadoran court? Under the principle of comity, a U.S court would defer and give effect to foreign laws and judicial decrees that are consistent with U.S law and public policy 2.  How can this attempt to undersell U.S businesses be defeated? The practice described in this problem is known as dumping, which is regarded as an unfair international trade practice Dumping is the sale of imported goods at “less than fair value.” Based on the price of those goods in the exporting country, an extra tariff—known as an antidumping duty—can be imposed on the imports Chapter 1.  What standard determines whether these parties have a contract? Under the objective theory of contracts, if a reasonable person would have thought that Joli had accepted Kerin’s offer when she signed and returned the letter, then a contract was made, and Joli is obligated to buy the book This depends, in part, on what was said in the letter and what was said in response For instance, did the letter contain a valid offer, and did the response constitute a valid acceptance? Under any circumstances, the issue is not whether either party subjectively believed that they did, or did not, have a contract 2.  Can Ed recover? Why or why not? No This contract, although not fully executed, is for an illegal purpose and therefore is void A void contract gives rise to no legal obligation on the part of any party A contract that is void is no contract There is nothing to enforce Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix E  Answers to the Issue Spotters  Chapter 10 1.  Is the contract enforceable? Why or why not? No, the contract can be avoided because Simmons and Jenson have made a bilateral mistake The issue is whether the mistake involves the identity of the stone (quartz versus diamond) or the value of the stone ($10 versus $1,000) Because both parties were mistaken as to the true character of the subject matter, the contract can be rescinded by either Had either party known that the stone was some type of gem, then even though its exact nature was unknown (diamond), the mistake would be one of value, not fact, and the contract would not be rescindable 2.  If Haney sues Greg, what would be the measure of recovery? A nonbreaching party is entitled to his or her benefit of the bargain under the contract Here, the innocent party is entitled to be put in the position she would have been in if the contract had been fully performed The measure of the benefit is the cost to complete the work ($500) These are compensatory damages Chapter 11 1.  Is this an acceptance of the offer or a counteroffer? If it is an acceptance, is it a breach of the contract? What if Fav-O-Rite told E-Design it was sending the printer stands as “an accommodation”? A shipment of nonconforming goods constitutes an acceptance of the offer and a breach, unless the seller seasonably notifies the buyer that the nonconforming shipment does not constitute an acceptance and is offered only as an accommodation Thus, since there was no notification here, the shipment was both an acceptance and a breach If, however, Fav-O-Rite had notified E-Design that it was sending the printer stands as an accommodation, the shipment would not constitute an acceptance and Fav-O-Rite would not be in breach 2.  Can Poster Planet sue Brite without waiting until May 1? Why or why not? Yes When anticipatory repudiation occurs, a buyer (or lessee) can resort to any remedy for breach even if the buyer tells the seller (the repudiating party in this problem) that the buyer will wait for the seller’s performance Chapter 12 1.  Can Lou recover from Jana? Why or why not? Probably To recover on the basis of negligence, the injured party as a plaintiff must show that the truck’s owner owed the plaintiff a duty of care, that the owner breached that duty, that the plaintiff was injured, and that the breach caused the injury In this situation, the owner’s actions breached the duty of reasonable care The billboard falling on the plaintiff was the direct cause of the injury, not the plaintiff’s own negligence Thus, liability turns on whether the plaintiff can connect the breach of duty to the injury This involves the test of proximate cause—the question of foreseeability The consequences to the injured party must have been a foreseeable result of the owner’s carelessness A–63 2.  What might the firm successfully claim in defense? The company might defend against this electrician’s claim by asserting that the electrician should have known of the risk and, therefore, the company had no duty to warn According to the problem, the danger is common knowledge in the electrician’s field and should have been apparent to this electrician, given his years of training and experience In other words, the company most likely had no need to warn the electrician of the risk The firm could also raise comparative negligence Both parties’ negligence, if any, could be weighed and the liability distributed proportionately The defendant could also assert assumption of risk, claiming that the electrician voluntarily entered into a dangerous situation, knowing the risk involved Chapter 13 1.  Is Superior Vehicles liable? Explain your answer Yes The manufacturer is liable for the injuries to the user of the product A manufacturer is liable for its failure to exercise due care to any person who sustains an injury proximately caused by a negligently made (defective) product 2.  If Real, Sweet, and Tasty were not negligent, can they be liable for the injury? Why or why not? Yes Under the doctrine of strict liability, persons may be liable for the results of their acts regardless of their intentions or their exercise of reasonable care (that is, regardless of fault) Chapter 14 1.  Has Roslyn violated any of the intellectual property rights discussed in this chapter? Explain Yes, Roslyn has committed theft of trade secrets Lists of suppliers and customers cannot be patented, copyrighted, or trademarked, but the information they contain is protected against appropriation by others as trade secrets And most likely, Roslyn signed a contract, agreeing not to use this information outside her employment by Organic But even without this contract, Organic could have made a convincing case against its ex-employee for a theft of trade secrets 2.  Is this patent infringement? If so, how might Global save the cost of suing World for infringement and at the same time profit from World’s sales? This is patent infringement A software maker in this situation might best protect its product, save litigation costs, and profit from its patent by the use of a license In the context of this problem, a license would grant permission to sell a patented item (A license can be limited to certain purposes and to the licensee only.) Chapter 15 1.  Has Karl done anything wrong? Explain Karl may have committed trademark infringement Search engines compile their results by looking through Web sites’ key-word fields Key words, or meta tags, increase the likelihood that a site will be included in search engine results, even if the words have no connection to the site Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–64  Appendix E  Answers to the Issue Spotters A site that appropriates the key words of other sites with more frequent hits will appear in the same search engine results as the more popular sites But using another’s trademark as a key word without the owner’s permission normally constitutes trademark infringement Of course, some uses of another’s trademark as a meta tag may be permissible if the use is reasonably necessary and does not suggest that the owner authorized or sponsored the use 2.  Can Eagle Corporation stop this use of eagle? If so, what must the company show? Explain Yes This may be an instance of trademark dilution Dilution occurs when a trademark is used, without permission, in a way that diminishes the distinctive quality of the mark Dilution does not require proof that consumers are likely to be confused by the use of the unauthorized mark The products involved not have to be similar Dilution does require, however, that a mark be famous when the dilution occurs situation the firm would be considered a manager-managed LLC The group may include only members, only nonmembers, or members and nonmembers If instead, all members participate in management, the firm would be a member-managed LLC In fact, unless the members agree otherwise, all members are considered to participate in the management of the firm 2.  If Elizabeth is petitioned into involuntary bankruptcy, does that constitute a dissolution of the limited partnership? Bankruptcy of the limited partnership itself causes dissolution, but bankruptcy of one of the limited partners does not dissolve the partnership unless it causes the bankruptcy of the firm Therefore, Elizabeth’s involuntary bankruptcy would not dissolve the firm Chapter 19 1.  What can Larry and Midwest do? Each of the parties can place a mechanic’s lien on the debtor’s property If the debtor does not pay what is owed, the property can be sold to satisfy the debt The only requirements are that the lien be filed within a specific time from the time of the work, depending on the state statute, and notice of the foreclosure and sale must be given to the debtor in advance 1.  Is there a way for Northwest Brands to avoid this double taxation? Explain your answer Yes Small businesses that meet certain requirements can qualify as S corporations, created specifically to permit small businesses to avoid double taxation The six requirements of an S corporation are (1) the firm must be a domestic corporation, (2) the firm must not be a member of an affiliated group of corporations, (3) the firm must have less than a certain number of shareholders, (4) the shareholders must be individuals, estates, or qualified trusts (or corporations in some cases), (5) there can be only one class of stock, and (6) no shareholder can be a nonresident alien 2.  Are these debts dischargeable in bankruptcy? Explain No Besides the claims listed in this problem, the debts that cannot be discharged in bankruptcy include amounts borrowed to pay back taxes, goods obtained by fraud, debts that were not listed in the petition, domestic support obligations, certain cash advances, and others 2.  Yvon, a Wonder shareholder, learns of the purchase and wants to sue the directors on Wonder’s behalf Can she it? Explain Yes A shareholder can bring a derivative suit on behalf of a corporation, if some wrong is done to the corporation Normally, any damages recovered go into the corporate treasury Chapter 17 Chapter 20 1.  When Darnell dies, his widow claims that as Darnell’s heir, she is entitled to take his place as Eliana’s partner or to receive a share of the firm’s assets Is she right? Why or why not? No A widow (or widower) has no right to take a dead partner’s place A partner’s death causes dissociation after which the partnership must purchase the dissociated partner’s partnership interest Therefore, the surviving partners must pay the decedent’s estate (for his widow) the value of the deceased partner’s interest in the partnership 1.  When Nadine learns the difference between the price that Dimka is willing to pay and the price at which the owner is willing to sell, she wants to buy the land and sell it to Dimka herself Can she this? Discuss No Nadine, as an agent, is prohibited from taking advantage of the agency relationship to obtain property that the principal (Dimka Corporation) wants to purchase This is the duty of loyalty that arises with every agency relationship Chapter 16 2.  Does this constitute “cause” for termination? Why or why not? Yes Failing to meet a specified sales quota can constitute a breach of a franchise agreement If the franchisor is acting in good faith, “cause” may also include the death or disability of the franchisee, the insolvency of the franchisee, and a breach of another term of the franchise agreement Chapter 18 1.  What are their options with respect to the management of their firm? The members of a limited liability company (LLC) may designate a group to run their firm, in which 2.  Can Davis hold Estee liable for whatever damages he has to pay? Why or why not? Yes A principal has a duty to indemnify an agent for liabilities incurred because of authorized and lawful acts and transactions and for losses suffered because of the principal’s failure to perform his or her duties Chapter 21 1.  Can AMC be held liable for breach of contract? If so, why? If not, why not? Yes Some courts have held that an implied employment contract exists between employer and employee when an employee handbook states that employees Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix E  Answers to the Issue Spotters  will be dismissed only for good cause An employer who fires a worker contrary to this promise can be held liable for breach of contract 2.  For Erin to obtain workers’ compensation, does her injury have to have been caused by Fine Print’s negligence? Does it matter whether the action causing the injury was intentional? Explain Workers’ compensation laws establish a procedure for compensating workers who are injured on the job Instead of suing to collect benefits, an injured worker notifies the employer of an injury and files a claim with the appropriate state agency The right to recover is normally determined without regard to negligence or fault, but intentionally inflicted injuries are not covered Unlike the potential for recovery in a lawsuit based on negligence or fault, recovery under a workers’ compensation statute is limited to the specific amount designated in the statute for the employee’s injury A–65 law, which makes it illegal to require union membership for continued employment Chapter 24 1.  To market the drug, what must United prove to the Food and Drug Administration? Under an extensive set of procedures established by the U.S Food and Drug Administration, which administers the federal Food, Drug, and Cosmetic Act, drugs must be shown to be effective as well as safe before they may be marketed to the public In general, manufacturers are responsible for ensuring that the drugs they offer for sale are free of any substances that could injure consumers 2.  What can Gert do? Under the Truth-in-Lending Act, a buyer who wishes to withhold payment for a faulty product purchased with a credit card must follow specific procedures to settle the dispute The credit card issuer then must intervene and attempt to settle the dispute Chapter 22 Chapter 25 1.  Is this sexual harassment? Why or why not? Yes One type of sexual harassment occurs when a request for sexual favors is a condition of employment, and the person making the request is a supervisor or acts with the authority of the employer A tangible employment action, such as continued employment, may also lead to the employer’s liability for the supervisor’s conduct That the injured employee is a male and the supervisor a female, instead of the other way around, would not affect the outcome Same-gender harassment is also actionable 1.  Are there any reasons that the court might refuse to issue an injunction against Resource’s operation? Explain Yes On the ground that the hardships that would be imposed on the polluter and on the community are greater than the hardships suffered by the residents, the court might deny an injunction If the plant is the core of the local economy, for instance, the residents may be awarded only damages 2.  Could Koko succeed in a suit against Lively for discrimination? Explain Yes, if she can show that she was not hired solely because of her disability The other elements for a discrimination suit based on a disability are that the plaintiff (1) has a disability and (2) is otherwise qualified for the job Both of these elements appear to be satisfied in this problem Chapter 23 1.  What must Gara under the Immigration Act to hire foreign employees for Skytech? To hire a foreign individual to work in the U.S., an employer must submit a petition to U.S Citizenship and Immigration Services, which determines whether the job candidate meets the legal standards Each visa is for a specific job In this situation, because Gara is looking for persons with specialized skills, he needs to show the individual qualifies for an H-1B visa To qualify, the person must have highly specialized knowledge and a bachelor’s degree or higher Because only sixty-five thousand H-1B visas are set aside each year for immigrants, Gara must be prepared and file the application within the first few weeks of the year 2.  Are these conditions legal? Why or why not? No A closed shop (a company that requires union membership as a condition of employment) is illegal A union shop (a company that does not require union membership as a condition of employment but requires workers to join the union after a certain time on the job) is illegal in a state with a right-to-work 2.  If the Environmental Protection Agency cleans up the site, from whom can it recover the cost? The Comprehensive Environmental Response, Compensation, and Liability Act of 1980 regulates the clean-up of hazardous waste disposal sites Any potentially responsible party can be charged with the entire cost of cleaning up a site Potentially responsible parties include the person that generated the waste (ChemCorp) the person that transported the waste to the site (Disposal), the person that owned or operated the site at the time of the disposal (Eliminators), and the current owner or operator of the site (Fluid) A party held responsible for the entire cost may be able to recoup some of it in a lawsuit against other potentially responsible parties Chapter 26 1.  Delmira wants to have Consuela evicted from the property What can Consuela do? This is a breach of the warranty deed’s covenant of quiet enjoyment The buyer can sue the seller and recover the purchase price of the house, plus any damages 2.  Can Haven transfer possession for even less time to Idyll Company? Explain Yes An owner of a fee simple has the most rights possible—he or she can give the property away, sell it, transfer it by will, use it for almost any purpose, possess it to the exclusion of all the world, or as in this case, transfer possession for any period of time The party to whom possession is transferred can also transfer his or her interest (usually only with the owner’s permission) for any lesser period of time Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–66  Appendix E  Answers to the Issue Spotters Chapter 27 1.  If Pop’s is a monopolist, is it in violation of Section of the Sherman Act? Why or why not? Size alone does not determine whether a firm is a monopoly—size in relation to the market is what matters A small store in a small, isolated town is a monopolist if it is the only store serving that market Monopoly involves the power to affect prices and output If a firm has sufficient market power to control prices and exclude competition, that firm has monopoly power Monopoly power in itself is not a violation of Section of the Sherman Act The offense also requires that the defendant intended to acquire or maintain that power through anticompetitive means 2.  What factors would a court consider to decide whether this arrangement violates the Clayton Act? This agreement is a tying arrangement The legality of a tying arrangement depends the purpose of the agreement, the agreement’s likely effect on competition in the relevant markets (the market for the tying product and the market for the tied product), and other factors Tying arrangements for commodi- ties are subject to Section of the Clayton Act Tying arrangements for services can be agreements in restraint of trade in violation of Section of the Sherman Act Chapter 28 1.  What sort of information would an investor consider material? The average investor is not concerned with minor inaccuracies but with facts that if disclosed would tend to deter him or her from buying the securities This would include facts that have an important bearing on the condition of the issuer and its business—liabilities, loans to officers and directors, customer delinquencies, and pending lawsuits 2.  Can Lee take advantage of this information to buy and sell Magma stock? Why or why not? No The Securities Exchange Act of 1934 extends liability to officers and directors in their personal transactions for taking advantage of inside information when they know it is unavailable to the persons with whom they are dealing Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it appendix F Sample Answers for Business Case Problems with Sample Answer Problem 1–6.  Reading Citations.  The court’s opinion in this case—United States v Yi, 704 F.3d 800 (9th Cir 2013)—can be found in volume 704 of West’s Federal Reporter, Third Series, on page 800 The United States Court of Appeals for the Ninth Circuit issued this opinion in 2013 Problem 2–8.  Discovery.  Yes, the items that were deleted from a Facebook page can be recovered Normally, a party must hire an expert to recover material in an electronic format, and this can be time consuming and expensive Electronic evidence, or e-evidence, consists of all computergenerated or electronically recorded information, such as posts on Facebook and other social media sites The effect that e-evidence can have in a case depends on its relevance and what it reveals In the facts presented in this problem, Isaiah should be sanctioned—he should be required to cover Allied’s cost of hiring the recovery expert and attorneys’ fees for confronting the misconduct In a jury trial, the court might also instruct the jury to presume that any missing items are harmful to Isaiah’s case If all of the material is retrieved and presented at the trial, any prejudice to Allied’s case might thereby be mitigated If not, the court might go so far as to order a new trial In the actual case on which this problem is based, Allied hired an expert, who determined that Isaiah had in fact removed some photos and other items from his Facebook page After the expert testified about the missing material, Isaiah provided Allied with all of it, including the photos that he had deleted Allied requested a retrial, but the court instead reduced the amount of damages awarded to Isaiah by the amount that it cost Allied to address his “misconduct.” Problem 3–4.  Arbitration Clause.  Based on a recent holding by the Washington state supreme court, the federal appeals court held that the arbitration provision was unconscionable and therefore invalid Because it was invalid, the restriction on class-action suits was also invalid The state court held that placing class-action restrictions in arbitration agreements with consumers improperly stripped consumers of rights they would normally have to attack certain industry practices Class-action suits are often brought in cases alleging deceptive or unfair industry practices when the losses suffered by the individual consumer are too small to warrant the consumer bringing suit In other words, the supposed added cell phone fees were so small that no individual consumer would be likely to litigate or arbitrate the matter due to the expenses involved Therefore, the clause in the arbitration agreement preventing consumers from joining together in a class-action suit violates public policy and is void and unenforceable Problem 4–5. Online Privacy. Facebook created a program that makes decisions for users Many believe that privacy is an extremely important right that should be fiercely protected Thus, using duty-based ethics, any program that has a default setting of giving out information is unethical Facebook should create the program as an opt-in program In addition, under the Kantian categorical imperative, if every company used opt-out programs that allowed the disclosure of potentially personal information, privacy might become merely theoretical If privacy were reduced or eliminated, the world might not be a better place From a utilitarian or outcome-based approach, an opt-out program might offer the benefits of being easy to created and start, as well as making it easy to recruit partner programs On the negative side, the program would eliminate users’ ability to chose whether to disclose information about themselves An opt-in program would maintain that user control but might entail higher startup costs because it would require more marketing to users up front to persuade them to opt in Problem 5–6.  Establishment Clause.  The establishment clause prohibits the government from passing laws or taking actions that promote religion or show a preference for one religion over another In assessing a government action, the courts look at the predominant purpose of the action and ask whether the action has the effect of endorsing religion Although here DeWeese claimed to have a nonreligious purpose for displaying the poster of the Ten Commandments in a courtroom, his own statements showed a religious purpose These statements reflected his views about “warring” legal philosophies and his belief that “our legal system is based on moral absolutes from divine law handed down by God through the Ten Commandments.” This plainly constitutes a religious purpose that violates the establishment clause because it has the effect of endorsing Judaism or Christianity over other religions In the case on which this problem is based, the court ruled in favor of the American Civil Liberties Union Problem 6–5. Agency Powers. The United States Supreme Court held that greenhouse gases fit within the Clean Air Act’s (CAA’s) definition of “air pollutant.” Thus, the Environmental Protection Agency (EPA) has the authority under that statute to regulate the emission of such gases from new motor vehicles According to the Court, the definition, which includes “any” air pollutant, embraces all airborne compounds “of whatever stripe.” The EPA’s focus on Congress’s 1990 amendments (or their lack) does not indicate the original intent behind the statute (and its amendments before 1990) Nothing in the statute A–67 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–68  Appendix F  Sample Answers for Business Case Problems with Sample Answer suggests that Congress meant to curtail the agency’s power to treat greenhouse gases as air pollutants In other words, the agency has a preexisting mandate to regulate “any air pollutant” that may endanger the public welfare The EPA also argued that, even if it had the authority to regulate greenhouse gases, the agency would not exercise that authority because any regulation would conflict with other administration priorities The Court acknowledged that the CAA conditions EPA action on the agency’s formation of a “judgment,” but explained that judgment must relate to whether a pollutant “cause[s], or contribute[s] to, air pollution which may reasonably be anticipated to endanger public health or welfare.” Thus, the EPA can avoid issuing regulations only if the agency determines that greenhouse gases not contribute to climate change (or if the agency reasonably explains why it cannot or will not determine whether they do) The EPA’s refusal to regulate was thus “arbitrary, capricious, or otherwise not in accordance with law.” The Court remanded the case for the EPA to “ground its reasons for action or inaction in the statute.” Problem 7–8. Criminal Liability. Yes, Green exhibited the required mental state to establish criminal liability A wrongful mental state (mens rea) is one of the elements typically required to establish criminal liability The required mental state, or intent, is indicated in an applicable statute or law For example, for murder, the required mental state is the intent to take another’s life A court can also find that the required mental state is present when a defendant’s acts are reckless or criminally negligent A defendant is criminally reckless if he or she consciously disregards a substantial and unjustifiable risk In this problem, Green was clearly aware of the danger to which he was exposing people on the street below, but he did not indicate that he specifically intended to harm anyone The risk of death created by his conduct, however, was obvious He must have known what was likely to happen if a bottle or plate thrown from the height of twenty-six stories hit a pedestrian or the windshield of an occupied motor vehicle on the street below Despite his claim that he was intoxicated, he was sufficiently aware to stop throwing things from the balcony when he saw police in the area, and he later recalled what he had done and what had happened In the actual case on which this problem is based, after a jury trial, Green was convicted of reckless endangerment On appeal, a state intermediate appellate court affirmed the conviction, based in part on the reasoning stated above Problem 8–6.  Sovereign Immunity.  The doctrine of sovereign immunity exempts foreign nations from the jurisdiction of U.S courts, subject to certain conditions The Foreign Sovereign Immunities Act (FSIA) of 1976 codifies this doctrine and exclusively governs the circumstances in which an action may be brought in a U.S court against a foreign nation A foreign state is not immune from the jurisdiction of U.S courts when the state (a) waives immunity, (b) engages in commercial activity, or (c) commits a tort in the United States or violates certain international laws Under the FSIA, a for- eign state includes its political subdivisions and “instrumentalities”—departments and agencies A commercial activity is a regular course of commercial conduct, transaction, or act that is carried out by the foreign state within the United States or has a direct effect in the United States The details of what constitutes a commercial activity are left to the courts But it seems clear that a foreign government can be considered to engage in commercial activity when, instead of regulating a market, the government participates in it In other words, when a foreign state, or its political subdivisions or instrumentalities, performs the type of actions in which a private party engages in commerce, the state’s actions are likewise commercial In the facts of this problem, Iran engaged in commercial activity outside the United States by making and marketing its counterfeit versions of Bell’s Model 206 Series helicopters This activity caused a direct effect in the United States by the consumer confusion that will likely result from Iran’s unauthorized use of Bell’s trade dress Thus, the court can exercise jurisdiction in these circumstances, and Iran may be as liable as a private party would be for the same acts In the actual case on which this problem is based, Iran did not respond to Bell’s complaint The court held that it had jurisdiction under the FSIA’s commercial activity exception, as explained above The court entered a default judgment against Iran and awarded damages and an injunction to Bell Problem 9–4.  Offer and Acceptance.  No, a contract was not formed in this case As the Iowa Supreme Court pointed out, the parties must voluntarily agree to enter into a contract Courts determine whether an offer has been made objectively—not subjectively Under the Restatement of Contracts (Second), “the test for an offer is whether it induces a reasonable belief in the recipient that [the recipient] can, by accepting, bind the sender.” The offeror may decide to whom to extend the offer According to the Restatement, an offer may create a power of acceptance in a specified person or in one or more of a specified group or class of persons, acting separately or together The court hearing this case explained: “In this situation, Prairie Meadows is the offeror It makes an offer to its patrons that, if accepted by wagering an amount and the patron wins, it will pay off the wager Simply stated, the issue is whether Prairie Meadows made an offer to Blackford Because Prairie Meadows has the ability to determine the class of individuals to whom the offer is made, it may also exclude certain individuals Blackford had been banned for life from the casino Under an objective test, unless the ban had been lifted, Blackford could not have reasonably believed he was among the class of individuals invited to accept Prairie Meadows’s offer.” In the actual case on which this problem is based, the jury found that the ban against Blackford had not been lifted and, therefore, Prairie Meadows had not extended him an offer to wager Because there was no offer to him, no contract could result The state supreme court therefore reversed the decision of the state appellate court and affirmed the trial court’s judgment Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix F  Sample Answers for Business Case Problems with Sample Answer  Problem 10–5.  Consequential Damages.  Simard is liable only for the losses and expenses related to the first resale Simard could reasonably anticipate that his breach would require another sale and that the sales price might be less than what he agreed to pay Therefore, he should be liable for the difference between his sales price and the first resale price ($29,000), plus any expenses arising from the first resale Simard is not liable, however, for any expenses and losses related to the second resale After all, Simard did not cause the second purchaser’s default, and he could not reasonably foresee that default as a probable result of his breach Problem 11–5.  Nonconforming Goods.  Padma Paper Mills notified Universal Exports about its breach, so Padma has two ways to recover even though it accepted the goods Padma’s first option is to argue that it revoked its acceptance, giving it the right to reject the goods To revoke acceptance, Padma would have to show that (a) the nonconformity substantially impaired the value of the shipment, (b) it predicated its acceptance on a reasonable assumption that Universal Exports would cure the nonconformity, and (c) Universal Exports did not cure the nonconformity within a reasonable time Padma’s second option is to keep the goods and recover for the damages caused by Universal Exports’ breach Under this option, Padma could recover at least the difference between the value of the goods as promised and their value as accepted Problem 12–8. Negligence.  Negligence requires proof that (a) the defendant owed a duty of care to the plaintiff, (b) the defendant breached that duty, (c) the defendant’s breach caused the plaintiff’s injury, and (d) the plaintiff suffered a legally recognizable injury With respect to the duty of care, a business owner has a duty to use reasonable care to protect business invitees This duty includes an obligation to discover and correct or warn of unreasonably dangerous conditions that the owner of the premises should reasonably foresee might endanger an invitee Some risks are so obvious that an owner need not warn of them But even if a risk is obvious, a business owner may not be excused from the duty to protect its customers from foreseeable harm Because Lucario was the Weatherford’s business invitee, the hotel owed her a duty of reasonable care to make its premises safe for her use The balcony ran nearly the entire width of the window in Lucario’s room She could have reasonably believed that the window was a means of access to the balcony The window/balcony configuration was dangerous, however, because the window opened wide enough for an adult to climb out, but the twelve-inch gap between one side of the window and the balcony was unprotected This unprotected gap opened to a drop of more than three stories to a concrete surface below Should the hotel have anticipated the potential harm to a guest opening the window in Room 59 and attempting to access the balcony? The hotel encouraged guests to “step out onto the balcony” to smoke The dangerous window/balcony configuration could have been remedied at a minimal cost These circumstances could be perceived as creating an “unreasonably dangerous” condition And it could be concluded that the hotel A–69 created or knew of the condition and failed to take reasonable steps to warn of it or correct it Of course, the Weatherford might argue that the window/balcony configuration was so obvious that the hotel was not liable for Lucario’s fall In the actual case on which this problem is based, the court concluded that the Weatherford did not breach its duty of care to Lucario On McMurtry’s appeal, a state intermediate appellate court held that this conclusion was in error, vacated the lower court’s judgment in favor of the hotel on this issue, and remanded the case Problem 13–8.  Product Liability.  Here, the accident was caused by Jett’s inattention, not by the texting device in the cab of his truck In a product liability case based on a design defect, the plaintiff has to prove that the product was defective at the time it left the hands of the seller or lessor The plaintiff must also show that this defective condition made the product “unreasonably dangerous” to the user or consumer If the product was delivered in a safe condition and subsequent mishandling made it harmful to the user, the seller or lessor normally is not liable To successfully assert a design defect, a plaintiff has to show that a reasonable alternative design was available and that the defendant failed to use it The plaintiffs could contend that the defendant manufacturer of the texting device owed them a duty of care because injuries to vehicle drivers and passengers, and others on the roads, were reasonably foreseeable due to the product’s design that (a) required the driver to divert his eyes from the road to view an incoming text from the dispatcher and (b) permitted the receipt of texts while the vehicle was moving But manufacturers are not required to design a product incapable of distracting a driver The duty owed by a manufacturer to the user or consumer of a product does not require guarding against hazards that are commonly known or obvious or protecting against injuries that result from a user’s careless conduct That is what happened here In the actual case on which this problem is based, the court reached the same conclusion, based on the reasoning stated above, and an intermediate appellate court affirmed the judgment Problem 14–5.  Trade Secrets.  Some business information that cannot be protected by trademark, patent, or copyright law is protected against appropriation by competitors as trade secrets Trade secrets consist of anything that makes a company unique and that would have value to a competitor—customer lists, plans, research and development, pricing information, marketing techniques, and production techniques, for example Theft of trade secrets is a federal crime In this problem, the documents in the boxes in the car could constitute trade secrets But a number of factors suggest that a finding of theft and imposition of liability would not be appropriate The boxes were not marked in any way that would indicate they contained confidential information The boxes were stored in an employee’s car The alleged thief was the employee’s spouse, not a CPR competitor, and she apparently had no idea what was in the boxes Leaving trade secrets so accessible does not show an effort to protect the information Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–70  Appendix F  Sample Answers for Business Case Problems with Sample Answer In the case on which this problem is based, the court dismissed Jones’s claim, in part on the reasoning stated above Problem 15–6.  Privacy.  No, Rolfe did not have a privacy interest in the information obtained by the subpoenas issued to Midcontinent Communications The courts have held that the right to privacy is guaranteed by the U.S Constitution’s Bill of Rights, and some state constitutions contain an explicit guarantee of the right A person must have a reasonable expectation of privacy, though, to maintain a suit or to assert a successful defense for an invasion of privacy People clearly have a reasonable expectation of privacy when they enter their personal banking or credit-card information online They also have a reasonable expectation that online companies will follow their own privacy policies But people not a reasonable expectation of privacy in statements made on Twitter and other data that they publicly disseminate In other words, there is no violation of a subscriber’s right to privacy when a third party Internet service provider receives a subpoena and discloses the subscriber’s information Here, Rolfe supplied his e-mail address and other personal information, including his Internet protocol address, to Midcontinent In other words, Rolfe publicly disseminated this information Law enforcement officers obtained this information from Midcontinent through the subpoenas issued by the South Dakota state court Rolfe provided his information to Midcontinent—he has no legitimate expectation of privacy in that information In the actual case on which this problem is based, Rolfe was charged with, and convicted of, possessing, manufacturing, and distributing child pornography, as well as other crimes As part of the proceedings, the court found that Rolfe had no expectation of privacy in the information that he made available to Midcontinent On appeal, the South Dakota Supreme Court upheld the conviction Problem 16–6. Automatic Stay. Gholston can recover damages because EZ Auto willfully violated the automatic stay EZ Auto repossessed the car even though it received notice of the automatic stay from the bankruptcy court Moreover, EZ Auto retained the car even after it was reminded of the stay by Gholston’s attorney Thus, EZ Auto knew about the automatic stay and violated it intentionally Because Gholston suffered direct damages as a result, she can recover from EZ Auto Problem 17–6.  Partnership Formation.  Garcia and Lucero probably satisfied all three requirements for forming a partnership They owned the two properties equally, agreed to share both profits and losses, and enjoyed equal management rights Moreover, it is immaterial that they lacked a written partnership agreement The writing requirement (Statute of Frauds) does not apply to these facts, and a partnership agreement can be oral or implied by the parties’ conduct Problem 18–5. LLC Operation. No One Bluewater member could not unilaterally “fire” another member without providing a reason Part of the attractiveness of the limited liability company (LLC) as a form of business enterprise is its flexibility The members can decide how to operate the business through an operating agreement For example, the agreement can set forth procedures for choosing or removing members or managers Here, the Bluewater operating agreement provided for a “super majority” vote to remove a member under circumstances that would jeopardize the firm’s contractor status Thus, one Bluewater member could not unilaterally “fire” another member without providing a reason In fact, a majority of the members could not terminate the other’s interest in the firm without providing a reason Moreover, the only acceptable reason would be a circumstance that undercut the firm’s status as a contractor The flexibility of the LLC business form relates to its framework, not to its members’ capacity to violate its operating agreement In the actual case on which this problem is based, Smith attempted to “fire” Williford without providing a reason In Williford’s suit, the court issued a judgment in his favor Problem 19–6.  Rights of Shareholders.  Yes Woods has a right to inspect Biolustré’s books and records Every shareholder is entitled to examine corporate records A shareholder can inspect the books in person or through an agent such as an attorney, accountant, or other authorized assistant The right of inspection is limited to the inspection and copying of corporate books and records for a proper purpose This is because the power of inspection is fraught with potential for abuse—for example, it can involve the disclosure of trade secrets and other confidential information Thus, a corporation is allowed to protect itself Here, Woods, through Hair Ventures, has the right to inspect Biolustré’s books and records She has a proper purpose for the inspection—to obtain information about Biolustré’s financial situation She, and other shareholders, had not received notice of shareholders’ meetings or corporate financial reports for years, or notice of Biolustré’s plan to issue additional stock Hair Ventures had a substantial investment in the company In the actual case on which this problem is based, the court ordered Biolustré to produce its books and records for Hair Ventures’ inspection Problem 20–6.  Liability for Contracts.  Hall may be held personally liable Hall could not be an agent for House Medic because it was a fictitious name and not a real entity Moreover, when the contract was formed, Hall did not disclose his true principal, which was Hall Hauling, Ltd Thus, Hall may be held personally liable as a party to the contract Problem 21–5.  Workers’ Compensation.  Fairbanks’s claim qualifies for workers’ compensation benefits To recover benefits under state workers’ compensation laws, the requirements are that the injury (a) was accidental and (b) occurred on the job or in the course of employment Fault is not an issue The employee must file a claim with the appropriate state agency or board that administers local workers’ compensation claims In this problem, Fairbanks’s claim for workers’ compensation benefits appears to have been timely filed with the appropriate state agency The focus of the dispute is on the second requirement listed above—an accidental injury that occurred on the job or in the course of employment Dynea required its employees to wear certain boots as a safety measure One of the Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Appendix F  Sample Answers for Business Case Problems with Sample Answer  boots caused a sore on Fairbanks’s leg The sore developed into a pustule and broke into a lesion Within a week, Fairbanks was hospitalized with an MRSA infection Dynea argued that the bacteria were on Fairbanks’s skin before he came to work Even if this were true, however, it was the rubbing of the boot that caused the sore through which the bacteria entered his body This fact fulfills the second requirement for the recovery of workers’ compensation benefits In the actual case on which this problem is based, the court issued a decision in favor of Fairbanks’s claim for benefits Problem 22–5. Retaliation by Employers. Yes Dawson could establish a claim for retaliation Title VII prohibits retaliation In a retaliation claim, an individual asserts that she or he suffered harm as a result of making a charge, testifying, or participating in a Title VII investigation or proceeding To prove retaliation, a plaintiff must show that the challenged action was one that would likely have dissuaded a reasonable worker from making or supporting a charge of discrimination In this problem, under applicable state law, it was unlawful for an employer to discriminate against an individual based on sexual orientation Dawson was subjected to derision on the part of co-workers, including his supervisor, based on his sexual orientation He filed a complaint with his employer’s human resources department Two days later, he was fired The proximity in time and the other circumstances, especially the supervisor’s conduct, would support a retaliation claim Also, the discharge would likely have dissuaded Dawson, or any reasonable worker, from making a claim of discrimination In the actual case on which this problem is based, the court held that Dawson offered enough evidence that “a reasonable trier of fact could find in favor of Dawson on his retaliation claim.” PROBLEM 23–5. Unfair Labor Practices. Yes The NLRB has consistently been suspicious of companies that grant added benefits during election campaigns These benefits will be considered as an unfair labor practice that biases elections, unless the employer can demonstrate that the benefits were unrelated to the unionization Therefore, the union’s conduct of persuading the employer to fire Stone for resisting paying union dues is an unfair labor practice Problem 24–7. Fair Debt-Collection Practices. Engler may recover under the Fair Debt Collection Practices Act (FDCPA) Atlantic is subject to the FDCPA because it is a debt-collection agency, and it was attempting to collect a debt on behalf of Bank of America Atlantic also used offensive tactics to collect from Engler After all, Atlantic gave Engler’s employer the false impression that Engler was a criminal, had a pending case, and was about to be arrested Finally, Engler suffered harm because he experienced discomfort, embarrassment, and distress as a result of Atlantic’s abusive conduct Engler may recover actual damages, statutory damages, and attorneys’ fees from Atlantic Problem 25–5. Environmental Impact Statement. When an agency acts in an arbitrary and capricious manner, then the court has grounds for intervention Otherwise, the court defers to the expertise of the agency, as revealed in the record A–71 Here, the environmental impact statement (EIS) was comprehensive, and the National Park Service (NPS) had credible reason to believe that the use of rafts on the river did not damage the wilderness status of portions of the park Since the NPS acted within its statutory guidelines and followed proper procedure in its decision making, the court would not intervene in the agency’s decision The appellate court found that the plaintiffs had failed to establish that the NPS acted in an arbitrary and capricious manner when it adopted the plan Problem 26–7.  Adverse Possession.  The McKeags satisfied the first three requirements for adverse possession: (a) Their possession was actual and exclusive because they used the beach and prevented others from doing so, including the Finleys, (b) Their possession was open, visible, and notorious because they made improvements to the beach and regularly kept their belongings there (c) Their possession was continuous and peaceable for the required ten years They possessed the property for more than four decades, and they even kept a large float there during the winter months Nevertheless, the McKeags’ possession was not hostile and adverse, which is the fourth requirement The Finleys had substantial evidence that they gave the McKeags permission to use the beach Rather than reject the Finleys’ permission as unnecessary, the McKeags sometimes said nothing and other times seemingly affirmed that the property belonged to the Finleys Thus, because the McKeags did not satisfy all four requirements, they cannot establish adverse possession Problem 27–6. Price Discrimination. Spa Steel satisfies most of the requirements for a price discrimination claim under Section of the Clayton Act Dayton Superior is engaged in interstate commerce, and it sells goods of like grade and quality to at least three purchasers Moreover, Spa Steel can show that, because it sells Dayton Superior’s products at a higher price, it lost business and thus suffered an injury To recover, however, Spa Steel will also need to prove that Dayton Superior charged Spa Steel’s competitors a lower price for the same product Spa Steel cannot recover if its prices were higher for reasons related to its own business, such as having a higher overhead or seeking a larger profit Problem 28–6.  Violations of the 1934 Act.  An omission or misrepresentation of a material fact in connection with the purchase or sale of a security may violate Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 The key question is whether the omitted or misrepresented information is material A fact, by itself, is not automatically material A fact will be regarded as material only if it is significant enough that it would likely affect an investor’s decision as to whether to buy or sell the company’s securities For example, a company’s potential liability in a product liability suit and the financial consequences to the firm are material facts that must be disclosed because they affect an investor’s decision to buy stock in the company Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it A–72  Appendix F  Sample Answers for Business Case Problems with Sample Answer In this case, the plaintiffs’ claim should not be dismissed To prevail on their claim that the defendants made material omissions in violation of Section 10(b) and SEC Rule 10-5, the plaintiffs must prove that the omission was material Their complaint alleged the omission of information linking Zicam and anosmia (loss of the sense of smell) and plausibly suggested that reasonable investors would have viewed this information as material Zicam products account for 70 percent of Matrixx’s sales Matrixx received reports of consumers who suffered anosmia after using Zicam Cold Remedy In public statements discussing revenues and product safety, Matrixx did not disclose this information But the infor- mation was significant enough to likely affect a consumer’s decision to use the product, and this would affect the company’s revenue and ultimately the commercial viability of the product The information was therefore significant enough to likely affect an investor’s decision whether to buy or sell Matrixx’s stock, and this would affect the stock price Thus, the plaintiffs’ allegations were sufficient Contrary to the defendants’ assertion, statistical sampling is not required to show materiality—reasonable investors could view reports of adverse events as material even if the reports did not provide statistically significant evidence Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary A or trustee to pay the creditor or provide additional guaranties to protect the creditor against the losses suffered by the creditor as a result of the stay Acceptance  In contract law, the offeree’s notification to the offeror that the offeree agrees to be bound by the terms of the offeror’s proposal Although historically the terms of acceptance had to be the mirror image of the terms of the offer, the Uniform Commercial Code provides that even modified terms of the offer in a definite expression of acceptance constitute a contract Adhesion contract  A “standard-form” contract, such as that between a large retailer and a consumer, in which the stronger party dictates the terms Accredited investors  In the context of securities offerings, “sophisticated” investors, such as banks, insurance companies, investment companies, the issuer’s executive officers and directors, and persons whose income or net worth exceeds certain limits Adjustable-rate mortgage (ARM)  A mortgage Acquittal  A certification or declaration follow- ing a trial that the individual accused of a crime is innocent, or free from guilt, and is thus absolved of the charges Act of state doctrine  A doctrine that provides that the judicial branch of one country will not examine the validity of public acts committed by a recognized foreign government within its own territory Actionable  Capable of serving as the basis of a lawsuit Actual authority  Authority of an agent that is express or implied Actual malice  A condition that exists when a person makes a statement with either knowledge of its falsity or a reckless disregard for the truth In a defamation suit, a statement made about a public figure normally must be made with actual malice for liability to be incurred Actus reus (pronounced ak-tus ray-uhs)  A guilty (prohibited) act The commission of a prohibited act is one of the two essential elements required for criminal liability, the other element being the intent to commit a crime Adequate protection doctrine  In bankruptcy law, a doctrine that protects secured creditors from losing their security as a result of an automatic stay on legal proceedings by creditors against the debtor once the debtor petitions for bankruptcy relief In certain circumstances, the bankruptcy court may provide adequate protection by requiring the debtor Adjudication  The process of resolving a dispute by presenting evidence and arguments before a neutral third party decision maker in a court or an administrative law proceeding in which the rate of interest paid by the borrower changes periodically, often with reference to a predetermined government interest rate (the index) Usually, the interest rate for ARMs is initially low and increases over time, but there is a cap on the amount that the rate can increase during any adjustment period Administrative agency  A federal, state, or local government agency established to perform a specific function Administrative agencies are authorized by legislative acts to make and enforce rules to administer and enforce the acts Administrative law  The body of law created by administrative agencies (in the form of rules, regulations, orders, and decisions) in order to carry out their duties and responsibilities Administrative law judge (ALJ)  One who presides over an administrative agency hearing and who has the power to administer oaths, take testimony, rule on questions of evidence, and make determinations of fact Administrative process  The procedure used by administrative agencies in the administration of law Adverse possession  The acquisition of title to real property by occupying it openly, without the consent of the owner, for a period of time specified by a state statute The occupation must be actual, open, notorious, exclusive, and in opposition to all others, including the owner Affidavit  A written or printed voluntary statement of facts, confirmed by the oath or affirmation of the party making it and made before a person having the authority to administer the oath or affirmation G–1 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–2  Glossary Affirm  To validate; to give legal force to See also Ratification Affirmative action  Job-hiring policies that give special consideration to members of protected classes in an effort to overcome present effects of past discrimination Affirmative defense  A response to a plaintiff’s claim that does not deny the plaintiff’s facts but attacks the plaintiff’s legal right to bring an action An example is the running of the statute of limitations After-acquired evidence  A type of evidence submitted in support of an affirmative defense in employment discrimination cases Evidence that, prior to the employer’s discriminatory act, the employee engaged in misconduct sufficient to warrant dismissal had the employer known of it earlier Agency  A relationship between two parties in which one party (the agent) agrees to represent or act for the other (the principal) Agency by estoppel  An agency that arises when a principal negligently allows an agent to exercise powers not granted to the agent, thus justifying others in believing that the agent possesses the requisite agency authority Agency coupled with an interest  An agency relationship in which the agent has some legal right to (an interest in) the property that is the subject of the agency, and thus the agency is created for the agent’s benefit instead of the principal’s Because the agent has an additional interest in the property beyond the normal commission for selling it, the agent’s position cannot be terminated until the agent’s interest ends Agent  A person who agrees to represent or act for another, called the principal Agreement  A meeting of two or more minds in regard to the terms of a contract Agreement is usually broken down into two events—an offer by one party to form a contract, and an acceptance of the offer by the person to whom the offer is made Alien corporation  A designation in the United States for a corporation formed in another country but doing business in the United States Allegation  A statement, claim, or assertion Allege  To state, recite, assert, or charge Alternative dispute resolution (ADR)  The resolu- tion of disputes in ways other than those involved in the traditional judicial process Negotiation, mediation, and arbitration are forms of ADR Amend  To change through a formal procedure American Arbitration Association (AAA)  The major organization offering arbitration services in the United States Answer  Procedurally, a defendant’s response to the plaintiff’s complaint Antecedent claim  A preexisting claim Anticipatory repudiation  An assertion or action by a party indicating that he or she will not perform an obligation that the party is contractually obligated to perform at a future time Antitrust law  The body of federal and state laws and statutes protecting trade and commerce from unlawful restraints, price discrimination, price fixing, and monopolies The principal federal antitrust statues are the Sherman Act of 1890, the Clayton Act of 1914, and the Federal Trade Commission Act of 1914 Apparent authority  Authority that is only apparent, not real In agency law, a person may be deemed to have had the power to act as an agent for another party if the other party’s manifestations to a third party led the third party to believe that an agency existed when, in fact, it did not Appeal  Resort to a superior court, such as an appellate court, to review the decision of an inferior court, such as a trial court or an administrative agency Appellant  The party who takes an appeal from one court to another Appellate court  A court having appellate jurisdiction Appellate jurisdiction  Courts having appellate jurisdiction act as reviewing courts, or appellate courts Generally, cases can be brought before appellate courts only on appeal from an order or a judgment of a trial court or other lower court Appellee  The party against whom an appeal is taken—that is, the party who opposes setting aside or reversing the judgment Appropriation  In tort law, the use by one person of another person’s name, likeness, or other identifying characteristic without permission and for the benefit of the user Arbitrary and capricious test  A court reviewing an informal administrative agency action applies this test to determine whether or not that action was in clear error The court gives wide discretion to the expertise of the agency and decides if the agency had Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   sufficient factual information on which to base its action If no clear error was made, then the agency’s action stands Arbitration  The settling of a dispute by submitting it to a disinterested third party (other than a court), who renders a decision The decision may or may not be legally binding Arbitration clause  A clause in a contract that pro- vides that, in the event of a dispute, the parties will submit the dispute to arbitration rather than litigate the dispute in court Arbitrator  A neutral third party or panel of experts that hear a dispute in arbitration Arraignment  A procedure in which an accused person is brought before the court to answer criminal charges The charge is read to the person, and he or she is asked to enter a plea—such as “guilty” or “not guilty.” Arson  The malicious burning of another’s dwelling Some statutes have expanded this to include any real property regardless of ownership and the destruction of property by other means—for example, by explosion Articles of incorporation  The document filed with the appropriate governmental agency, usually the secretary of state, when a business is incorporated State statutes usually prescribe what kind of information must be contained in the articles of incorporation Articles of organization  The document filed with a designated state official by which a limited liability company is formed Articles of partnership  A written agreement that sets forth each partner’s rights and obligations with respect to the partnership Artisan’s lien  A possessory lien given to a person who has made improvements and added value to another person’s personal property as security for payment for services performed Assault  Any word or action intended to make another person fearful of immediate physical harm; a reasonably believable threat Assignee  The person to whom contract rights are assigned Assignment  The act of transferring to another all or part of one’s rights arising under a contract Assignor  The person who assigns contract rights G–3 Assumption of risk  A defense against negligence that can be used when the plaintiff was aware of a danger and voluntarily assumed the risk of injury from that danger Attachment  (1) In the context of secured transac- tions, the process by which a security interest in the property of another becomes enforceable (2) In the context of judicial liens, a court-ordered seizure and taking into custody of property prior to the securing of a judgment for a past-due debt Attempted monopolization  Any actions by a firm to eliminate competition and gain monopoly power Authenticate  To sign a record, or with the intent to sign a record, to execute or to adopt an electronic sound, symbol, or the like to link with the record A record is retrievable information inscribed on a tangible medium or stored in an electronic or other medium Authority  In agency law, the agent’s permission to act on behalf of the principal An agent’s authority may be actual (express or implied) or apparent See also Actual authority; Apparent authority Authorization card  A card signed by an employee that gives a union permission to act on his or her behalf in negotiations with management Unions typically use authorization cards as evidence of employee support during union organization Authorized means  In contract law, the means of acceptance authorized by the offeror Automatic stay  In bankruptcy proceedings, the suspension of almost all litigation and other action by creditors against the debtor or the debtor’s property The stay is effective the moment the debtor files a petition in bankruptcy Award  In the context of litigation, the amount of money awarded to a plaintiff in a civil lawsuit as damages In the context of arbitration, the arbitrator’s decision B Bailment  A situation in which the personal property of one person (a bailor) is entrusted to another (a bailee), who is obligated to return the bailed property to the bailor or dispose of it as directed Bait-and-switch advertising  Advertising a product at a very attractive price (the bait) and then informing the consumer, once he or she is in the store, that the advertised product is either not available or is of poor quality The customer is then urged to purchase (switched to) a more expensive item Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–4  Glossary Bankruptcy court  A federal court of limited jurisdiction that handles only bankruptcy proceedings Bankruptcy proceedings are governed by federal bankruptcy law Bankruptcy trustee  A person who is either appointed by the U.S Department of Justice or by creditors in bankruptcy cases In all bankruptcies under Chapters 7, 12, or 13, a trustee is appointed by the U.S Trustee, who is an officer of the Department of Justice Chapter 11 bankruptcies allow the debtor to continue to manage the property as a “debtor in possession,” but this person can be replaced for cause with a bankruptcy trustee Battery  The unprivileged, intentional touching of another Benefit corporation  A for-profit corporation that seeks to have a material positive impact on society and the environment This new business form is available by statute in a growing number of states Beyond a reasonable doubt  The standard used to determine the guilt or innocence of a person criminally charged To be guilty of a crime, one must be proved guilty “beyond and to the exclusion of every reasonable doubt.” A reasonable doubt is one that would cause a prudent person to hesitate before acting in matters important to him or her manipulated only by the software source Although the network is sometimes legitimate, usually this term is reserved for a group of computers that have been infected by malicious robot software In a botnet, each connected computer becomes a zombie, or drone Boycott  A concerted refusal to business with a particular person or entity in order to obtain concessions or to express displeasure with certain acts or practices of that person or business See also Secondary boycott Breach  To violate a law, by an act or an omission, or to break a legal obligation that one owes to another person or to society Breach of contract  The failure, without legal excuse, of a promisor to perform the obligations of a contract Bribery  The offering, giving, receiving, or soliciting of anything of value with the aim of influencing an official action or an official’s discharge of a legal or public duty or (with respect to commercial bribery) a business decision Bilateral contract  A type of contract that arises when a promise is given in exchange for a return promise Brief  A formal legal document submitted by the attorney for the appellant—or the appellee (in answer to the appellant’s brief)—to an appellate court when a case is appealed The appellant’s brief outlines the facts and issues of the case, the judge’s rulings or jury’s findings that should be reversed or modified, the applicable law, and the arguments on the client’s behalf Bill of lading  A document that serves both as Browse-wrap terms  Terms and conditions of use evidence of the receipt of goods for shipment and as documentary evidence of title to the goods Bill of Rights  The first ten amendments to the U.S Constitution Binding authority  Any source of law that a court must follow when deciding a case Binding authorities include constitutions, statutes, and regulations that govern the issue being decided, as well as court decisions that are controlling precedents within the jurisdiction Blue sky laws  State laws that regulate the offer and sale of securities Bona fide  Good faith A bona fide obligation is one made in good faith—that is, sincerely and honestly Bona fide occupational qualification (BFOQ)  that are presented to an Internet user at the time certain products, such as software, are being downloaded but that need not be agreed to (by clicking “I agree,” for example) before being able to install or use the product Bureaucracy  A large organization that is structured hierarchically to carry out specific functions Burglary  The unlawful entry into a building with the intent to commit a felony (Some state statutes expand this to include the intent to commit any crime.) Business ethics  Ethics in a business context; a con- sensus of what constitutes right or wrong behavior in the world of business and the application of moral principles to situations that arise in a business setting Identifiable characteristics reasonably necessary to the normal operation of a particular business These characteristics can include gender, national origin, and religion, but not race Business invitees  Those people, such as customers Botnet  Short for robot network—a group of com- corporate management from liability for actions that result in corporate losses or damages if the actions puters that run an application that is controlled and or clients, who are invited onto business premises by the owner of those premises for business purposes Business judgment rule  A rule that immunizes Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   G–5 are undertaken in good faith and are within both the power of the corporation and the authority of management to make Cause of action  A situation or set of facts sufficient to justify a right to sue Business necessity  A defense to allegations of cial order prohibiting a person or business firm from conducting activities that an agency or court has deemed illegal employment discrimination in which the employer demonstrates that an employment practice that discriminates against members of a protected class is related to job performance Business tort  Wrongful interference with the busi- ness rights of another Buyout price  The amount payable to a partner on his or her dissociation from a partnership, based on the amount distributable to that partner if the firm were wound up on that date, and offset by any damages for wrongful dissociation Buy-sell agreement  In the context of partnerships, an express agreement made at the time of partnership formation for one or more of the partners to buy out the other or others should the situation warrant—and thus provide for the smooth dissolution of the partnership Bylaws  A set of governing rules adopted by a corpo- ration or other association Bystander  A spectator, witness, or person who was standing nearby when an event occurred and who did not engage in the business or act leading to the event C C.I.F or C.&F.  Cost, insurance, and freight—or just cost and freight A pricing term in a contract for the sale of goods requiring, among other things, that the seller place the goods in the possession of a carrier before risk passes to the buyer Case law  The rules of law announced in court deci- sions Case law includes the aggregate of reported cases that interpret judicial precedents, statutes, regulations, and constitutional provisions Case on point  A previous case involving factual circumstances and issues that are similar to those in the case before the court Categorical imperative  A concept developed by the philosopher Immanuel Kant as an ethical guideline for behavior In deciding whether an action is right or wrong, or desirable or undesirable, a person should evaluate the action in terms of what would happen if everybody else in the same situation, or category, acted the same way Causation in fact  An act or omission without (“but for”) which an event would not have occurred Cease-and-desist order  An administrative or judi- Certificate of limited partnership  The basic document filed with a designated state official by which a limited partnership is formed Certification mark  A mark used by one or more persons, other than the owner, to certify the region, materials, mode of manufacture, quality, or accuracy of the owner’s goods or services When used by members of a cooperative, association, or other organization, such a mark is referred to as a collective mark Examples of certification marks include the “Good Housekeeping Seal of Approval” and “UL Tested.” Certiorari  See Writ of certiorari Chain-style business franchise  A franchise that operates under a franchisor’s trade name and that is identified as a member of a select group of dealers that engage in the franchisor’s business The franchisee is generally required to follow standardized or prescribed methods of operation Examples of this type of franchise are McDonald’s and most other fast-food chains Chancellor  An adviser to the king at the time of the early king’s courts of England Individuals petitioned the king for relief when they could not obtain an adequate remedy in a court of law, and these petitions were decided by the chancellor Charging order  In partnership law, an order granted by a court to a judgment creditor that entitles the creditor to attach profits or assets of a partner on dissolution of the partnership Checks and balances  The system by which each of the three branches of the national government (executive, legislative, and judicial) exercises checks on the powers of the other branches Choice-of-language clause  A clause in a contract designating the official language by which the contract will be interpreted in the event of a future disagreement over the contract’s terms Choice-of-law clause  A clause in a contract designating the law (such as the law of a particular state or nation) that will govern the contract Citation  A reference to a publication in which a legal authority—such as a statute or a court decision—or other source can be found Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–6  Glossary Civil law  The branch of law dealing with the definition and enforcement of all private or public rights, as opposed to criminal matters Civil law system  A system of law derived from that of the Roman Empire and based on a code rather than case law The predominant system of law in the nations of continental Europe and the nations that were once their colonies In the United States, Louisiana is the only state that has a civil law system Click-on agreement  An agreement that arises when a buyer, engaging in a transaction on a computer, indicates his or her assent to be bound by the terms of an offer by clicking on a button that says, for example, “I agree”; sometimes referred to as a click-on license or a click-wrap agreement Close corporation  A corporation whose shareholders are limited to a small group of persons, often only family members The rights of shareholders of a close corporation usually are restricted regarding the transfer of shares to others Close corporations are also referred to as closely held, family, or privately held corporations Closed shop  A firm that requires union member- ship by its workers as a condition of employment The closed shop was made illegal by the LaborManagement Relations Act of 1947 Closing  The final step in the sale of real estate—also called settlement or closing escrow The escrow agent coordinates the closing with the recording of deeds, the obtaining of title insurance, and other concurrent closing activities A number of costs must be paid, in cash, at the time of closing, and they can range from several hundred to several thousand dollars, depending on the amount of the mortgage loan and other conditions of the sale Closing argument  An argument made after the plaintiff and defendant have rested their cases Closing arguments are made prior to the jury charges Cloud computing  The delivery to users of ondemand services from third-party servers over a network Cloud computing is a delivery model The most widely used cloud computing services are Software as a Service (SaaS), which offers companies a cheaper way to buy and use packaged applications that are no longer run on servers in house Collateral  Under Article of the Uniform Commer- cial Code, the property subject to a security interest Collateral promise  A secondary promise that is ancillary (subsidiary) to a principal transaction or primary contractual relationship, such as a promise made by one person to pay the debts of another if the latter fails to perform A collateral promise normally must be in writing to be enforceable Collective bargaining  The process by which labor and management negotiate the terms and conditions of employment, including working hours and workplace conditions Collective mark  A mark used by members of a cooperative, association, or other organization to certify the region, materials, mode of manufacture, quality, or accuracy of the specific goods or services Examples of collective marks include the labor union marks found on tags of certain products and the credits of movies, which indicate the various associations and organizations that participated in the making of the movies Comity  A deference by which one nation gives effect to the laws and judicial decrees of another nation This recognition is based primarily on respect Comment period  A period of time following an administrative agency’s publication or a notice of a proposed rule during which private parties may comment in writing on the agency proposal in an effort to influence agency policy The agency takes any comments received into consideration when drafting the final version of the regulation Commerce clause  The provision in Article I, Section 8, of the U.S Constitution that gives Congress the power to regulate interstate commerce Commercial impracticability  A doctrine under which a seller may be excused from performing a contract when (1) a contingency occurs, (2) the contingency’s occurrence makes performance impracticable, and (3) the nonoccurrence of the contingency was a basic assumption on which the contract was made Despite the fact that UCC 2–615 expressly frees only sellers under this doctrine, courts have not distinguished between buyers and sellers in applying it Commercial use  Use of land for business activities only; sometimes called business use Commingle  To put funds or goods together into one mass so that the funds or goods are so mixed that they no longer have separate identities In corporate law, if personal and corporate interests are commingled to the extent that the corporation has no separate identity, a court may “pierce the corporate veil” and expose the shareholders to personal liability Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   Common carrier  A carrier that transfers people or goods for hire to the general public Common law  That body of law developed from custom or judicial decisions in English and U.S courts, not attributable to a legislature Common stock  Shares of ownership in a corpo- G–7 Concurring opinion  A written opinion outlining the views of a judge or justice to make or emphasize a point that was not made or emphasized in the majority opinion Condemnation  The process of taking private property for public use through the government’s power of eminent domain ration that give the owner of the stock a proportionate interest in the corporation with regard to control, earnings, and net assets Shares of common stock are lowest in priority with respect to payment of dividends and distribution of the corporation’s assets on dissolution Condition  A possible future event, the occurrence or nonoccurrence of which will trigger the performance of a legal obligation or terminate an existing obligation under a contract Community property  A form of concurrent own- that must be met before a party’s promise becomes absolute Condition precedent  A condition in a contract ership of property in which each spouse technically owns an undivided one-half interest in property acquired during the marriage This form of joint ownership occurs in only a minority of states and Puerto Rico Confiscation  A government’s taking of privately owned business or personal property without a proper public purpose or an award of just compensation Comparative negligence  A theory in tort law tract specifications under which the liability for injuries resulting from negligent acts is shared by all parties who were negligent (including the injured party), on the basis of each person’s proportionate negligence Compelling government interest  A test of con- stitutionality that requires the government to have compelling reasons for passing any law that restricts fundamental rights, such as free speech, or distinguishes between people based on a suspect trait Compensatory damages  A money award equiva- lent to the actual value of injuries or damages sustained by the aggrieved party Complaint  The pleading made by a plaintiff alleg- Conforming goods  Goods that conform to con- Consent  Voluntary agreement to a proposition or an act of another A concurrence of wills Consequential damages  Special damages that compensate for a loss that is not direct or immediate (for example, lost profits) The special damages must have been reasonably foreseeable at the time the breach or injury occurred in order for the plaintiff to collect them Consideration  Generally, the value given in return for a promise or a performance The consideration, which must be present to make the contract legally binding, must be something of legally sufficient value and bargained for ing wrongdoing on the part of the defendant; the document that, when filed with a court, initiates a lawsuit Constitutional law  Law that is based on the U.S Complete performance  Performance of a contract strictly in accordance with the contract’s terms Constructive delivery  An act equivalent to the Computer crime  Any violation of criminal law that involves knowledge of computer technology for its perpetration, investigation, or prosecution Concentrated industry  An industry in which a large percentage of market sales is controlled by either a single firm or a small number of firms Concurrent jurisdiction  Jurisdiction that exists when two different courts have the power to hear a case For example, some cases can be heard in either a federal or a state court Concurrent ownership  Joint ownership Constitution and the constitutions of the various states actual, physical delivery of property that cannot be physically delivered because of difficulty or impossibility For example, the transfer of a key to a safe constructively delivers the contents of the safe Constructive discharge  A termination of employment brought about by making an employee’s working conditions so intolerable that the employee reasonably feels compelled to leave Consumer credit  Credit extended primarily for personal or household use Consumer-debtor  An individual whose debts are primarily consumer debts (debts for purchases made primarily for personal or household use) Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–8  Glossary Consumer goods  Goods that are primarily for per- sonal or household use Consumer law  The body of statutes, agency rules, and judicial decisions protecting consumers of goods and services from dangerous manufacturing techniques, mislabeling, unfair credit practices, deceptive advertising, and so on Consumer laws provide remedies and protections that are not ordinarily available to merchants or to businesses Contract  An agreement that can be enforced in court; formed by two or more parties, each of whom agrees to perform or to refrain from performing some act now or in the future Contractual capacity  The legal ability to enter into contracts The threshold mental capacity required by law for a party who enters into a contract to be bound by that contract Contributory negligence  A theory in tort law under which a complaining party’s own negligence contributed to or caused his or her injuries Contributory negligence is an absolute bar to recovery in a minority of jurisdictions Conversion  The wrongful taking, using, or retain- ing possession of personal property that belongs to another Conveyance  The transfer of a title to land from one person to another by deed; a document (such as a deed) by which an interest in land is transferred from one person to another Conviction  The outcome of a criminal trial in which the defendant has been found guilty of the crime “Cooling-off” laws  A set of federal and state laws designed to protect purchasers and lessees of goods or property For example, the Federal Trade Commission’s cooling-off period is three business days for purchases of goods or services from door-todoor salespersons Cooling-off periods vary for loans, mortgages, leases, etc Co-ownership  Joint ownership Copyright  The exclusive right of authors to publish, print, or sell an intellectual production for a statutory period of time A copyright has the same monopolistic nature as a patent or trademark, but it differs in that it applies exclusively to works of art, literature, and other works of authorship, including computer programs Corporate governance  The relationship between a corporation and its shareholders—specifically, a system that details the distribution of rights and responsibilities of those within the corporation and spells out the rules and procedures for making corporate decisions Corporate social responsibility  The concept that corporations can and should act ethically and be accountable to society for their actions Corporation  A legal entity formed in compliance with statutory requirements The entity is distinct from its shareholders-owners Cosign  The act of signing a document (such as a note promising to pay another in return for a loan or other benefit) jointly with another person and thereby assuming liability for performing what was promised in the document Cost-benefit analysis  A decision-making technique that involves weighing the costs of a given action against the benefits of the action Co-surety  A joint surety One who assumes liability jointly with another surety for the payment of an obligation Counteradvertising  New advertising that is undertaken pursuant to a Federal Trade Commission order for the purpose of correcting earlier false claims that were made about a product Counterclaim  A claim made by a defendant in a civil lawsuit that in effect sues the plaintiff Counteroffer  An offeree’s response to an offer in which the offeree rejects the original offer and at the same time makes a new offer Course of dealing  Prior conduct between parties to a contract that establishes a common basis for their understanding Course of performance  The conduct that occurs under the terms of a particular agreement Such conduct indicates what the parties to an agreement intended it to mean Court of equity  A court that decides controversies and administers justice according to the rules, principles, and precedents of equity Court of law  A court in which the only remedies that could be granted were things of value, such as money damages In the early English king’s courts, courts of law were distinct from courts of equity Covenant not to compete  A contractual promise to refrain from competing with another party for a certain period of time and within a certain geographic area Although covenants not to compete restrain Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   G–9 trade, they are commonly found in partnership agreements, business sale agreements, and employment contracts If they are ancillary to such agreements, covenants not to compete will normally be enforced by the courts unless the time period or geographic area is deemed unreasonable Cyber crime  A crime that occurs online, in the virtual community of the Internet, as opposed to the physical world Cover  A buyer or lessee’s purchase on the open Cyber fraud  Fraud that involves the online theft of market of goods to substitute for those promised but never delivered by the seller Under the Uniform Commercial Code, if the cost of cover exceeds the cost of the contract goods, the buyer or lessee can recover the difference, plus incidental and consequential damages Cram-down provision  A provision of the mance to correct his or her performance within the contract period credit-card information, banking details, and other information for criminal use Cyber mark  A trademark in cyberspace Cyber tort  A tort committed via the Internet Cyberlaw  An informal term used to refer to all laws governing electronic communications and transactions, particularly those conducted via the Internet Bankruptcy Code that allows a court to confirm a debtor’s Chapter 11 reorganization plan even though only one class of creditors has accepted it To exercise the court’s right under this provision, the court must demonstrate that the plan does not discriminate unfairly against any creditors and is fair and equitable Cybersquatting  The act of registering a domain name that is the same as, or confusingly similar to, the trademark of another and then offering to sell that domain name back to the trademark owner Creditor  A person to whom a debt is owed by D another person (the debtor) Creditors’ composition agreement  An agreement formed between a debtor and his or her creditors in which the creditors agree to accept a lesser sum than that owed by the debtor in full satisfaction of the debt Crime  A wrong against society proclaimed in a statute and punishable by society through fines and/ or imprisonment—or, in some cases, death Criminal act  See Actus reus Criminal intent  See Mens rea Criminal law  Law that defines and governs actions that constitute crimes Generally, criminal law has to with wrongful actions committed against society for which society demands redress Cross-examination  The questioning of an oppos- ing witness during a trial Cumulative voting  A method of shareholder voting designed to allow minority shareholders to be represented on the board of directors With cumulative voting, the number of members of the board to be elected is multiplied by the total number of voting shares held The result equals the number of votes a shareholder has, and this total can be cast for one or more nominees for director Cure  Under the Uniform Commercial Code, the right of a party who tenders nonconforming perfor- Damages  Money sought as a remedy for a breach of contract or for a tortious act Debtor in possession (DIP)  In Chapter 11 bank- ruptcy proceedings, a debtor who is allowed to continue in possession of the estate in property (the business) and to continue business operations Deceptive advertising  Advertising that misleads consumers, either by making unjustified claims concerning a product’s performance or by omitting a material fact concerning the product’s composition or performance Declaratory judgment  A court’s judgment on a justiciable controversy when the plaintiff is in doubt as to his or her legal rights Decree  The judgment of a court of equity Deed  A document by which title to property (usu- ally real property) is passed Defamation  Any published or publicly spoken false statement that causes injury to another’s good name, reputation, or character Default  When a debtor fails to pay as promised Default judgment  A judgment entered by a court against a defendant who has failed to appear in court to answer or defend against the plaintiff’s claim Defendant  One against whom a lawsuit is brought or the accused person in a criminal proceeding Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–10  Glossary Defense  Reasons that a defendant offers in an action or suit as to why the plaintiff should not obtain what he or she is seeking Delegation  The transfer of a contractual duty to a third party The party delegating the duty (the delegator) to the third party (the delegatee) is still obliged to perform on the contract should the delegatee fail to perform Delegation doctrine  A doctrine based on Article I, Section 8, of the U.S Constitution, which has been construed to allow Congress to delegate some of its power to make and implement laws to administrative agencies The delegation is considered to be proper as long as Congress sets standards outlining the scope of the agency’s authority tion from each other and from third parties prior to trial Disparagement of property  An economically injurious false statement made about another’s product or property A general term for torts that are more specifically referred to as slander of quality or slander of title Disparate-impact discrimination  A form of employment discrimination that results from certain employer practices or procedures that, although not discriminatory on their face, have a discriminatory effect Disparate-treatment discrimination  A form of Deposition  The testimony of a party to a lawsuit or employment discrimination that results when an employer intentionally discriminates against employees who are members of protected classes Destination contract  A contract in which the Dissenting opinion  A written opinion by a judge or justice who disagrees with the majority opinion a witness taken under oath before a trial seller is required to ship the goods by carrier and deliver them at a particular destination The seller assumes liability for any losses or damage to the goods until they are tendered at the destination specified in the contract Dilution  With respect to trademarks, a doctrine under which distinctive or famous trademarks are protected from certain unauthorized uses of the marks regardless of a showing of competition or a likelihood of confusion Congress created a federal cause of action for dilution in 1995 with the passage of the Federal Trademark Dilution Act Direct examination  The examination of a witness by the attorney who calls the witness to the stand to testify on behalf of the attorney’s client Disaffirmance  The legal avoidance, or setting aside, of a contractual obligation Discharge  The termination of an obligation (1) In contract law, discharge occurs when the parties have fully performed their contractual obligations or when events, conduct of the parties, or operation of law releases the parties from performance (2) In bankruptcy proceedings, the extinction of the debtor’s dischargeable debts Discharge in bankruptcy  The release of a debtor from all debts that are provable, except those specifically excepted from discharge by statute Disclosed principal  A principal whose identity is known to a third party at the time the agent makes a contract with the third party Discovery  A phase in the litigation process during which the opposing parties may obtain informa- Dissociation  The severance of the relationship between a partner and a partnership when the partner ceases to be associated with the carrying on of the partnership business Dissolution  The formal disbanding of a partnership or a corporation It can take place by (1) acts of the partners or, in a corporation, of the shareholders and board of directors; (2) the death of a partner; (3) the expiration of a time period stated in a partnership agreement or a certificate of incorporation; or (4) judicial decree Distributed network  A network that can be used by persons located (distributed) around the country or the globe to share computer files Distribution agreement  A contract between a seller and a distributor of the seller’s products setting out the terms and conditions of the distributorship Distributorship  A business arrangement that is established when a manufacturer licenses a dealer to sell its product An example of a distributorship is an automobile dealership Diversity of citizenship  Under Article III, Section 2, of the Constitution, a basis for federal court jurisdiction over a lawsuit between (1) citizens of different states, (2) a foreign country and citizens of a state or of different states, or (3) citizens of a state and citizens or subjects of a foreign country The amount in controversy must be more than $75,000 before a federal court can take jurisdiction in such cases Divestiture  The act of selling one or more of a company’s parts, such as a subsidiary or plant; often Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   mandated by the courts in merger or monopolization cases Dividend  A distribution to corporate shareholders of corporate profits or income, disbursed in proportion to the number of shares held Docket  The list of cases entered on a court’s calen- dar and thus scheduled to be heard by the court Document of title  Paper exchanged in the regular course of business that evidences the right to possession of goods (for example, a bill of lading or a warehouse receipt) Domain name  The series of letters and symbols G–11 ers, including both humans and the planet Those duties may be derived from religious principles or from other philosophical reasoning Duty of care  The duty of all persons, as established by tort law, to exercise a reasonable amount of care in their dealings with others Failure to exercise due care, which is normally determined by the “reasonable person standard,” constitutes the tort of negligence E E-agent  A semiautonomous computer program that is capable of executing specific tasks used to identify site operators on the Internet; Internet “addresses.” E-commerce  Business transacted in cyberspace Domestic corporation  In a given state, a corpora- space and is evidenced only by electronic impulses (such as those that make up a computer’s memory), rather than, for example, a typewritten form tion that does business in, and is organized under the laws of, that state Double jeopardy  A situation occurring when a per- son is tried twice for the same criminal offense; prohibited by the Fifth Amendment to the Constitution Double taxation  A feature (and disadvantage) of E-contract  A contract that is entered into in cyber- E-evidence  A type of evidence that consists of computer-generated or electronically recorded information, including e-mail, voice mail, spreadsheets, word-processing documents, and other data the corporate form of business Because a corporation is a separate legal entity, corporate profits are taxed by state and federal governments Dividends are again taxable as ordinary income to the shareholders receiving them E-signature  As defined by the Uniform Electronic Down payment  The part of the purchase price of Early neutral case evaluation  A form of alterna- real property that is paid in cash up front, reducing the amount of the loan or mortgage Dram shop act  A state statute that imposes liability on the owners of bars and taverns, as well as those who serve alcoholic drinks to the public, for injuries resulting from accidents caused by intoxicated persons when the sellers or servers of alcoholic drinks contributed to the intoxication Due process clause  The provisions of the Fifth and Fourteenth Amendments to the Constitution that guarantee that no person shall be deprived of life, liberty, or property without due process of law Similar clauses are found in most state constitutions Dumping  The selling of goods in a foreign country at a price below the price charged for the same goods in the domestic market Transactions Act, “an electronic sound, symbol, or process attached to or logically associated with a record and executed or adopted by a person with the intent to sign the record.” tive dispute resolution in which a neutral third party evaluates the strengths and weakness of the disputing parties’ positions The evaluator’s opinion forms the basis for negotiating a settlement Easement  A nonpossessory right to use another’s property in a manner established by either express or implied agreement Embezzlement  The fraudulent appropriation of funds or other property by a person to whom the funds or property has been entrusted Eminent domain  The power of a government to take land for public use from private citizens for just compensation Employee  A person who works for an employer for a salary or for wages Duress  Unlawful pressure brought to bear on a person, causing the person to perform an act that he or she would not otherwise perform Employer  An individual or business entity that hires employees, pays them salaries or wages, and exercises control over their work Duty-based ethics  An ethical philosophy rooted in the idea that every person has certain duties to oth- Employment at will  A common law doctrine under which either party may terminate an employment Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–12  Glossary relationship at any time for any reason, unless a contract specifies otherwise Employment discrimination  Treating employees or job applicants unequally on the basis of race, color, national origin, religion, gender, age, or disability; prohibited by federal statutes Enabling legislation  A statute enacted by Congress that authorizes the creation of an administrative agency and specifies the name, composition, purpose, and powers of the agency being created Encryption  The process by which a message (plain- text) is transformed into something (ciphertext) that the sender and receiver intend third parties not to understand Establishment clause  The provision in the First Amendment to the U.S Constitution that prohibits Congress from creating any law “respecting an establishment of religion.” Ethical reasoning  A reasoning process in which an individual links his or her moral convictions or ethical standards to the particular situation at hand Ethics  Moral principles and values applied to social behavior Evidence  Proof offered at trial—in the form of testi- mony, documents, records, exhibits, objects, and so on—for the purpose of convincing the court or jury of the truth of a contention Exclusionary rule  In criminal procedure, a rule Entrapment  In criminal law, a defense in which under which any evidence that is obtained in violation of the accused’s constitutional rights guaranteed by the Fourth, Fifth, and Sixth Amendments, as well as any evidence derived from illegally obtained evidence, will not be admissible in court Entrepreneur  One who initiates and assumes the financial risks of a new enterprise and who undertakes to provide or control its management Exclusive agency  An agency in which a principal Environmental impact statement (EIS)  A state- Exclusive jurisdiction  Jurisdiction that exists when a case can be heard only in a particular court or type of court, such as a federal court or a state court the defendant claims that he or she was induced by a public official—usually an undercover agent or police officer—to commit a crime that he or she would otherwise not have committed ment required by the National Environmental Policy Act for any major federal action that will significantly affect the quality of the environment The statement must analyze the action’s impact on the environment and explore alternative actions that might be taken Environmental law  The body of statutory, regula- tory, and common law relating to the protection of the environment Equal dignity rule  In most states, a rule stating that express authority given to an agent must be in writing if the contract to be made on behalf of the principal is required to be in writing Equal protection clause  The provision in the Fourteenth Amendment to the Constitution that guarantees that no state will “deny to any person within its jurisdiction the equal protection of the laws.” This clause mandates that state governments treat similarly situated individuals in a similar manner Equitable maxims  General propositions or prin- ciples of law that have to with fairness (equity) Escrow account  An account that is generally held in the name of the depositor and escrow agent The funds in the account are paid to a third person only on fulfillment of the escrow condition grants an agent an exclusive territory and does not allow another agent to compete in that territory Exclusive-dealing contract  An agreement under which a seller forbids a buyer to purchase products from the seller’s competitors Exculpatory clause  A clause that releases a contractual party from liability in the event of monetary or physical injury, no matter who is at fault Executed contract  A contract that has been com- pletely performed by both parties Executive agency  An administrative agency within the executive branch of government At the federal level, executive agencies are those within the cabinet departments Executory contract  A contract that has not as yet been fully performed Export  To sell products to buyers located in other countries Express authority  Authority expressly given by one party to another In agency law, an agent has express authority to act for a principal if both parties agree, orally or in writing, that an agency relationship exists in which the agent had the power (authority) to act in the place of, and on behalf of, the principal Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   Express contract  A contract in which the terms of the agreement are fully and explicitly stated in words, oral or written Express warranty  A seller’s or lessor’s oral or writ- ten promise, ancillary to an underlying sales or lease agreement, as to the quality, description, or performance of the goods being sold or leased Expropriation  The seizure by a government of privately owned business or personal property for a proper public purpose and with just compensation Extrinsic evidence  Evidence that relates to a contract but is not contained within the document itself, such as the testimony of parties and witnesses, or additional agreements or communications A court may consider extrinsic evidence only when a contract term is ambiguous and the evidence does not contradict the express terms of the contract F F.A.S.  Free alongside A contract term that requires the seller, at his or her own expense and risk, to deliver the goods alongside the ship before risk passes to the buyer F.O.B.  Free on board A contract term that indicates that the selling price of the goods includes transportation costs (and that the seller carries the risk of loss) to the specific F.O.B place named in the contract The place can be either the place of initial shipment (for example, the seller’s city or place of business) or the place of destination (for example, the buyer’s city or place of business) Family limited liability partnership (FLLP)  A limited liability partnership (LLP) in which the majority of the partners are persons related to each other, essentially as spouses, parents, grandparents, siblings, cousins, nephews, or nieces A person acting in a fiduciary capacity for persons so related could also be a partner All of the partners must be natural persons or persons acting in a fiduciary capacity for the benefit of natural persons Federal form of government  A system of government in which the states form a union and the sovereign power is divided between a central government and the member states Federal question  A question that pertains to the U.S Constitution, acts of Congress, or treaties A federal question provides a basis for federal jurisdiction Federal Rules of Civil Procedure (FRCP)  The rules controlling procedural matters in civil trials brought before the federal district courts G–13 Fee simple absolute  An ownership interest in land in which the owner has the greatest possible aggregation of rights, privileges, and power The owner can use, possess, or dispose of the property as he or she chooses during his or her lifetime On death, the interest in the property passes to the owner’s heirs Felony  A crime—such as arson, murder, rape, or robbery—that carries the most severe sanctions, usually ranging from one year in a state or federal prison to the forfeiture of one’s life Fiduciary  As a noun, a person having a duty cre- ated by his or her undertaking to act primarily for another’s benefit in matters connected with the undertaking As an adjective, a relationship founded on trust and confidence Fiduciary duty  The duty, imposed on a fiduciary by virtue of his or her position, to act primarily for another’s benefit Filtering software  A computer program that includes a pattern through which data are passed When designed to block access to certain Web sites, the pattern blocks the retrieval of a site whose URL or key words are on a list within the program Final order  The final decision of an administra- tive agency on an issue If no appeal is taken, or if the case is not reviewed or considered anew by the agency commission, the administrative law judge’s initial order becomes the final order of the agency Firm offer  An offer (by a merchant) that is irre- vocable without consideration for a period of time (not longer than three months) A firm offer by a merchant must be in writing and must be signed by the offeror Fixed-rate mortgage  A standard mortgage with a fixed, or unchanging, rate of interest The loan payments on these mortgages remain the same for the duration of the loan, which ranges between fifteen and forty years Fixed-term tenancy  A type of tenancy under which property is leased for a specified period of time, such as a month, a year, or a period of years; also called a tenancy for years Forbearance  The act of refraining from exercising a legal right An agreement between the lender and the borrower in which the lender agrees to temporarily cease requiring mortgage payments, to delay foreclosure, or to accept smaller payments than previously scheduled Force majeure (pronounced mah-zhure) clause  A provision in a contract stipulating that certain unforeseen Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–14  Glossary events—such as war, political upheavals, acts of God, or other events—will excuse a party from liability for nonperformance of contractual obligations Foreclosure  A proceeding in which a mortgagee either takes title to or forces the sale of the mortgagor’s property in satisfaction of a debt Free-writing prospectus  Any type of written, electronic, or graphic offer of securities that describes the issuing corporation or its securities and includes a legend indicating that the investor may obtain the prospectus at the SEC’s Web site Frustration of purpose  A court-created doctrine tion that does business in the state without being incorporated therein under which a party to a contract will be relieved of his or her duty to perform when the objective purpose for performance no longer exists (due to reasons beyond that party’s control) Foreseeable risk  In negligence law, the risk of Full faith and credit clause  A clause in Article Foreign corporation  In a given state, a corpora- harm or injury to another that a person of ordinary intelligence and prudence should have reasonably anticipated or foreseen when undertaking an action or refraining from undertaking an action Formal contract  A contract that by law requires a IV, Section 1, of the Constitution that provides that “Full Faith and Credit shall be given in each State to the public Acts, Records, and Judicial Proceedings of every other State.” The clause ensures that rights established under deeds, wills, contracts, and the like in one state will be honored by the other states and that any judicial decision with respect to such property rights will be honored and enforced in all states Forum  A jurisdiction, court, or place in which dis- G Forgery  The fraudulent making or altering of any writing in a way that changes the legal rights and liabilities of another specific form, such as being executed under seal, to be valid putes are litigated and legal remedies are sought Forum-selection clause  A provision in a contract designating the court, jurisdiction, or tribunal that will decide any disputes arising under the contract Franchise  Any arrangement in which the owner of a trademark, trade name, or copyright licenses another to use that trademark, trade name, or copyright, under specified conditions or limitations, in the selling of goods and services Franchise tax  A state or local government tax on the right and privilege of carrying on a business in the form of a corporation Garnishment  A legal process used by a creditor to collect a debt by seizing property of the debtor (such as wages) that is being held by a third party (such as the debtor’s employer) General jurisdiction  Exists when a court’s subject- matter jurisdiction is not restricted A court of general jurisdiction normally can hear any type of case General partner  In a limited partnership, a part- ner who assumes responsibility for the management of the partnership and liability for all partnership debts Franchisee  One receiving a license to use another’s (the franchisor’s) trademark, trade name, or copyright in the sale of goods and services Good faith  Under the Uniform Commercial Code, good faith means honesty in fact With regard to merchants, good faith means honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade Franchisor  One licensing another (the franchisee) Good Samaritan statute  A state statute that pro- to use his or her trademark, trade name, or copyright in the sale of goods or services Fraudulent misrepresentation (fraud)  Any mis- representation, either by misstatement or omission of a material fact, knowingly made with the intention of deceiving another and on which a reasonable person would and does rely to his or her detriment Free exercise clause  The provision in the First Amendment to the U.S Constitution that prohibits Congress from making any law “prohibiting the free exercise” of religion vides that persons who rescue or provide emergency services to others in peril—unless they so recklessly, thus causing further harm—cannot be sued for negligence Goodwill  In the business context, the valuable reputation of a business viewed as an intangible asset Grand jury  A group of citizens called to decide, after hearing the state’s evidence, whether a reasonable basis (probable cause) exists for believing that a crime has been committed and whether a trial ought to be held Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   Grant deed  A deed that simply recites words of consideration and conveyance Under statute, a grant deed may impliedly warrant that at least the grantor has not conveyed the property’s title to someone else Grantee  One to whom a grant (of land or property, for example) is made Grantor  A person who makes a grant, such as a transferor of property or the creator of a trust Group boycott  The refusal to deal with a particular person or firm by a group of competitors; prohibited by the Sherman Act Guarantor  A person who agrees to satisfy the debt of another (the debtor) only after the principal debtor defaults A guarantor’s liability is thus secondary G–15 handle, use, or deal in nonunion-produced goods of other employers A type of secondary boycott explicitly prohibited by the Labor-Management Reporting and Disclosure Act of 1959 I I-551 Alien Registration Receipt  Proof that a noncitizen has obtained permanent residency in the United States; the so-called green card I-9 verification  A form from the Department of Homeland Security, U.S Citizenship and Immigration Services, used for employment eligibility verification; a form that documents that each new employee is authorized to work in the United States Identification  In a sale of goods, the express H Hacker  A person who uses one computer to break into another Professional computer programmers refer to such persons as “crackers.” Hearsay  An oral or written statement made out of court that is later offered in court by a witness (not the person who made the statement) to prove the truth of the matter asserted in the statement Hearsay is generally inadmissible as evidence designation of the specific goods provided for in the contract Identity theft  The act of stealing another’s identify- ing information—such as a name, date of birth, or Social Security number—and using that information to access the victim’s financial resources Impeach  To challenge the credibility of a person’s testimony or attempt to discredit a party or witness Implication  A way of creating an easement or Herfindahl-Hirschman Index (HHI)  An index profit in real property when it is reasonable to imply its existence from the circumstances surrounding the division of the property Historical school  A school of legal thought that emphasizes the evolutionary process of law and that looks to the past to discover what the principles of contemporary law should be Implied authority  Authority that is created not by an explicit oral or written agreement but by implication In agency law, implied authority (of the agent) can be conferred by custom, inferred from the position the agent occupies, or implied by virtue of being reasonably necessary to carry out express authority Holding company  A company whose business Implied contract   A contract formed in whole or measuring market concentration for purposes of antitrust enforcement It is calculated by summing the squares of the percentage market shares held by the respective firms activity is holding shares in another company Homestead exemption  A law permitting a debtor to retain the family home, either in its entirety or up to a specified dollar amount, free from the claims of unsecured creditors or trustees in bankruptcy Horizontal merger  A merger between two firms that are competing in the same market Horizontal restraint  Any agreement that in some way restrains competition between rival firms competing in the same market Hot-cargo agreement  An agreement in which employers voluntarily agree with unions not to in part from the conduct of the parties (as opposed to an express contract) Also known as implied-in-fact contract Implied warranty  A warranty that the law derives by implication or inference from the nature of the transaction or the relative situation or circumstances of the parties Implied warranty of fitness for a particular purpose  A warranty that goods sold or leased are fit for a particular purpose The warranty arises when any seller or lessor knows the particular purpose for which a buyer or lessee will use the goods and knows that the buyer or lessee is relying on the skill Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–16  Glossary and judgment of the seller or lessor to select suitable goods actions (usually criminal actions involving lesser crimes) by a law officer, such as a magistrate Implied warranty of habitability  An implied Information return  A tax return submitted by a partnership that reports the income earned by the business The partnership as an entity does not pay taxes on the income received by the partnership A partner’s profit from the partnership (whether distributed or not) is taxed as individual income to the individual partner promise by a landlord that rented residential premises are fit for human habitation—that is, in a condition that is safe and suitable for people to live in Implied warranty of merchantability  A war- ranty that goods being sold or leased are reasonably fit for the ordinary purpose for which they are sold or leased, are properly packaged and labeled, and are of fair quality The warranty automatically arises in every sale or lease of goods made by a merchant who deals in goods of the kind sold or leased Impossibility of performance  A doctrine under which a party to a contract is relieved of his or her duty to perform when performance becomes impossible or totally impracticable (through no fault of either party) In personam jurisdiction  Court jurisdiction over the “person” involved in a legal action; personal jurisdiction In rem jurisdiction  Court jurisdiction over a defendant’s property Incidental damages  Expenses that are caused directly by a breach of contract, such as those incurred to obtain performance from another source Indemnify  To compensate or reimburse another for losses or expenses incurred Independent contractor  One who works for, and receives payment from, an employer but whose working conditions and methods are not controlled by the employer An independent contractor is not an employee but may be an agent Independent regulatory agency  An administrative agency that is not considered part of the government’s executive branch and is not subject to the authority of the president Independent agency officials cannot be removed without cause Infringement  A violation of another’s legally recognized right The term is commonly used with reference to the invasion by one party of another party’s rights in a patent, trademark, or copyright Initial order  In the context of administrative law, an agency’s disposition in a matter other than a rulemaking An administrative law judge’s initial order becomes final unless it is appealed Injunction  A court decree ordering a person to or refrain from doing a certain act or activity Inside director  A person on the board of directors who is also an officer of the corporation Insider  A corporate director or officer, or other employee or agent, with access to confidential information and a duty not to disclose that information in violation of insider-trading laws Insider trading  The purchase or sale of securities on the basis of “inside information” (information that has not been made available to the public) in violation of a duty owed to the company whose stock is being traded Insolvent  Under the Uniform Commercial Code, a term describing a person who ceases to pay “his debts in the ordinary course of business or cannot pay his debts as they become due or is insolvent within the meaning of federal bankruptcy law” [UCC 1–201(23)] Indictment (pronounced in-dyte-ment)  A charge by a grand jury that a reasonable basis (probable cause) exists for believing that a crime has been committed and that a trial should be held Insurable interest  An interest either in a person’s life or well-being or in property that is sufficiently substantial that insuring against injury to (or the death of) the person or against damage to the property does not amount to a mere wagering (betting) contract Industrial use  Land use for light or heavy manu- Insurance  A contract in which, for a stipulated con- Informal contract  A contract that does not require a specified form or formality in order to be valid Intangible property  Property that is incapable of facturing, shipping, or heavy transportation Information  A formal accusation or complaint (without an indictment) issued in certain types of sideration, one party agrees to compensate the other for loss on a specific subject by a specified peril being apprehended by the senses (such as by sight or touch) Intellectual property is an example of intangible property Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   Intellectual property  Property resulting from intellectual, creative processes Patents, trademarks, and copyrights are examples of intellectual property Intended beneficiary  A third party for whose benefit a contract is formed An intended beneficiary can sue the promisor if such a contract is breached Intentional tort  A wrongful act knowingly committed International law  The law that governs relations among nations International customs and treaties are generally considered to be two of the most important sources of international law International organization  In international law, a term that generally refers to an organization composed mainly of nations and usually established by treaty The United States is a member of more than one hundred multilateral and bilateral organizations, including at least twenty through the United Nations Internet service provider (ISP)  A business or organization that offers users access to the Internet and related services G–17 J Joint and several liability  In partnership law, a doctrine under which a plaintiff may sue, and collect a judgment from, one or more of the partners separately (severally, or individually) or all of the partners together (jointly) This is true even if one of the partners sued did not participate in, ratify, or know about whatever gave rise to the cause of action Joint liability  Shared liability In partnership law, partners incur joint liability for partnership obligations and debts For example, if a third party sues a partner on a partnership debt, the partner has the right to insist that the other partners be sued with him or her Joint tenancy  The joint ownership of property by two or more co-owners in which each co-owner owns an undivided portion of the property On the death of one of the joint tenants, his or her interest automatically passes to the surviving joint tenants Judgment  The final order or decision resulting from a legal action Judicial lien  A lien on property created by a court order Interpretive rule  An administrative agency rule that simply declares a policy or explains the agency’s position and does not establish any legal rights or obligations Judicial process  The procedures relating to, or con- Interrogatories  A series of written questions for decide on the constitutionality of legislative enactments and actions of the executive branch which written answers are prepared and then signed under oath by a party to a lawsuit, usually with the assistance of the party’s attorney Inverse condemnation  The taking of private property by the government without payment of just compensation as required by the U.S Constitution The owner must sue the government to recover just compensation Investment company  A company that acts on behalf of many smaller shareholder-owners by buying a large portfolio of securities and professionally managing that portfolio nected with, the administration of justice through the judicial system Judicial review  The process by which courts Junior lienholder  A person or business that holds a lien that is subordinate to one or more other liens on the same property Jurisdiction  The authority of a court to hear and decide a specific action Jurisprudence  The science or philosophy of law Justiciable controversy  A controversy that is not hypothetical or academic but real and substantial A requirement that must be satisfied before a court will hear a case Investment contract  In securities law, a transac- tion in which a person invests in a common enterprise reasonably expecting profits that are derived primarily from the efforts of others Irrevocable offer  An offer that cannot be revoked or recalled by the offeror without liability A merchant’s firm offer is an example of an irrevocable offer K King’s court  A medieval English court The king’s courts, or curiae regis, were established by the Norman conquerors of England The body of law that developed in these courts was common to the entire English realm and thus became known as the common law Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–18  Glossary L Laches  The equitable doctrine that bars a party’s right to legal action if the party has neglected for an unreasonable length of time to act on his or her rights Larceny  The wrongful taking and carrying away of another person’s personal property with the intent to permanently deprive the owner of the property Some states classify larceny as either grand or petit, depending on the property’s value Latent defects  A defect that is not obvious or can- not readily be ascertained Law  A body of enforceable rules governing relation- Legislative rule  An administrative agency rule that affects substantive legal rights and carries the same weight as a congressionally enacted statute Lessee  One who acquires the right to possess and use goods under the Uniform Commercial Code or real property under a lease Lessor  One who transfers the right to possess and use goods (or real property) to another under a lease Letter of credit  A written instrument, usually issued by a bank on behalf of a customer or other person, in which the issuer promises to honor drafts or other demands for payment by third persons in accordance with the terms of the instrument ships among individuals and between individuals and their society Liability  Any actual or potential legal obligation, duty, debt, or responsibility Lease  In real property law, a contract by which the Libel  Defamation in writing or other form (such as in owner of real property (the landlord, or lessor) grants to a person (the tenant, or lessee) an exclusive right to use and possess the property, usually for a specified period of time, in return for rent or some other form of payment Lease agreement  In regard to the lease of goods, an agreement in which one person (the lessor) agrees to transfer the right to the possession and use of property to another person (the lessee) in exchange for rental payments Leasehold estate  An estate in realty held by a a digital recording) having the quality of permanence License  In the context of intellectual property, a contract permitting the use of a trademark, copyright, patent, or trade secret for certain purposes In the context of real property, a revocable right or privilege of a person to come on another person’s land Licensee  One who receives a license to use, or enter onto, another’s property Lien (pronounced leen)  A claim against specific prop- erty to satisfy a debt tenant under a lease In every leasehold estate, the tenant has a qualified right to possess and/or use the land Life estate  An interest in land that exists only for Legal positivism  A school of legal thought cen- Limited jurisdiction  Exists when a court’s subjectmatter jurisdiction is limited Bankruptcy courts and probate courts are examples of courts with limited jurisdiction tered on the assumption that there is no law higher than the laws created by a national government Laws must be obeyed, even if they are unjust, to prevent anarchy Legal realism  A school of legal thought that was popular in the 1920s and 1930s and that challenged many existing jurisprudential assumptions, particularly the assumption that subjective elements play no part in judicial reasoning Legal realists generally advocated a less abstract and more pragmatic approach to the law, an approach that would take into account customary practices and the circumstances in which transactions take place The school left a lasting imprint on American jurisprudence Legal reasoning  The process of reasoning by which a judge harmonizes his or her decision with the judicial decisions of previous cases the duration of the life of some person, usually the holder of the estate Limited liability company (LLC)  A hybrid form of business enterprise that offers the limited liability of the corporation but the tax advantages of a partnership Limited liability limited partnership (LLLP)  A type of limited partnership The difference between a limited partnership and an LLLP is that the liability of the general partner in an LLLP is the same as the liability of the limited partner That is, the liability of all partners is limited to the amount of their investments in the firm Limited liability partnership (LLP)  A form of partnership that allows professionals to enjoy the tax benefits of a partnership while limiting their personal liability for the malpractice of other partners Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   Limited partner  In a limited partnership, a partner who contributes capital to the partnership but has no right to participate in the management and operation of the business The limited partner assumes no liability for partnership debts beyond the capital contributed Limited partnership (LP)  A partnership consist- ing of one or more general partners (who manage the business and are liable to the full extent of their personal assets for debts of the partnership) and one or more limited partners (who contribute only assets and are liable only to the extent of their contributions) Liquidated damages  An amount, stipulated in the contract, that the parties to a contract believe to be a reasonable estimation of the damages that will occur in the event of a breach Liquidated debt  A debt that is due and certain in amount Liquidation  (1) In regard to bankruptcy, the sale of all of the nonexempt assets of a debtor and the distribution of the proceeds to the debtor’s creditors Chapter of the Bankruptcy Code provides for liquidation bankruptcy proceedings (2) In regard to corporations, the process by which corporate assets are converted into cash and distributed among creditors and shareholders according to specific rules of preference Litigant  A party to a lawsuit Litigation  The process of resolving a dispute through the court system Lockout  Occurs when an employer shuts down to prevent employees from working typically because it cannot reach a collective bargaining agreement with the union Long arm statute  A state statute that permits a state to obtain personal jurisdiction over nonresident defendants A defendant must have “minimum contacts” with that state for the statute to apply M Mailbox rule  A rule providing that an accep- tance of an offer becomes effective on dispatch Acceptance takes effect, thus completing formation of the contract, at the time the offeree sends or delivers the communication via the mode expressly or impliedly authorized by the offeror Main purpose rule  A rule of contract law under which an exception to the Statute of Frauds is made if the main purpose in accepting secondary liability G–19 under a contract is to secure a personal benefit If this situation exists, the contract need not be in writing to be enforceable Majority opinion  A court’s written opinion, outlining the views of the majority of the judges or justices deciding the case Malpractice  Professional misconduct or the failure to exercise the requisite degree of skill as a professional Negligence—the failure to exercise due care—on the part of a professional, such as a physician or an attorney, is commonly referred to as malpractice Malware  Malicious software programs designed to disrupt or harm a computer, network, smartphone, or other device Market concentration  A situation that exists when a small number of firms share the market for a particular good or service For example, if the four largest grocery stores in Chicago accounted for 80 percent of all retail food sales, the market clearly would be concentrated in those four firms Market power  The power of a firm to control the market price of its product A monopoly has the greatest degree of market power Marketable title  Title to real estate that is reasonably free from encumbrances, defects in the chain of title, and other matters that affect title, such as adverse possession Market-share liability  A theory of product liabil- ity under which a court can hold each manufacturer of a harmful product responsible for a percentage of a plaintiff’s damages that is equal to the percentage of its market share Material fact  A fact to which a reasonable person would attach importance in determining his or her course of action Mechanic’s lien  A statutory lien on the real property of another, created to ensure payment for work performed and materials furnished in the repair or improvement of real property, such as a building Mediation  A method of settling disputes outside of court by using the services of a neutral third party, called a mediator The mediator acts as a communicating agent between the parties and suggests ways in which the parties can resolve their dispute Mediator  A neutral third party that hears disputes in mediation Member  The term used to designate a person who has an ownership interest in a limited liability company Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–20  Glossary Mens rea (pronounced mehns ray-uh)  Criminal intent A wrongful mental state, which is as necessary as a wrongful act, to establish criminal liability What constitutes a guilty mental state varies according to the wrongful action Thus, for murder, the mens rea is the intent to take a life For theft, the mens rea must involve both the knowledge that the property belongs to another and the intent to deprive the owner of it ness enterprise—in effect, “laundering” the “dirty money.” Merchant  A person who is engaged in the purchase Monopoly  A term generally used to describe a market in which there is a single seller or a limited number of sellers and sale of goods Under the Uniform Commercial Code, a person who deals in goods of the kind involved in the sales contract; for further definitions, see UCC 2–104 Meta tags  Words inserted into a Web site’s key- words field to increase the site’s appearance in search engine results Metadata  Data that are automatically recorded by electronic devices and provide information about who created a file and when, and who accessed, modified, or transmitted it on their hard drives Can be described as data about data Minimum-contacts requirement  The require- ment that before a state court can exercise jurisdiction over a foreign corporation, the foreign corporation must have sufficient contacts with the state A foreign corporation that has its home office in the state or that has manufacturing plants in the state meets this requirement Minimum wage  The lowest wage, either by govern- ment regulation or union contract, that an employer may pay an hourly worker Mini-trial  A private proceeding in which each party to a dispute argues its position before the other side and vice versa A neutral third party may be present and act as an adviser if the parties fail to reach an agreement Mirror image rule  A common law rule that requires, for a valid contractual agreement, that the terms of the offeree’s acceptance adhere exactly to the terms of the offeror’s offer Misdemeanor  A lesser crime than a felony, punish- able by a fine or imprisonment for up to one year in other than a state or federal penitentiary Mitigation of damages  A rule requiring a plaintiff to have done whatever was reasonable to minimize the damages caused by the defendant Money laundering  Falsely reporting income that has been obtained through criminal activity as income obtained through a legitimate busi- Monopolization  The possession of monopoly power in the relevant market and the willful acquisition or maintenance of that power, as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident Monopoly power  The ability of a monopoly to dictate what takes place in a given market Moral minimum  The minimum degree of ethical behavior expected of a business firm, which is usually defined as compliance with the law Mortgage  A written instrument that gives a creditor (the mortgagee) an interest in, or lien on, the debtor’s (mortgagor’s) real property as security for a debt If the debt is not paid, the property can be sold by the creditor and the proceeds used to pay the debt Motion  A procedural request or application pre- sented by an attorney to the court on behalf of a client Motion for a directed verdict  In a state court, a party’s request that the judge enter a judgment in her or his favor before the case is submitted to a jury because the other party has not presented sufficient evidence to support the claim The federal courts refer to this request as a motion for judgment as a matter of law Motion for a new trial  A motion asserting that the trial was so fundamentally flawed (because of error, newly discovered evidence, prejudice, or other reason) that a new trial is necessary to prevent a miscarriage of justice Motion for judgment as a matter of law  In a federal court, a party’s request that the judge enter a judgment in her or his favor before the case is submitted to a jury because the other party has not presented sufficient evidence to support the claim The state courts refer to this request as a motion for a directed verdict Motion for judgment n.o.v.  A motion requesting the court to grant judgment in favor of the party making the motion on the ground that the jury verdict against him or her was unreasonable and erroneous Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   G–21 Motion for judgment on the pleadings  A motion by either party to a lawsuit at the close of the pleadings requesting the court to decide the issue solely on the pleadings without proceeding to trial The motion will be granted only if no facts are in dispute Necessity  In criminal law, a defense against liabil- Motion for summary judgment  A motion Negligence  The failure to exercise the standard of care that a reasonable person would exercise in similar circumstances requesting the court to enter a judgment without proceeding to trial The motion can be based on evidence outside the pleadings and will be granted only if no facts are in dispute Motion to dismiss  A pleading in which a defen- dant asserts that the plaintiff’s claim fails to state a cause of action (that is, has no basis in law) or that there are other grounds on which a suit should be dismissed Multiple product order  An order issued by the Federal Trade Commission to a firm that has engaged in deceptive advertising by which the firm is required to cease and desist from false advertising not only in regard to the product that was the subject of the action but also in regard to all the firm’s other products Municipal court  A city or community court with criminal jurisdiction over traffic violations and, less frequently, with civil jurisdiction over other minor matters Mutual assent  The element of agreement in the formation of a contract The manifestation of contract parties’ mutual assent to the same bargain is required to establish a contract Mutual fund  A specific type of investment com- pany that continually buys or sells to investors shares of ownership in a portfolio Mutual rescission  An agreement between the parties to cancel their contract, releasing the parties from further obligations under the contract The object of the agreement is to restore the parties to the positions they would have occupied had no contract ever been formed See also Rescission N National law  Law that pertains to a particular nation (as opposed to international law) ity Under Section 3.02 of the Model Penal Code, this defense is justifiable if “the harm or evil sought to be avoided” by a given action “is greater than that sought to be prevented by the law defining the offense charged.” Negligence per se  An act (or failure to act) in viola- tion of a statutory requirement Negotiation  In regard to dispute settlement, a pro- cess in which parties attempt to settle their dispute without going to court, with or without attorneys to represent them Nominal damages  A small monetary award (often one dollar) granted to a plaintiff when no actual damage was suffered or when the plaintiff is unable to show such loss with sufficient certainty Nonconforming goods  Goods that not conform to contract specifications Normal trade relations (NTR) status  A status granted through an international treaty by which each member nation must treat other members at least as well as it treats the country that receives its most favorable treatment This status was formerly known as most-favored-nation status Notary public  A public official authorized to attest to the authenticity of signatures Notice-and-comment rulemaking  An administrative rulemaking procedure that involves the publication of a notice of a proposed rulemaking in the Federal Register, a comment period for interested parties to express their views on the proposed rule, and the publication of the agency’s final rule in the Federal Register Novation  The substitution, by agreement, of a new contract for an old one, with the rights under the old one being terminated Typically, there is a substitution of a new person who is responsible for the contract and the removal of an original party’s rights and duties under the contract Nuisance  A common law doctrine under which per- sons may be held liable for using their property in a manner that unreasonably interferes with others’ rights to use or enjoy their own property Natural law  The belief that government and the legal system should reflect universal moral and ethical principles that are inherent in human nature The natural law school is the oldest and one of the most significant schools of legal thought O Objective theory of contracts  A theory under which the intent to form a contract will be judged by Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–22  Glossary outward, objective facts (what the party said when entering into the contract, how the party acted or appeared, and the circumstances surrounding the transaction) as interpreted by a reasonable person, rather than by the party’s own secret, subjective intentions Outside director  A person on the board of direc- Offer  A promise or commitment to perform or Partially disclosed principal  A principal whose tors who does not hold a management position at the corporation P Offeree  A person to whom an offer is made identity is unknown by a third person, but the third person knows that the agent is or may be acting for a principal at the time the agent and the third person form a contract Offeror  A person who makes an offer Partner  A co-owner of a partnership Online dispute resolution (ODR)  The resolution of disputes with the assistance of organizations that offer dispute-resolution services via the Internet Partnership  An agreement by two or more per- refrain from performing some specified act in the future Opening statement  A statement made to the jury at the beginning of a trial by a party’s attorney, prior to the presentation of evidence The attorney briefly outlines the evidence that will be offered and the legal theory that will be pursued Operating agreement  In a limited liability company, an agreement in which the members set forth the details of how the business will be managed and operated Opinion  A statement by the court expressing the reasons for its decision in a case Option contract  A contract under which the offeror cannot revoke his or her offer for a stipulated time period and the offeree can accept or reject the offer during this period without fear that the offer will be made to another person The offeree must give consideration for the option (the irrevocable offer) to be enforceable Order for relief  A court’s grant of assistance to a complainant In bankruptcy proceedings, the order relieves the debtor of the immediate obligation to pay the debts listed in the bankruptcy petition Ordinance  A law passed by a local governing unit, such as a municipality or a county Original jurisdiction  Courts having original jurisdiction are courts of the first instance, or trial courts—that is, courts in which lawsuits begin, trials take place, and evidence is presented Outcome-based ethics  An ethical philosophy that focuses on the impacts of a decision on society or on key stakeholders Output contract  An agreement in which a seller agrees to sell and a buyer agrees to buy all or up to a stated amount of what the seller produces sons to carry on, as co-owners, a business for profit Partnership by estoppel  A judicially created partnership that may, at the court’s discretion, be imposed for purposes of fairness The court can prevent those who present themselves as partners (but who are not) from escaping liability if a third person relies on an alleged partnership in good faith and is harmed as a result Pass-through entity  Any entity that does not have its income taxed at the level of that entity Examples are partnerships, S corporations, and limited liability companies Past consideration  Something given or some act done in the past, which cannot ordinarily be consideration for a later bargain Patent  A government grant that gives an inventor the exclusive right or privilege to make, use, or sell his or her invention for a limited time period The word patent usually refers to some invention and designates either the instrument by which patent rights are evidenced or the patent itself Peer-to-peer (P2P) networking  The sharing of resources (such as files, hard drives, and processing styles) among multiple computers without necessarily requiring a central network server Penalty  A sum inserted into a contract, not as a measure of compensation for its breach but rather as punishment for a default The agreement as to the amount will not be enforced, and recovery will be limited to actual damages Per curiam opinion  By the whole court; a court opinion written by the court as a whole instead of being authored by a judge or justice Per se  A Latin term meaning “in itself” or “by itself.” Per se violation  A type of anticompetitive agreement—such as a horizontal price-fixing agreement— Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   G–23 that is considered to be so injurious to the public that there is no need to determine whether it actually injures market competition Rather, it is in itself (per se) a violation of the Sherman Act out a mutually satisfactory disposition of the case, subject to court approval It usually involves the defendant’s pleading guilty to a lesser offense in return for a lighter sentence Perfect tender rule  A common law rule under Pleadings  Statements made by the plaintiff and the defendant in a lawsuit that detail the facts, charges, and defenses involved in the litigation The complaint and answer are part of the pleadings which a seller was required to deliver to the buyer goods that conformed perfectly to the requirements stipulated in the sales contract A tender of nonconforming goods would automatically constitute a breach of contract Under the Uniform Commercial Code, the rule has been greatly modified Performance  In contract law, the fulfillment of one’s duties arising under a contract with another; the normal way of discharging one’s contractual obligations Periodic tenancy  A lease interest in land for an indefinite period involving payment of rent at fixed intervals, such as week to week, month to month, or year to year Persuasive authority  Any legal authority or source of law that a court may look to for guidance but need not follow when making its decision Petition in bankruptcy  The document that is filed with a bankruptcy court to initiate bankruptcy proceedings The official forms required for a petition in bankruptcy must be completed accurately, sworn to under oath, and signed by the debtor Petitioner  In equity practice, a party that initiates a lawsuit Plurality opinion  A court opinion that is joined by the largest number of the judges or justices hearing the case, but less than half of the total number Police powers  Powers possessed by states as part of their inherent sovereignty These powers may be exercised to protect or promote the public order, health, safety, morals, and general welfare Possessory lien  A lien that allows one person to retain possession of another’s property as security for a debt or obligation owed by the owner of the property to the lienholder An example of a possessory lien is an artisan’s lien Potentially responsible party (PRP)  A potentially liable party under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) Any person who generated the hazardous waste, transported the waste, owned or operated the site at the time of disposal, or currently owns or operates the site may be responsible for some or all of the clean-up costs involved Power of attorney  A written document, which kind of criminal offense, such as a traffic or buildingcode violation is usually notarized, authorizing another to act as one’s agent; can be special (permitting the agent to specified acts only) or general (permitting the agent to transact all business for the principal) Phishing  Online fraud in which criminals pretend Precedent  A court decision that furnishes an Petty offense  In criminal law, the least serious to be legitimate companies by using e-mails or malicious Web sites that trick individuals and companies into providing useful information, such as bank account numbers, Social Security numbers, and credit-card numbers Pierce the corporate veil  To disregard the corpo- example or authority for deciding subsequent cases involving identical or similar facts Predatory pricing  The pricing of a product below cost with the intent to drive competitors out of the market rate entity, which limits the liability of shareholders, and hold the shareholders personally liable for a corporate obligation Predominant-factor test  A test courts use to determine whether a contract is primarily for the sale of goods or for the sale of services Plaintiff  One who initiates a lawsuit Preemption  A doctrine under which certain federal laws preempt, or take precedence over, conflicting state or local laws Plea  In criminal law, a defendant’s allegation, in response to the charges brought against him or her, of guilt or innocence Plea bargaining  The process by which a criminal defendant and the prosecutor in a criminal case work Preemptive rights  Rights held by shareholders that entitle them to purchase newly issued shares of a corporation’s stock, equal in percentage to shares already held, before the stock is offered to any Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–24  Glossary outside buyers Preemptive rights enable shareholders to maintain their proportionate ownership and voice in the corporation Preference  In bankruptcy proceedings, property transfers or payments made by the debtor that favor (give preference to) one creditor over others The bankruptcy trustee is allowed to recover payments made both voluntarily and involuntarily to one creditor in preference over another Preferred creditor  One who has received a prefer- ential transfer from a debtor Preferred stock  Classes of stock that have prior- ity over common stock as to payment of dividends and distribution of assets on the corporation’s dissolution Prepayment penalty  A provision in a mortgage loan contract that requires the borrower to pay a penalty if the mortgage is repaid in full within a certain period Preponderance of the evidence  A standard in civil law cases under which the plaintiff must convince the court that, based on the evidence presented by both parties, it is more likely than not that the plaintiff’s allegation is true Prescription  A way of creating an easement or profit in real property by openly using the property, without the true owner’s consent, for the required period of time (similar to adverse possession) Pretrial conference  A conference, scheduled before the trial begins, between the judge and the attorneys litigating the suit The parties may settle the dispute, clarify the issues, schedule discovery, and so on during the conference Pretrial motion  A written or oral application to a court for a ruling or order, made before trial Price discrimination  Setting prices in such a way that two competing buyers pay two different prices for an identical product or service Price-fixing agreement  An agreement between competitors in which the competitors agree to fix the prices of products or services at a certain level; prohibited by the Sherman Act Prima facie case  A case in which the plaintiff has produced sufficient evidence of his or her conclusion that the case can go to a jury; a case in which the evidence compels the plaintiff’s conclusion if the defendant produces no evidence to disprove it Principal  In agency law, a person who agrees to have another, called the agent, act on his or her behalf Principle of rights  The principle that human beings have certain fundamental rights (to life, freedom, and the pursuit of happiness, for example) Those who adhere to this “rights theory” believe that a key factor in determining whether a business decision is ethical is how that decision affects the rights of others These others include the firm’s owners, its employees, the consumers of its products or services, its suppliers, the community in which it does business, and society as a whole Privilege  In tort law, the ability to act contrary to another person’s right without that person’s having legal redress for such acts Privilege may be raised as a defense to defamation Privileges and immunities clause  Article IV, Section 2, of the Constitution requires states not to discriminate against one another’s citizens A resident of one state cannot be treated as an alien when in another state He or she may not be denied such privileges and immunities as legal protection, access to courts, travel rights, and property rights Privity of contract  The relationship that exists between the promisor and the promisee of a contract Pro rata  Proportionately; in proportion Probable cause  Reasonable grounds to believe the existence of facts warranting certain actions, such as the search or arrest of a person Probate court  A state court of limited jurisdiction that conducts proceedings relating to the settlement of a deceased person’s estate Procedural due process  The requirement that any government decision to take life, liberty, or property must be made fairly For example, fair procedures must be used in determining whether a person will be subjected to punishment or have some burden imposed on him or her Procedural law  Rules that define the manner in which the rights and duties of individuals may be enforced Procedural unconscionability  Occurs when one contractual party lacks knowledge or understanding of the contract terms, often due to inconspicuous print or the lack of an opportunity to read the contract or to ask questions about its meaning Procedural unconscionability often involves an adhesion contract, which is a contract drafted by the dominant party and then presented to the other— the adhering party—on a take-it-or-leave-it basis Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   Product liability  The legal liability of manufactur- ers, sellers, and lessors of goods to consumers, users, and bystanders for injuries or damages that are caused by the goods Product misuse  A defense against product liability that may be raised when the plaintiff used a product in a manner not intended by the manufacturer If the misuse is reasonably foreseeable, the seller will not escape liability unless measures were taken to guard against the harm that could result from the misuse Profit  In real property law, the right to enter onto G–25 becomes known to the public because of his or her position or activities Public policy  A government policy based on widely held societal values and (usually) expressed or implied in laws or regulations Publicly held corporation  A corporation for which shares of stock have been sold to the public Puffery  A salesperson’s exaggerated claims concern- ing the quality of goods offered for sale Such claims involve opinions rather than facts and are not considered to be legally binding promises or warranties and remove things from the property of another (for example, the right to enter onto a person’s land and remove sand and gravel therefrom) Punitive damages  Money damages that may be Promise  A person’s assurance that he or she will or will not something Purchase-money security interest (PMSI)  A secu- Promissory estoppel  A doctrine that applies when a promisor makes a clear and definite promise on which the promisee justifiably relies Such a promise is binding if justice will be better served by the enforcement of the promise Prospectus  A document required by federal or state securities laws that describes the financial operations of a corporation, thus allowing investors to make informed decisions Protected class  A class of persons with identifiable characteristics who historically have been victimized by discriminatory treatment for certain purposes Depending on the context, these characteristics include age, color, gender, national origin, race, and religion awarded to a plaintiff to punish the defendant and deter future similar conduct rity interest that arises when a seller or lender extends credit for part or all of the purchase price of goods purchased by a buyer Q Quantum meruit (pronounced kwahn-tuhm mehr-oowuht)  Literally, “as much as he deserves”—an expres- sion describing the extent of liability on a contract implied in law (quasi contract) An equitable doctrine based on the concept that one who benefits from another’s labor and materials should not be unjustly enriched thereby but should be required to pay a reasonable amount for the benefits received, even absent a contract Quasi contract  A fictional contract imposed on par- Proximate cause  Legal cause; exists when the ties by a court in the interests of fairness and justice Usually, quasi contracts are imposed to avoid the unjust enrichment of one party at the expense of another Proxy  In corporation law, a written agreement Question of fact  In a lawsuit, an issue involving a factual dispute that can only be decided by a judge (or, in a jury trial, a jury) connection between an act and an injury is strong enough to justify imposing liability between a stockholder and another under which the stockholder authorizes the other to vote the stockholder’s shares in a certain manner Proxy fight  A conflict between an individual, group, or firm attempting to take control of a corporation and the corporation’s management for the votes of the shareholders Public corporation  A corporation owned by a federal, state, or municipal government—not to be confused with a publicly held corporation Public figures  Individuals who are thrust into the public limelight Public figures include government officials and politicians, movie stars, wellknown businesspersons, and generally anybody who Question of law  In a lawsuit, an issue involving the application or interpretation of a law Therefore, the judge, and not the jury, decides the issue Quitclaim deed  A deed intended to pass any title, interest, or claim that the grantor may have in the property but not warranting that such title is valid A quitclaim deed offers the least amount of protection against defects in the title Quorum  The number of members of a decision- making body that must be present before business may be transacted Quota  An assigned import limit on goods Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–26  Glossary R Release  A contract in which one party forfeits the right to pursue a legal claim against the other party legal force to an obligation that previously was not enforceable Relevant evidence  Evidence tending to make a Ratification  The act of accepting and giving Reaffirmation agreement  An agreement between a debtor and a creditor in which the debtor reaffirms, or promises to pay, a debt dischargeable in bankruptcy To be enforceable, the agreement must be made prior to the discharge of the debt by the bankruptcy court Real property  Land and everything attached to it, such as foliage and buildings Reasonable person standard  The standard of behavior expected of a hypothetical “reasonable person.” The standard against which negligence is measured and that must be observed to avoid liability for negligence Rebuttal  The refutation of evidence introduced by an adverse party’s attorney Receiver  In a corporate dissolution, a court- appointed person who winds up corporate affairs and liquidates corporate assets Record  According to the Uniform Electronic Transactions Act, information that is either inscribed on a tangible medium or stored in an electronic or other medium and that is retrievable The Uniform Computer Information Transactions Act uses the term record instead of writing Recording statutes  Statutes that allow deeds, mortgages, and other real property transactions to be recorded so as to provide notice to future purchasers or creditors of an existing claim on the property Redemption  A repurchase, or buying back Reformation  A court-ordered correction of a written contract so that it reflects the true intentions of the parties Regulation Z  A set of rules promulgated by the Federal Reserve Board to implement the provisions of the Truth-in-Lending Act Rejection  In contract law, an offeree’s express or implied manifestation not to accept an offer In the law governing contracts for the sale of goods, a buyer’s manifest refusal to accept goods on the ground that they not conform to contract specifications Rejoinder  The defendant’s answer to the plaintiff’s rebuttal fact at issue in the case more or less probable than it would be without the evidence Only relevant evidence is admissible in court Remanded  Sent back If an appellate court disagrees with a lower court’s judgment, the case may be remanded to the lower court for further proceedings in which the lower court’s decision should be consistent with the appellate court’s opinion on the matter Remedy  The relief given to an innocent party to enforce a right or compensate for the violation of a right Remedy at law  A remedy available in a court of law Money damages are awarded as a remedy at law Remedy in equity  A remedy allowed by courts in situations where remedies at law are not appropriate Remedies in equity are based on settled rules of fairness, justice, and honesty, and include injunction, specific performance, rescission and restitution, and reformation Replevin (pronounced rih-pleh-vin)  An action to recover specific goods in the hands of a party who is wrongfully withholding them from the other party Reply  Procedurally, a plaintiff’s response to a defendant’s answer Reporter  A publication in which court cases are published, or reported Requirements contract  An agreement in which a buyer agrees to purchase and the seller agrees to sell all or up to a stated amount of what the buyer needs or requires Res ipsa loquitur (pronounced rehs ehp-suh lowquuh-tuhr)  A doctrine under which negligence may be inferred simply because an event occurred, if it is the type of event that would not occur in the absence of negligence Literally, the term means “the facts speak for themselves.” Resale price maintenance agreement  An agree- ment between a manufacturer and a retailer in which the manufacturer specifies the minimum retail price of its products Resale price maintenance agreements are illegal per se under the Sherman Act Rescind (pronounced rih-sihnd)  To cancel See also Rescission Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   Rescission (pronounced rih-sih-zhen)  A remedy whereby a contract is canceled and the parties are returned to the positions they occupied before the contract was made; may be effected through the mutual consent of the parties, by their conduct, or by court decree Residential use  Use of land for construction of buildings for human habitation only Respondeat superior (pronounced ree-spahn-dee-uht soo-peer-ee-your)  In Latin, “Let the master respond.” G–27 it can be revoked at any time prior to acceptance without liability Right of contribution  The right of a co-surety who pays more than his or her proportionate share on a debtor’s default to recover the excess paid from other co-sureties Right of first refusal  The right to purchase personal or real property—such as corporate shares or real estate—before the property is offered for sale to others A doctrine under which a principal or an employer is held liable for the wrongful acts committed by agents or employees while acting within the course and scope of their agency or employment Right of redemption  The right of a defaulting borrower to redeem property before a foreclosure sale by paying the full amount of the debt, plus any interest and costs that have accrued Respondent  In equity practice, the party who Right of reimbursement  The legal right of a per- Restitution  An equitable remedy under which a person is restored to his or her original position prior to loss or injury, or placed in the position he or she would have been in had the breach not occurred Right of subrogation  The right of a person to answers a bill or other proceeding Restraint of trade  Any contract or combination that tends to eliminate or reduce competition, effect a monopoly, artificially maintain prices, or otherwise hamper the course of trade and commerce as it would be carried on if left to the control of natural economic forces Restrictive covenant  A private restriction on the use of land If its benefit or obligation passes with the land’s ownership, it is said to “run with the land.” Retained earnings  The portion of a corporation’s profits that has not been paid out as dividends to shareholders Retainer  An advance payment made by a client to a law firm to cover part of the legal fees and/or costs that will be incurred on that client’s behalf Reverse  To reject or overrule a court’s judgment An appellate court, for example, might reverse a lower court’s judgment on an issue if it feels that the lower court committed an error during the trial or that the jury was improperly instructed Reverse discrimination  Discrimination against majority groups, such as white males, that results from affirmative action programs, in which preferences are given to minority members and women Reversible error  An error by a lower court that is sufficiently substantial to justify an appellate court’s reversal of the lower court’s decision Revocation  In contract law, the withdrawal of an offer by an offeror Unless an offer is irrevocable, son to be restored, repaid, or indemnified for costs, expenses, or losses incurred or expended on behalf of another stand in the place of (be substituted for) another, giving the substituted party the same legal rights that the original party had Right-to-work law  A state law providing that employees are not to be required to join a union as a condition of obtaining or retaining employment Robbery  The act of forcefully and unlawfully taking personal property of any value from another Force or intimidation is usually necessary for an act of theft to be considered a robbery Rule of four  A rule of the United States Supreme Court under which the Court will not issue a writ of certiorari unless at least four justices approve of the decision to issue the writ Rule of reason  A test by which a court balances the positive effects (such as economic efficiency) of an agreement against its potentially anticompetitive effects In antitrust litigation, many practices are analyzed under the rule of reason Rulemaking  The process undertaken by an admin- istrative agency when formally adopting a new regulation or amending an old one Rulemaking involves notifying the public of a proposed rule or change and receiving and considering the public’s comments Rules of evidence  Rules governing the admissibility of evidence in trial courts S S corporation  A close business corporation that has met certain requirements as set out by the Internal Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–28  Glossary Revenue Code and thus qualifies for special income tax treatment Essentially, an S corporation is taxed the same as a partnership, but its owners enjoy the privilege of limited liability Sale  The passing of title (evidence of ownership rights) from the seller to the buyer for a price Sales contract  A contract for the sale of goods under which the ownership of goods is transferred from a seller to a buyer for a price Scienter (pronounced sy-en-ter)  Knowledge by the misrepresenting party that material facts have been falsely represented or omitted with an intent to deceive Search warrant  An order granted by a public authority, such as a judge, that authorizes law enforcement personnel to search particular premises or property Seasonably  Within a specified time period If no period is specified, within a reasonable time SEC Rule 10b-5  A rule of the Securities and Exchange Commission that makes it unlawful, in connection with the purchase or sale of any security, to make any untrue statement of a material fact or to omit a material fact if such omission causes the statement to be misleading Secondary boycott  A union’s refusal to work for, purchase from, or handle the products of a secondary employer, with whom the union has no dispute, for the purpose of forcing that employer to stop doing business with the primary employer, with whom the union has a labor dispute Securities  Generally, corporate stocks and bonds A security may also be a note, debenture, stock warrant, or any document given as evidence of an ownership interest in a corporation or as a promise of repayment by a corporation Self-defense  The legally recognized privilege to protect one’s self or property against injury by another The privilege of self-defense protects only acts that are reasonably necessary to protect one’s self or property Self-incrimination  The act of implicating oneself in a crime or exposing oneself to criminal prosecution The Fifth Amendment to the U.S Constitution protects persons from being compelled to incriminate themselves Seniority system  In regard to employment rela- tionships, a system in which those who have worked longest for the company are first in line for promotions, salary increases, and other benefits They are also the last to be laid off if the workforce must be reduced Service mark  A mark used in the sale or the advertising of services, such as to distinguish the services of one person from the services of others Titles, character names, and other distinctive features of radio and television programs may be registered as service marks Service of process  The delivery of the complaint and summons to a defendant Sexual harassment  In the employment context, the granting of job promotions or other benefits in return for sexual favors or conduct that is so sexually offensive that it creates a hostile working environment Share  A unit of stock See also Stock Shareholder  One who purchases shares of a corpo- ration’s stock, thus acquiring an equity interest in the corporation Shareholder’s derivative suit  A suit brought by a shareholder to enforce a corporate cause of action against a third person Sharia  Civil law principles of some Middle Eastern countries that are based on the Islamic directives that follow the teachings of the prophet Muhammad Shipment contract  A contract in which the seller is required to ship the goods by carrier The buyer assumes liability for any losses or damage to the goods after they are delivered to the carrier Generally, all contracts are assumed to be shipment contracts if nothing to the contrary is stated in the contract Short sale  A sale of real property for an amount that is less than the balance owed on the mortgage loan, usually due to financial hardship Both the lender and the borrower must consent to a short sale Following a short sale, the borrower still owes the balance of the mortgage debt (after the sale proceeds are applied) to the lender unless the lender agrees to forgive the remaining debt Short-swing profits  Profits made by officers, direc- tors, and certain large stockholders resulting from the use of nonpublic (inside) information about their companies; prohibited by Section 12 of the 1934 Securities Exchange Act Shrink-wrap agreement  An agreement whose terms are expressed in a document located inside a Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   box in which goods (usually software) are packaged; sometimes called a shrink-wrap license Signature  Under the Uniform Commercial Code, “any symbol executed or adopted by a party with a present intention to authenticate a writing.” Slander  Defamation in oral form Slander of quality  The publication of false infor- mation about another’s product, alleging that it is not what its seller claims Slander of title  The publication of a statement that denies or casts doubt on another’s legal ownership of any property, causing financial loss to that property’s owner Also called trade libel Small claims courts  Special courts in which parties G–29 Spot zoning  A zoning classification granted to a parcel of land that is different from the classification given to other land in the immediate area Stakeholders  Groups, other than the company’s shareholders, that are affected by corporate decisions Stakeholders include employees, customers, creditors, suppliers, and the community in which the corporation operates Standing to sue  The requirement that an individual must have a sufficient stake in a controversy before he or she can bring a lawsuit The plaintiff must demonstrate that he or she either has been injured or has been threatened with injury Stare decisis (pronounced ster-ay dih-si-ses)  A com- mon law doctrine under which judges are obligated to follow the precedents established in prior decisions may litigate small claims (usually, claims involving $2,500 or less) Attorneys are not required in small claims courts, and in many states attorneys are not allowed to represent the parties Statute of Frauds  A state statute under which Social media  The means by which people can cre- Statute of limitations  A federal or state statute ate, share, and exchange ideas and comments via the Internet Sociological school  A school of legal thought that views the law as a tool for promoting justice in society Sole proprietorship  The simplest form of busi- ness, in which the owner is the business The owner reports business income on his or her personal income tax return and is legally responsible for all debts and obligations incurred by the business Sovereign immunity  A doctrine that immunizes certain types of contracts must be in writing to be enforceable setting the maximum time period during which a certain action can be brought or certain rights enforced Statute of repose  Basically, a statute of limitations that is not dependent on the happening of a cause of action Statutes of repose generally begin to run at an earlier date and run for a longer period of time than statutes of limitations Statutory law  The body of law enacted by legisla- tive bodies (as opposed to constitutional law, administrative law, or case law) foreign nations from the jurisdiction of U.S courts when certain conditions are satisfied Stock  An equity (ownership) interest in a corporation, measured in units of shares Sovereignty  The quality of having independent authority over a geographic area For instance, state governments have the authority to regulate affairs within their border Stock buyback  Sometimes, publicly held companies use funds from their own treasuries to repurchase their own stock The result is that the price of the stock usually goes up Spam  Bulk, unsolicited (junk) e-mail Stock certificate  A certificate issued by a corporation evidencing the ownership of a specified number of shares in the corporation Special-use permit  A permit that allows for a spe- cific exemption to zoning regulations for a particular piece of land in a location that has a particular zoning characteristic Local zoning authorities grant special-use permits Specific performance  An equitable remedy requiring the breaching party to perform as promised under the contract; usually granted only when money damages would be an inadequate remedy and the subject matter of the contract is unique (for example, real property) Stock option  See Stock warrant Stock warrant  A certificate that grants the owner the option to buy a given number of shares of stock, usually within a set time period Strict liability  Liability regardless of fault In tort law, strict liability may be imposed on defendants in cases involving abnormally dangerous activities, dangerous animals, or defective products Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–30  Glossary Strike  An extreme action undertaken by unionized workers when collective bargaining fails The workers leave their jobs, refuse to work, and (typically) picket the employer’s workplace Subject-matter jurisdiction  Jurisdiction over the subject matter of a lawsuit Submission  The act of referring a dispute to an arbitrator Subpoena  A document commanding a person to appear at a certain time and place or give testimony concerning a certain matter Substantial performance  Performance that does not vary greatly from the performance promised in a contract The performance must create substantially the same benefits as those promised in the contract Substantive due process  A requirement that focuses on the content, or substance, of legislation If a law or other governmental action limits a fundamental right, such as the right to travel or to vote, it will be held to violate substantive due process unless it promotes a compelling or overriding state interest Substantive law  Law that defines the rights and duties of individuals with respect to each other, as opposed to procedural law, which defines the manner in which these rights and duties may be enforced Substantive unconscionability  Occurs when contracts, or portions of contracts, are oppressive or overly harsh Courts generally focus on provisions that deprive one party of the benefits of the agreement or leave that party without remedy for nonperformance by the other An example of substantive unconscionability is the agreement by a welfare recipient with a fourth-grade education to purchase a refrigerator for $2,000 under an installment contract Suit  See Litigation Summary jury trial (SJT)  A method of settling disputes in which a trial is held, but the jury’s verdict is not binding The verdict acts only as a guide to both sides in reaching an agreement during the mandatory negotiations that immediately follow the summary jury trial Summons  A document informing a defendant that a legal action has been commenced against him or her and that the defendant must appear in court on a certain date to answer the plaintiff’s complaint The document is delivered by a sheriff or any other person so authorized Superseding cause  An intervening force or event that breaks the connection between a wrongful act and an injury to another; in negligence law, a defense to liability Supremacy clause  The provision in Article VI of the Constitution that provides that the Constitution, laws, and treaties of the United States are “the supreme Law of the Land.” Under this clause, state and local laws that directly conflict with federal law will be rendered invalid Surety  A person, such as a cosigner on a note, who agrees to be primarily responsible for the debt of another Suretyship  An express contract in which a third party to a debtor-creditor relationship (the surety) promises to be primarily responsible for the debtor’s obligation Symbolic speech  Nonverbal conduct that expresses opinions or thoughts about a subject Symbolic speech is protected under the First Amendment’s guarantee of freedom of speech T Taking  The taking of private property by the government for public use Under the Fifth Amendment to the Constitution, the government may not take private property for public use without “just compensation.” Tangible employment action  A significant change in employment status, such as firing or failing to promote an employee, reassigning the employee to a position with significantly different responsibilities, or effecting a significant change in employment benefits Tangible property  Property that has physical existence and can be distinguished by the senses of touch, sight, and so on A car is tangible property A patent right is intangible property Tariff  A tax on imported goods Technology licensing  Allowing another to use and profit from intellectual property (patents, copyrights, trademarks, innovative products or processes, and so on) for consideration In the context of international business transactions, technology licensing is sometimes an attractive alternative to the establishment of foreign production facilities Tenancy at sufferance  A type of tenancy under which one who, after rightfully being in possession of leased premises, continues (wrongfully) to occupy the property after the lease has been terminated The tenant has no rights to possess the property and Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   occupies it only because the person entitled to evict the tenant has not done so Tenancy at will  A type of tenancy under which either party can terminate the tenancy without notice; usually arises when a tenant who has been under a tenancy for years retains possession, with the landlord’s consent, after the tenancy for years has terminated Tenancy by the entirety  The joint ownership of property by a husband and wife Neither party can transfer his or her interest in the property without the consent of the other Tenancy in common  Co-ownership of property in which each party owns an undivided interest that passes to his or her heirs at death Tenant  One who has the temporary use and occu- pation of real property owned by another person, called the landlord The duration and terms of the tenancy are usually established by a lease Tender  An unconditional offer to perform an obligation by a person who is ready, willing, and able to so Tender of delivery  Under the Uniform Commercial Code, a seller’s or lessor’s act of placing conforming goods at the disposal of the buyer or lessee and giving the buyer or lessee whatever notification is reasonably necessary to enable the buyer or lessee to take delivery Third party beneficiary  One for whose benefit a promise is made in a contract but who is not a party to the contract Tippee  A person who receives inside information Title insurance  Insurance commonly purchased by a purchaser of real property to protect against loss in the event that the title to the property is not free from liens or superior ownership claims Tolling  Temporary suspension of the running of a prescribed period (such as a statute of limitations) For instance, a statute of limitations may be tolled until the party suffering an injury has discovered it or should have discovered it Tombstone ad  An advertisement, historically in a format resembling a tombstone, of a securities offering The ad informs potential investors of where and how they may obtain a prospectus Tort  A civil wrong not arising from a breach of contract A breach of a legal duty that proximately causes harm or injury to another G–31 Tortfeasor  One who commits a tort Toxic tort  A personal injury caused by exposure to a toxic substance, such as asbestos or hazardous waste Victims can sue for medical expenses, lost wages, and pain and suffering Trade dress  The image and overall appearance of a product—for example, the distinctive decor, menu, layout, and style of service of a particular restaurant Basically, trade dress is subject to the same protection as trademarks Trade libel  The publication of false information about another’s product, alleging it is not what its seller claims; also referred to as slander of quality Trade name  A term that is used to indicate part or all of a business’s name and that is directly related to the business’s reputation and goodwill Trade names are protected under the common law (and under trademark law, if the name is the same as the firm’s trademark) Trade secret  Information or a process that gives a business an advantage over competitors who not know the information or process Trademark  A distinctive mark, motto, device, or implement that a manufacturer stamps, prints, or otherwise affixes to the goods it produces so that they may be identified on the market and their origins made known Once a trademark is established (under the common law or through registration), the owner is entitled to its exclusive use Transferred intent  A legal principle under which a person who intends to harm one individual, but unintentionally harms a second person, can be liable to the second victim for an intentional tort The law transfers the required intent to the second victim Treaty  An agreement formed between two or more independent nations Treble damages  Damages consisting of three times the amount of damages determined by a jury in certain cases as required by statute Trespass to land  The entry onto, above, or below the surface of land owned by another without the owner’s permission or legal authorization Trespass to personal property  The unlawful taking or harming of another’s personal property; interference with another’s right to the exclusive possession of his or her personal property Trespasser  One who commits the tort of trespass in one of its forms Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–32  Glossary Trial court  A court in which trials are held and Unilateral contract  A contract that results when Triple bottom line  The idea that investors and others should consider not only corporate profits, but also the corporation’s impact on people and on the planet in assessing the firm (The bottom line is people, planet, and profits.) Union shop  A place of employment in which all workers, once employed, must become union members within a specified period of time as a condition of their continued employment testimony taken Tying arrangement  An agreement between a buyer and a seller in which the buyer of a specific product or service becomes obligated to purchase additional products or services from the seller an offer can only be accepted by the offeree’s performance Unliquidated debt  A debt that is uncertain in amount Unreasonably dangerous product  In product on mistakes, such as typographical errors, made by Internet users when inputting information into a Web browser liability, a product that is defective to the point of threatening a consumer’s health and safety A product will be considered unreasonably dangerous if it is dangerous beyond the expectation of the ordinary consumer or if a less dangerous alternative was economically feasible for the manufacturer, but the manufacturer failed to produce it U Usage of trade  Any practice or method of deal- Typosquatting  A form of cybersquatting that relies U.S trustee  A government official who performs certain administrative tasks that a bankruptcy judge would otherwise have to perform Ultra vires (pronounced uhl-trah vye-reez)  A Latin term meaning “beyond the powers”; in corporate law, acts of a corporation that are beyond its express and implied powers to undertake Unanimous opinion  A court opinion in which all of the judges or justices of the court agree to the court’s decision Unconscionable (pronounced un-kon-shun-uh-bul)  A contract or clause that is void on the basis of public policy because one party, as a result of his or her disproportionate bargaining power, is forced to accept terms that are unfairly burdensome and that unfairly benefit the dominating party See also Procedural unconscionability; Substantive unconscionability Undisclosed principal  A principal whose identity is ing having such regularity of observance in a place, vocation, or trade as to justify an expectation that it will be observed with respect to the transaction in question Usury  Charging an illegal rate of interest Utilitarianism  An approach to ethical reasoning in which ethically correct behavior is related to an evaluation of the consequences of a given action on those who will be affected by it In utilitarian reasoning, a “good” decision is one that results in the greatest good for the greatest number of people affected by the decision V Valid contract  A contract that results when elements necessary for contract formation (agreement, consideration, legal purpose, and contractual capacity) are present unknown by a third person, and the third person has no knowledge that the agent is acting for a principal at the time the agent and the third person form a contract Validation notice  An initial notice to a debtor from a collection agency informing the debtor that he or she has thirty days to challenge the debt and request verification Unenforceable contract  A valid contract rendered unenforceable by some statute or law Variance  A form of relief or exception from zoning Uniform law  A model law created by the National Venue (pronounced ven-yoo)  The geographical dis- Conference of Commissioners on Uniform State Laws and/or the American Law Institute for the states to consider adopting If the state adopts the law, it becomes statutory law in that state Each state has the option of adopting or rejecting all or part of a uniform law and other laws that is granted to a property owner trict in which an action is tried and from which the jury is selected Verdict  A formal decision made by a jury Vertical merger  The acquisition by a company at one stage of production of a company at a higher Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Glossary   or lower stage of production (such as its supplier or retailer) Vertical restraint  Any restraint on trade created by agreements between firms at different levels in the manufacturing and distribution process Vertically integrated firm  A firm that carries out two or more functional phases—such as manufacture, distribution, retailing—of a product Vesting  Under the Employee Retirement Income Security Act of 1974, a pension plan becomes vested when an employee has a legal right to the benefits purchased with the employer’s contributions, even if the employee is no longer working for this employer Vicarious liability  Legal responsibility placed on one person for the acts of another Virus  A type of malware that is transmitted between computers and attempts to deliberate damage to systems and data Void contract  A contract having no legal force or binding effect Voidable contract  A contract that may be legally avoided (canceled, or annulled) at the option of one of the parties Voidable preference  In bankruptcy law, a pref- erence that may be avoided, or set aside, by the trustee Voir dire (pronounced vwahr deehr)  A French phrase meaning, literally, “to see, to speak.” In jury trials, the phrase refers to the process in which the attorneys question prospective jurors to determine whether they are biased or have any connection with a party to the action or with a prospective witness Voting trust  An agreement (trust contract) under which legal title to shares of corporate stock is transferred to a trustee who is authorized by the shareholders to vote the shares on their behalf W Waiver  An intentional, knowing relinquishment of a legal right Warranty  A promise that certain facts are truly as they are represented to be Warranty deed  A deed in which the grantor guar- antees to the grantee that the grantor has title to the property conveyed in the deed, that there are no encumbrances on the property other than what the G–33 grantor has represented, and that the grantee will enjoy quiet possession of the property; a deed that provides the greatest amount of protection for the grantee Warranty disclaimer  A seller’s or lessor’s negation or qualification of a warranty Waste  The abuse or destructive use of real property by one who is in rightful possession of the property but who does not have title to it Waste does not include ordinary depreciation due to age and normal use Watered stock  Shares of stock issued by a corporation for which the corporation receives, as payment, less than the fair market value of the shares Wetlands  Areas of land designated by government agencies (such as the Army Corps of Engineers or the Environmental Protection Agency) as protected areas that support wildlife and that therefore cannot be filled in or dredged by private contractors or parties Whistleblowing  An employee’s disclosure to government, the press, or upper-management authorities that the employer is engaged in unsafe or illegal activities White-collar crime  Nonviolent crime committed by individuals or corporations to obtain a personal or business advantage Winding up  The second of two stages involved in the termination of a partnership or corporation Once the firm is dissolved, it continues to exist legally until the process of winding up all business affairs (collecting and distributing the firm’s assets) is complete Workers’ compensation laws  State statutes establishing an administrative procedure for compensating workers’ injuries that arise out of—or in the course of—their employment, regardless of fault Workout  A formal contract between a debtor and his or her creditors in which the parties agree to negotiate a payment plan for the amount due on the loan instead of proceeding to foreclosure Worm  A type of malware that is designed to copy itself from one computer to another without human interaction A worm can copy itself automatically and can replicate in great volume and with great speed Worms, for example, can send out copies of themselves to every contact in your e-mail address book Writ of attachment  A court’s order, prior to a trial to collect a debt, directing the sheriff or other officer to seize nonexempt property of the debtor If the Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it G–34  Glossary creditor prevails at trial, the seized property can be sold to satisfy the judgment Writ of certiorari (pronounced sur-shee-uh-rahree)   A writ from a higher court asking the lower court for the record of a case Writ of execution  A court’s order, after a judg- ment has been entered against the debtor, directing the sheriff to seize (levy) and sell any of the debtor’s nonexempt real or personal property The proceeds of the sale are used to pay off the judgment, accrued interest, and costs of the sale Any surplus is paid to the debtor Wrongful discharge  An employer’s termina- of an employment contract or laws that protect employees Z Zoning  The division of a city by legislative regulation into districts and the application in each district of regulations having to with structural and architectural designs of buildings and prescribing the use to which buildings within designated districts may be put Zoning laws  The rules and regulations that collectively manage the development and use of land tion of an employee’s employment in violation Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Table of Cases Following is a list of all the cases mentioned in this text, including those within the footnotes, features, and case problems Any case that was an excerpted case for a chapter is given special emphasis by having its title boldfaced A Abdullahi v Pfizer, Inc., 95 Abidor v Napolitano, 167 Abraham v Alpha Chi Omega, 324 Absolute Trading Corp v Bariven S.A., 277 Aceves v U.S Bank, 218 Adams v Jones, 20 Adarand Constructors, Inc v Peña, 520 Adjani, United States v., 114 Alberty-Vélez v Corporación de Puerto Rico para la Difusión Pública, 468 Alden v Maine, 517 Allied Concrete Co v Lester, 59 Allied Erecting and Dismantling Co v Genesis Equipment & Manufacturing, Inc., 95 America Channel, LLC v Time Warner Cable, Inc., 608 American Civil Liberties Union of Ohio Foundation, Inc v DeWeese, 119 American Civil Liberties Union v National Security Agency, 117 American Express Co v Italian Colors Restaurant, 68 American Library Association, United States v., 112 American Movie Classics v Rainbow Media Holdings, 489 American Needle, Inc v National Football League, 602 A&M Records, Inc v Napster, Inc., 346 Angelo Todesca Corp., Commonwealth v., 434 Antilles Cement Corp v Fortuno, 119 Apple, Inc., United States v., 602 Apple, Inc v Amazon.com, Inc., 22–24 Apple, Inc v Samsung Electronics Company, 327 Application of the United States of America for an Order Pursuant, In re, 357 Aqua Clear Technologies, Inc., In re, 443 Arbaugh v Y&H Corp., 505 Archer v Warner, 377 Arizona v Johnson, 164 Arizona v United States, 528 Arkansas Game and Fish Commission v United States, 592 Armenian Assembly of America, Inc v Cafesjian, 441 Arnold, Schwinn & Co., United States v., 603 Ashley County, Arkansas v Pfizer, Inc., 94 Aspen Skiing Co v Aspen Highlands Skiing Corp., 608 Auer v Paliath, 482–483 Austin Rare Coins, Inc v Acoins.com, 356 Austin v Nestlé USA, Inc., 58 Autry v Republic Productions, 230 Azur v Chase Bank, USA, N.A., 471 B Bad Frog Brewery, Inc v New York State Liquor Authority, 110–111 Baker v Via Christi Regional Medical Center, 512 Basis Technology Corp v Amazon.com, Inc., 197–198 Bates v Dow Agrosciences, LLC, 573 Bates v United Parcel Service, Inc., 518 Baugh v Columbia Heart Clinic, P.A., 209–210 Beck-Wilson v Principi, 511 Bell Atlantic Corp v Twombly, 611 Bell Helicopter Textron, Inc v Islamic Republic of Iran, 182 Belmont v MB Investment Partners, Inc., 432–433 Berg & Berg Enterprises, LLC v Boyle, 464 Berg v Merchants Association Collection Division, Inc., 640 Bessemer & Lake Erie Railroad Co v Seaway Marine Transport, 283 Best Cartage, Inc v Stonewall Packaging, LLC, 399 Bestfoods, United States v., 574 Beydoun, United States v., 325 Biglane v Under the Hill Corp., 579 Biolustré, Inc v Hair Ventures, LLC, 460–461 Blackford v Prairie Meadows Racetrack and Casino, 218 Blackmon v Iverson, 209 Blackwell Publishing, Inc v Custom Copies, Inc., 339 Blankenship v USA Truck, Inc., 463 Bluewater Logistics, LLC v Williford, 430 Board of Supervisors of Louisiana State University v Smack Apparel Co., 324 Board of Trustees of the University of Alabama v Garrett, 517 Boles v Sun Ergoline, Inc., 315 Bonhomme v St James, 222 Booker, United States v., 158 Bowen v Gardner, 277 Bowman, Person v., 259–260 Bradford v Department of Community Based Services, 523 Branco v Credit Collection Services, Inc., 640 Brantley v NBC Universal, Inc., 640 Brennan’s, Inc v Colbert, 442–443 Bridgeport Music, Inc v Dimension Films, 345 TC–1 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it TC–2  Table of Cases Briefing.com v Jones, 338–389 Broadcom Corp v Qualcomm, Inc., 605 Brodie v Jordan, 456 Brown v Board of Education of Topeka, Brown v Entertainment Merchants Association, 314 Brown v W.P Media, Inc., 440 Bruesewitz v Wyeth, LLC, 307–308 B-Sharp Musical Productions, Inc v Haber, 235 B.S International, Ltd v JMAM, LLC, 276 BUC International Corp v International Yacht Council, Ltd., 329 Buckeye Check Cashing, Inc v Cardegna, 63 Buell-Wilson v Ford Motor Co., 283 Buis, In re, 380 Bullock v Philip Morris USA, Inc., 310 Bunch v Hoffinger Industries, Inc., 313 Burck v Mars, Inc., 290 Burlington Industries, Inc v Ellerth, 512 Burnett v Pourgol, 460 Burson v Simard, 240 Busch v Viacom International, Inc., 285 Byrd v Maricopa County Sheriff’s Department, 164 C Café Erotica v Florida Department of Transportation, 110 Calles v Scripto-Tokai Corp., 319 Capitol Records, Inc v Thomas-Rasset, 356 Cardizem CD Antitrust Litigation, In re, 602 Caremark International, Inc Derivative Litigation, In re, 464 Carrier Corp v Outokumpu Oyj, 613–614 Century Insurance Co v Guerrero Brothers, Inc., 367 Chalfant v Titan Distribution, Inc., 524 Chamber of Commerce of the United States v Securities and Exchange Commission, 138 Chamley v Khokha, 298 Chevron U.S.A., Inc v Natural Resources Defense Council, Inc., 129 Chiarella v United States, 628 China Agritech, Inc Shareholder Derivative Litigation, In re, 464 Chinasa, United States v., 148 Christy Sports, LLC v Deer Valley Resort Co., 616 CITGO Asphalt Refining Co v Paper, Allied-Industrial, Chemical, and Energy Workers International Union Local No 2-991, 500 Citigroup, Inc Shareholder Derivative Litigation, In re, 464 Citizens United v Federal Election Commission, 109–110 City of See name of city Clarity Services, Inc v Barney, 542 Cleary v Philip Morris USA, Inc., 562 Cleveland Construction, Inc v Levco Construction, Inc., 63–64 Cline v Berg, 597 Clint Pharmaceuticals v Northfield Urgent Care, LLC, 58 The Coca-Cola Co v The Koke Co of America, 320–321 Coco Investments, LLC v Zamir Manager River Terrace, LLC, 429 Cohen v McDonald’s Corp., 561 Cohen v Seinfeld, 241 Coker v Pershad, 468–469 Colbert v Carr, 15 Colgate & Co., United States v., 607 Collier v Turner Industries Group, LLC, 511 Columbia Pictures Industries v Bunnell, 348 Commonwealth v See name of party Community Bank & Trust v Koenig & Vits, Inc., 387 Computer Task Group, Inc v Brotby, 50 Conley v National Mines Corp., 139 Conrad v Bendewald, 339 Consolidated Edison Co v Public Service Commission, 109 Continental T.V., Inc v GTE Sylvania, Inc., 603 Covenant Health & Rehabilitation of Picayune, LP v Lumpkin, 77 Craker v Drug Enforcement Administration, 134–135 Crawford v Metropolitan Government of Nashville and Davidson County, Tennessee, 513 Credit Lyonnais Bank Nederland N.V v Pathe Communications Corp., 464 Crosswhite v Jumpking, Inc., 313 Crummey v Morgan, 34 Cuesport Properties, LLC v Critical Developments, LLC, 240 Cumbie v Woody Woo, Inc., 503 Curley v Kaiser, 404 Curves for Women Angola v Flying Cat, LLC, 415 D Davis, SEC Administrative File No 3-10080, In re, 634 Davis v HSBC Bank Nevada, N.A., 95 Davis v O’Melveny & Myers, LLC, 68 Dayton Superior Corp v Spa Steel Products, Inc., 616 Dees v United Rentals North America, Inc., 506–507, 523 Department of Housing and Urban Development v Rucker, 143 Dirks v SEC, 628 Dissolution of Midnight Star Enterprises, In re, 427 District of Columbia v Heller, 106 Dobrovolny v Ford Motor Co., 318 Dodona I, LLC v Goldman, Sachs & Co., 639 Doe v AOL, LLC, 27 Doe v Prosecutor, Marion County, Indiana, 108–109 Drake v Walton County, 592 Drummond American, LLC v Share Corp., 389 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Table of Cases   Durkee v Geologic Solutions, Inc., 319 DVD Copy Control Association v Bunner, 391 Dweck v Nasser, 461 Dynea USA, Inc v Fairbanks, 503–504 E Eastern Railroad Presidents Conference v Noerr Motor Freight, Inc., 612 eBay, Inc v MercExchange, LLC, 327 Edward J Goodman Life Income Trust v Jabil Circuit, Inc., 638 EEOC v Cheesecake Factory, Inc., 512 EEOC v Dial Corp., 520 EEOC v Fry’s Electronics, Inc., 390 EEOC v Waffle House, Inc., 517 E.I DuPont de Nemours and Co v Kolon Industries, 605–606 Eldred v Ashcroft, 328, 336 Ellis v Bluesky Charter School, 491 Engler v Atlantic Resource Management, LLC, 562 Entergy Corp v Riverkeeper, Inc., 568–569 ESPN, Inc v Quiksilver, Inc., 323 Espresso Disposition Corp v Santana Sales & Marketing Group, Inc., 47–48 Esprit Log and Timber Frame Homes, Inc v Wilcox, 240 Estate v See name of party Estee Lauder Companies v Batra, 389 Eurodif, S.A., United States v., 182 F Fadal Machining Centers, LLC v Mid-Atlantic CNC, Inc., 430 Fair Housing Council of San Fernando Valley v Roommate.com, LLC, 353 Family Winemakers of California v Jenkins, 103–104 Faragher v City of Boca Raton, 512 Faretta v California, 41 Farhang v Indian Institute of Technology, 182 Federal Baseball Club of Baltimore, Inc v National League of Professional Baseball Clubs, 612 Federal Communications Commission v Fox Television Stations, Inc., 126–127 Federal Trade Commission v Check Investors, Inc., 562 Federal Trade Commission v MedLab, Inc., 546 Federal Trade Commission v Verity International, Ltd., 550 Federal Trade Commission v Whole Foods Market, Inc., 607 Feldman v Google, Inc., 204 Felix Storch, Inc v Martinucci Desserts USA, Inc., 488 Ferguson v Jenkins, 395 First National Bank of Boston v Bellotti, 109 TC–3 Fisher v University of Texas, 521 Fitl v Strek, 269–270 Fleshner v Pepose Vision Institute, 58 FMS, Inc v Volvo Construction Equipment North America, Inc., 408 Fontanez-Nunez v Janssen Ortho, LLC, 512 Fox Television Stations, Inc v Federal Communications Commission, 127 Francin v Mosby, Inc., 518 Frosty Treats, Inc., v Sony Computer Entertainment America, Inc., 323 Fteja v Facebook, Inc., 204 Fuji Photo Film Co v International Trade Commission, 174 G Gaming Venture, Inc v Tastee Restaurant Corp., 212 Garcia v Lucero, 414 Garware Polyester, Ltd v Intermax Trading Corp., 178 Gaudin, United States v., 450 Gebhart v SEC, 630 Geertson Seed Farms v Johanns, 576 George V Restauration S.A v Little Rest Twelve, Inc., 325 Gholston, In re, 386–387 Gibbons v Ogden, 102 Gilland v Sportsmen’s Outpost, Inc., 390 Gilmer v Interstate Johnson Lane Corp., 68 Glacial Plains Cooperative v Lindgren, 257 Golan v Holder, 335–336 Goldberg v UBS AG, 169 Goldman v Cohen, 561 Gomez-Perez v Potter, 515 Gonzales v Raich, 102 Gratz v Bollinger, 520 Gray Printing Co v Blushing Brides, LLC, 430 Greenman v Yuba Power Products, Inc., 307 Green Mountain Chrysler Plymouth Dodge Jeep v Crombie, 577 Grinnell Corp, United States v., 605 Griswold v Connecticut, 116 Gross v FBL Financial Services, Inc., 515 Grutter v Bollinger, 520 Gucci America, Inc v Wang Huoqing, 35–36 Gunasekera v Irwin, 119 Guth v Loft, Inc., 448–449, 463 Guttman v Huang, 464 Guzman, United States v., 119 H Haas, SEC Administrative File No 3-10081, In re, 634 Hallmark Cards, Inc v Murley, 231–232 Hall v Geiger-Jones Co., 632 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it TC–4  Table of Cases Hamer v Sidway, 208 Hamilton v Beretta U.S.A Corp., 390 Hanjuan Jin, United States v., 339 Harman v McAfee, 387 Harris v Forklift Systems, 512 Hartwell, United States v., 114 Harvestons Securities, Inc v Narnia Investments, Ltd., 59 Hasbro, Inc v Internet Entertainment Group, Ltd., 344–345 Hashmi v Mukasey, 541 Hausman, In re, 439 Hawkins v McGee, 196 Heart of Atlanta Motel v United States, 102 Hebbring v U.S Trustee, 371 Hemp Industries Association v Drug Enforcement Administration, 129 Henderson v National Railroad Passenger Corp., 303 Hernandez v Banks, 211 Holiday Inn Franchising, Inc.v Hotel Associates, Inc., 411–412 Holmes v Multimedia KSDK, Inc., 214 Horton Automatics v The Industrial Division of the Communications Workers of America, 77 Horvath v HRT Enterprises, 414 Hosch v Colonial Pacific Leasing Corp., 215 Houseman v Dare, 268 Hunter v Mansell, 597 Hurst v Socialist People’s Libyan Arab Jamahiriya, 183 Huskin v Hall, 488–489 Hustler Magazine, Inc v Falwell, 285 Hypertouch, Inc v Valueclick, Inc., 548–550 I Illeto v Glock, Inc, 390 Illinois Tool Works, Inc v Independent Ink, Inc., 610 Indiana Surgical Specialists v Griffin, 360 In re See name of party Intel Corp Microprocessor Antitrust Litigation, In re, 51 International Paper Co v Stuit, 390 International Shoe Co v State of Washington, 29 Izquierdo v Gyroscope, Inc., 296 J Jacob & Youngs v Kent, 224–225 Jamieson v Woodward & Lothrop, 316 Jamison Well Drilling, Inc v Pfeifer, 233 Jannusch v Naffziger, 250 Jauregui v Bobb’s Piano Sales & Service, Inc., 269 Jaynes v Commonwealth of Virginia, 159 Jerman v Carlisle, McNellie, Rini, Kramer & Ulrich, LPA, 558–560 Jesmer v Retail Magic, Inc., 205 Jespersen v Harrah’s Operating Co., 509 Jiann Min Chang v Alabama Agricultural and Mechanical University, 508 Ji-Haw Industrial Co v Broquet, 29 Joel v Morison, 483 Johnson Construction Co v Shaffer, 80–81 Johnson v California, 115 Johnson v Medtronic, Inc., 312–313 Johnston v School District of Philadelphia, 509 John Wiley & Sons, Inc v Kirtsaeng, 332 Jones, United States v., 153 Jones v Adams, 20 Jones v Hamilton, 339 Jones v Star Credit Corp., 258 Jordan v Moses, 404 JTH Tax, Inc., People v., 415 K Kailin v Armstrong, 597 Kelly v United States, 211 Kelo v City of New London, Connecticut, 590 Khulumani v Barclay National Bank, Ltd., 178 Kim v Park, 227 Kiobel v Royal Dutch Petroleum Co., 179–180 Kirtsaeng v John Wiley & Sons, Inc., 332 Kiwanuka v Bakilana, 303 Klimecek, United States v., 164 Koch Materials Co v Shore Slurry Seal, Inc., 265 Kohel v Bergen Auto Enterprises, L.L.C., 226–227, 241 Kozeny, United States v., 95 Krasner v HSH Nordbank AG, 94 KSR International Co v Teleflex, Inc., 326 Kuehn, In re, 372 Kuhn v Tumminelli, 422 L LabMD, Inc v Tiversa, Inc., 356–357 Laborers’ International Union of North America, Local 578 v National Labor Relations Board, 541 Landy v D’Alessandro, 464 Lane v Facebook, Inc., 94 Langdon v Google, Inc., 107 LaSalle Bank National Association v Cypress Creek 1, 386 Laurel Creek Health Care Center v Bishop, 470 Lawrence v Fox, 216 Leadsinger, Inc v BMG Music Publishing, 331 Ledbetter v Goodyear Tire Co., 511 Leegin Creative Leather Products, Inc v PSKS, Inc., 603–604, 616 Lee v Miner, 101 Les Enterprises Jacques Defour & Fils, Inc v Dinsick Equipment Corp., 268 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Table of Cases   Lewis v Heartland Inns of America, LLC, 523 L&H Construction Co v Circle Redmont, Inc., 220 Lhotka v Geographic Expeditions, Inc., 68–70 Linde v Arab Bank, PLC, 170–171 Litwin v Blackstone Group, LP, 624–625 Li v Canberra Industries, 504 Livonia, City of, Employees’ Retirement System and Local 295/Local 851 v Boeing Co., 630–631 LJL Transportation, Inc v Pilot Air Freight Corp., 411 Local Joint Executive Board of Las Vegas v National Labor Relations Board, 534–535 Lockheed Martin Corp v Speed, 542 Lopez, United States v., 102 Lopez v El Palmar Taxi, Inc., 468 Louis Vuitton Malletier S.A v Haute Diggity Dog, LLC, 322 Lowden v T-Mobile USA, Inc., 76 Lucas, United States v., 569–570 Lucy v Zehmer, 196 Lumley v Gye, 291 Lundberg v Church Farm, Inc., 476–477 Lyondell Chemical Co v Ryan, 448 Lyons, United States v., 148 M MacPherson v Buick Motor Co., 306 Main Avenue, LLC v PP Door Enterprise Inc., 387 Mala v Crown Bay Marina, Inc., 31–32 Manin v National Transportation Safety Board, 139 Marbury v Madison, 29, 101 Massachusetts v Environmental Protection Agency, 138, 566 Matrixx Initiatives, Inc v Siracusano, 638 Maverick Recording Co v Harper, 347–348 Mayo Foundation for Medical Education and Research v United States, 130–131 May v Chrysler Group, LLC, 82–83 Mazak Corp v King, 463 McBeth v Carpenter, 429 McBride v Taxman Corp., 479 McCall v Scott, 464 McDonald’s Corp v C.B Management Co., 414 McFarland v Virginia Retirement Services of Chesterfield, LLC, 416 McKeag v Finley, 597 McKee v Laurion, 287–288 McKennon v Nashville Banner Publishing Co., 520 McLean v JPMorgan Chase Bank, N.A., 362–363 McMurtry v Weatherford Hotel, Inc., 303 Mead Corporation, United States v., 130 Medtronic, Inc v Hughes, 303 Messerschmidt v Millender, 154–155 Metro-Goldwyn-Mayer Studios, Inc v Grokster, Ltd., 346 Microsoft Corp., United States v., 607 Microsoft Corp v AT&T Corp., 327 TC–5 Midwest Automotive III, LLC v Iowa Department of Transportation, 410 Miller v California, 111 Miller v Harris, 489 Miller v U.S Foodservice, Inc., 464 Mims v Starbucks Corp., 494 Mintel Learning Technology, Inc v Ambrow Education Holding Ltd., 333 Mirama Enterprises, Inc., United States v., 555 Miranda v Arizona, 155–156 Missouri ex rel Nixon v American Blast Fax, Inc., 550 Mitchell County v Zimmerman, 113 MM Companies, Inc v Liquid Audio, Inc., 445 Moeller, In re, 464 Monsanto Co v Bowman, 326 Monsanto Co v Scruggs, 326 Moore v Barony House Restaurant, LLC, 318 Moore v Moore, 488 Morales-Cruz v University of Puerto Rico, 513–514 Moran v Willensky, 415 Mora v Jackson Memorial Foundation, Inc., 515–516 Moren v Jax Restaurant, 402 Morrison, United States v., 102 Morse v Frederick, 108 Moseley v Pepco Energy Services, Inc., 88–90 Moseley v V Secret Catalogue, Inc., 322 Mosley, In re, 377 Moundridge, Kansas, City of v Exxon Mobil Corp., 608 Mueller v McMillian Warner Insurance Co., 298 Myers v Lutsen Mountains Corp., 389 N Nagrampa v MailCoups, Inc., 68 National Aeronautics and Space Administration v Nelson, 501–502 National Football League Players Association v National Football League Management Council, 77 National Steel Corp v NLRB, 530 Nationwide Mutual Insurance Co v Wood, 218 NCR Corp v Korala Associates, Ltd., 66–67 Nevada Department of Human Resources v Hibbs, 517 New York, City of v Beretta U.S.A Corp., 390 New York, State of v Green, 165 New York State Restaurant Association v New York City Board of Health, 562 New York Times Co v Sullivan, 289 NLRB v Town & Country Electric, Inc., 531 Nobody in Particular Presents, Inc v Clear Channel Communications, Inc., 608 Nomo Agroindustrial Sa De CV v Enza Zaden North America, Inc., 272 Nosal, United States v., 475 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it TC–6  Table of Cases O O’Brien, In re, 349–350 O’Donnell v Burlington Coat Factory Warehouse, Inc., 523 OfficeSupplyStore.com v Kansas City School Board, 254 Olmstead v United States, 116 Olsen v Johnston, 218 Omole, United States v., 165 Oncale v Sundowner Offshore Services, Inc., 514 OnNet USA, Inc v Play9D.com, 343 Ora, Commonwealth v., 108 Oregon v Legal Services Corp., 37 ORX Resources, Inc v MBW Exploration, LLC, 417–418, 430 Oshana v Buchanan Energy, 414 Overseas Private Investment Corp v Kim, 386 Owner-Operator Independent Drivers Association, Inc v Federal Motor Carrier Safety Administration, 139 P Pacific Bell Telephone Co v Linkline Communications, Inc., 607 Padma Paper Mills, Ltd v Universal Exports, Inc., 276 Paduano v American Honda Motor Co., 551–552 Palsgraf v Long Island Railroad Co., 297–298 Pan Handle Realty, LLC v Olins, 189–190 Parents Involved in Community Schools v Seattle School District No 1, 521 Parker v Brown, 612 Payne v Hurwitz, 230 PCS Nitrogen Inc v Ashley II of Charleston LLC, 577 Pelman v McDonald’s Corp., 316 Pennsylvania State Police v Suders, 512 Persson v Smart Inventions, Inc., 460 Philipello v Taylor, 390 PhoneDog v Kravitz, 333 Piazza v Major League Baseball, 612 Pietrylo v Hillstone Restaurant Group, 351 Plessy v Ferguson, Polk v Polk, 420–421 Pomales v Celulares Telefonica, Inc., 512 Portnoy v Cryo-Cell International, Inc., 453 Powerhouse Custom Homes, Inc v 84 Lumber Co., 202 Printz v United States, 102 Production Resources Group, LLC v NCT Group, Inc., 464 Purdue Frederick Co., United States v., 79 Q Quality Car & Truck Leasing, Inc v Sark, 395–396 Quality Pork International v Rupari Food Services, Inc., 257 Quill Corp v North Dakota, 250 R Ragsdale v Wolverine World Wide, Inc., 496 Ramsey v Allstate Insurance Co., 218 Rangel v sanofi aventis U.S LLC, 523 Rapanos v United States, 569 Redevelopment Authority of City of Philadelphia v New Eastwick Corp., 596–597 Regina v Dudley and Stephens, 27 Ricci v DeStefano, 509 Riegel v Medtronic, Inc., 105 Riverdale Mills Corp v Pimpare, 138 River Runners for Wilderness v Martin, 576–577 Robinson v Match.com, LLC, 222 Rocky Mountain Chocolate Factory, Inc v SDMS, Inc., 409 Rodriquez v Wal-Mart Stores, Inc., 351 Rogalski v Little Poker League, LLC, 192 Roman Catholic Church of Our Lady of Sorrows v Prince Realty Management, LLC, 583 Roscoe, People v., 144 Rose, United States v., 616–617 Roundy’s, Inc v NLRB, 529 Royal & Sun Alliance Insurance, PLC v International Management Services Co., 277 RSN Properties, Inc v Engineering Consulting Services, Ltd., 238 Rubin v Murray, 436 Rylands v Fletcher, 305 S Sackett v Environmental Protection Agency, 571–572 Safeco Insurance Co of America v Burr, 557 Sánchez-Rodríguez v AT&T Mobility Puerto Rico, Inc., 510 Santa Barbara, City of v Superior Court, 389 Santiago v Phoenix Newspapers, Inc., 488 Santivanez v Estado Plurinacional de Bolivia, 182 Saunders v Branch Banking & Trust Co of Virginia, 557 Scarborough v Rollins, 588–589 Schmude v Tricam Industries, Inc., 310 Schroer v Billington, 544 Scotwood Industries, Inc v Frank Miller & Sons, Inc., 277 Scouler & Co., LLC v Schwartz, 464 SDBC Holdings, Inc v National Labor Relations Board, 541 Seal Polymer Industries v Med-Express, Inc., 27, 58 Search King, Inc v Google Technology, Inc., 107 SEC v Alpha Telcom, Inc., 619 SEC v Edwards, 619 SEC v Montana, 639 SEC v Rocklage, 628 SEC v Texas Gulf Sulphur Co., 626–627 SEC v W J Howey Co., 619 Selleck v Cuenca, 221 Services Employees International Union v National Union of Healthcare Workers, 531–532 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Table of Cases   Sexton, In re, 386 Shar’s Cars, LLC v Elder, 402 Sheridan v Marathon Petroleum Co., 616 SHL Imaging, Inc v Artisan House, Inc., 470 Shoop v DaimlerChrysler Corp., 273 Shoyoye v County of Los Angeles, 285 Simels, In re, 450 Singh, United States v., 144 Sitaras, SEC Administrative File No 3-10082, In re, 634 Slusser v Vantage Builders, Inc., 494 Smith v Atlantic Gun & Tackle, Inc., 390 Smith v Cutter Biological, Inc., 313 Smith v Ingersoll-Rand Co., 316 Smith v Johnson and Johnson, 494 Sniezek v Kansas City Chiefs Football Club, 218 Socony-Vacuum Oil Co., United States v., 602 South Dakota, State of v Rolfe, 356 Southern Prestige Industries, Inc v Independence Plating Corp., 30 Spectrum Stores, Inc v Citgo Petroleum Corp., 171 Sricom, Inc v Ebislogic, Inc., 389 Stainbrook v Low, 236 Stambovsky v Ackley, 585–586 Standard Oil Co of California v United States, 609 Stanford, United States v., 636 Stanley, In re, 368 Starbucks Corp v Lundberg, 322 Stark v Ford Motor Co., 318 Starr v Sony BMG Music Entertainment, 616 State Farm Mutual Automobile Insurance Co v Campbell, 283 State Oil Co v Khan, 603 State v See name of opposing party Stewart, United States v., 631 S & T Oil Equipment & Machinery, Ltd v Juridica Investments, Ltd., 176–177 Stone v Jetmar Properties, LLC, 440 Stop the Beach Renourishment, Inc v Florida Department of Environmental Protection, 641 STR Constructors, Ltd v Newman Tile, Inc., 240 Stultz v Safety and Compliance Management, Inc., 213 Supreme Court of New Hampshire v Piper, 101 Sutherland Institute v Continuative, LLC, WIPO Arbitration and Mediation Center, 390 Sutowski v Eli Lilly & Co., 313 T Tatman v Space Coast Kennel Club, Inc., 389 Taylor v Baseball Club of Seattle, LP, 299–300 Taylor v Caldwell, 388 TEKsystems, Inc v Bolton, 389 Tennessee v Lane, 517 Tepperwien v Entergy Nuclear Operations, Inc., 514 Texas v Johnson, 106 TC–7 Thomas Weisel Partners, LLC v BNP Paribas, 389 Thompson v North American Stainless, 513 Town of Midland v Morris, 590–592 Toyota Motor Sales, U.S.A., Inc v Tabari, 344 Travelscape, LLC v South Carolina Department of Revenue, 250 Treadway v Gateway Chevrolet Oldsmobile, Inc., 556 Triple E, Inc v Hendrix & Dail, Inc., 272 Trollinger v Tyson Foods, Inc., 526–527 Trunk v City of San Diego, 113 Trustees of Dartmouth College v Woodward, 434 Tull v Atchison Leather Products, Inc., 504 Tummino v Hamburg, 554 Turner v State of Arkansas, 164 U Uhrhahn Construction & Design, Inc v Hopkins, 194 UMG Recordings, Inc v Augusto, 331 United Fabrics International, Inc v C&J Wear, Inc., 339 United Mine Workers of America v Pennington, 612 United States v See name of opposing party U.S Airways, Inc v Barnett, 520 USDigital, Inc., In re, 464 V Van Horn v Watson, 299 Van Orden v Perry, 113 Varsity Gold, Inc v Porzio, 390 Venture Sales, LLC v Perkins, 423–424 Verizon New York, Inc v National Labor Relations Board, 540–541 Video Software Dealers Association v Schwarzenegger, 314 Village of Euclid v Ambler Realty Co., 593 Vitt v Apple Computer, Inc., 276 Vizcaino v U.S District Court for the Western District of Washington, 469 W Wachovia Securities, LLC v Banco Panamericano, Inc., 461 Waddell v Boyce Thompson Institute for Plant Research, Inc., 492–493 Wallace v Busch Entertainment Corp., 389 Wal-Mart Stores, Inc v Coughlin, 463 Wal-Mart Stores, Inc v Dukes, 506 Warner v Southwest Desert Images, LLC, 481 Warnick v Warnick, 404 Water Craft Management, LLC v Mercury Marine, 609 Watts v Lester E Cox Medical Centers, 284 Webster, Estate of v Thomas, 405–406 Weidner v Carroll, 331 Weimar v Lyons, 461 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it TC–8  Table of Cases Welsh, In re, 381–382 Wendeln v The Beatrice Manor, Inc., 492 Western Fire Truck, Inc v Emergency One, Inc., 489 Weyerhaeuser Co v Ross-Simmons Hardwood Lumber Co., 608 Whitehead v Humphrey, 585 White Plains Coat & Apron Co v Cintas Corp., 303 Whitmer, People v., 146–147 Wickard v Filburn, 102 Wilchcombe v TeeVee Toons, Inc., 339 Williams, United States v., 112 Williams v Beemiller, Inc., 390 Willis v Coca Cola Enterprises, Inc., 503 Wilson Court Limited Partnership v Tony Maroni’s, Inc., 365–366 Wilson Sporting Goods Co v Hickox, 310–311 Winstead v Jackson, 329–330, 339 Wisconsin Electric Power Co v Union Pacific Railroad Co., 224 WPS, Inc v Expro Americas, LLC, 254–255 Wrench, L.L.C v Taco Bell Corp., 217 Wright v Finance Service of Norwalk, Inc., 558 Wright v Moore, 298 Y Yeagle v Collegiate Times, 303 Yi, United States v., 27 Yun Tung Chow v Reckitt & Coleman, Inc., 318 Z Z4 Technologies, Inc v Microsoft Corp., 328 02 Development, LLC v 607 South Park, LLC, 419 Zippo Manufacturing Co v Zippo Dot Com, Inc., 33 Zortman v J.C Christensen & Associates, Inc., 640 Zucco Partners, LLC v Digimarc Corp., 638 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index A Absolute promises, 223 Abusive litigation, 290–291 Acceptance authorized means of, 202 communication of, 201–202, 253–254 conditioned on offeror’s assent, 255 contractual, 191, 200–203 defined, 200 of delivered goods, 265–266 revocation of, 269 deposited acceptance rule, 202 e-mail, 202 lease contracts, 253–256 mailbox rule, 202 mirror image rule, 200, 254 mode of, 202 online for e-contracts, 204–205 as requirement of contract, 191 sales contracts, 253–256 silence as, 201 substitute method of, 202–203 timeliness of, 202 unequivocal, 200–201 Accommodation, nonconforming goods shipped as, 253 Accord, satisfaction and, 228 Accounting agent’s duty to, 472–473 of partnership assets or profits, 400 requirements to prevent bribes of foreign officials, 92 Accredited investors, 622–623 Act, promise for, 192 Actionable, 285 Act of state doctrine, 171 Acts, authorized and unauthorized, by agent, 478–479 Actual (express or implied) authority, 474 Actual malice, 289 Actus reus, 142 Adequate protection doctrine, 372 Adhesion contract, 68 Adjudication, 133–135 Adjustable-rate mortgage, 361 Administrative agencies, 121–136 adjudication by, 133–135 agency orders, 134 arbitrary and capricious test, 125–127 as bureaucracy, 125 Chevron deference, 129–131 comprehensive regulatory scheme, 121–122 creation of, 122 decisions by, judicial deference to, 129–131 defined, delegation doctrine, 124–125 enabling legislation, 122 enforcement of rules by, 132–135 formal complaints, 133 informal actions by, 129 investigations by, 132–144 negotiated settlements, 133 powers of, and Constitution, 124–125 public accountability, 136 rulemaking by, 127–129 social media and, 349–350 throughout government, 121 types of, 122–124 Administrative employees, overtime wages, 494 Administrative law defined, finding, 14 Administrative law judge (ALJ), role of, 133–134 Administrative Procedure Act (APA), 125–129, 133–134 Administrative rules, 14 Admission exception to Statute of Frauds, 256–257 request for, 50 Adverse possession, 588–589 Advertisements bait-and-switch advertising, 547 based on half-truths, 547 clear and conspicuous disclosure, 547 contractual offers versus, 197 counteradvertising, 550 deceptive advertising, 546–551 FTC actions, 550 online deceptive, 547–550 puffery, 546 spam, 547–550 Affidavits, 49 Affirmation, express warranty and, 271 Affirmative action, 520–521 Affirmative defense, 46, 299 Affordable Care Act, 100, 499 After-acquired evidence of employee misconduct, 520 Age discrimination based, 515–517 of majority, 210 replacing older workers with younger, 516–517 Age Discrimination in Employment Act (ADEA), 180, 505 procedures under, 515–516 replacing older workers with younger, 516–517 state employees not covered by, 517 Agency relationship, 466–486 coupled with an interest, 485 defined, 466 duties in, 472–473 employer-employee relationships, 466–467 employer–independent contractor relationships, 467 employment status determination, 467–469 I–1 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–2  Index with foreign firm, 172 formation of, 470–471 by agreement, 470 by estoppel, 471 by operation of law, 471 by ratification, 470–471 liability in for contracts, 478–480 for torts and crimes, 480–484 partnership and, 396–397, 401 rights and remedies in, 473–474 termination of, 484–486 Agents acts of authorized, 478–479 e-agents, 479–480 authority of apparent, 476–477 emergency, 477 equal dignity rule, 474 express, 474 implied, 474–475 power of attorney, 474 ratification, 477 bankruptcy, agency termination and, 486 of corporation, 438, 466 crimes of, 484 death or insanity, agency termination and, 485 defined, 199, 466 duties of accounting, 472 loyalty, 472 obedience, 472 performance, 472 to principal, 472–473, 542 gratuitous, 472 insurance agent, 467 misrepresentation of, 480–481 negligence of, 481–483 nonpartner agent, 398–399 principal’s duties to, 473, 543 rights and remedies of, 473–474 termination of agency, 484–486 torts of, 483–484 Agreements acceptance, 200–203 agency formation by, 470 buy-sell agreement (buyout agreement), 405–406 click-on agreement, 204 contract discharge by, 227–228 contractual, 191, 195–203 creditors’ composition, 360 lease See Lease contracts mutual assent, 195 noncompete, 213 offer requirement, 196–199 offer termination, 199–200 operating, 421–422 partnership, 398–399 preliminary, 197–198 price-fixing, 601 reaffirmation agreement, 377–378 as requirement of contract, 191 resale price maintenance agreement, 603–604 settlement, 228 shrink-wrap agreement, 204–205 that lack consideration, 207–210 tie-in sales agreement, 609 Agriculture, Department of, 123 Air pollution, 565–567 mobile sources, 565–566 stationary sources, 566 violations of Clean Air Act, 566–567 Airspace rights, 578 Alien corporation, 434 Alien Registration Receipt, 526 Alien Tort Claims Act (ATCA), 178 Alleges, 10 Alter-ego theory, 443 corporations and, 417, 443 limited liability company and, 417–418 Alternative dispute resolution (ADR) advantages of, 60 arbitration, 62–71 integration of, with court procedures, 72–73 mediation, 61–62 negotiation, 60–61 online (ODR), 73–74 service providers, 73 Amazon tax, 250 America Invents Act, 326 American Arbitration Association (AAA), 73 American Bar Association, 81 American Institute of Certified Public Accountants (AICPA), 81 American Law Institute, 206 American Nurses Association, 81 Americans with Disabilities Act (ADA), 180, 505 disability defined, 517–518 procedures under, 517 reasonable accommodations, 518–519 Answer, 46 Anticipatory repudiation, 227, 266 Anti-Counterfeiting Trade Agreement (ACTA), 337 Anticybersquatting Consumer Protection Act (ACPA), 342, 343 Antidumping duty, 175 Antitrust law, 599–614 Clayton Act, 608–610 enforcement of, 611 exclusionary practices, 609–610 exemptions from, 611, 612 extraterritorial application of, 612–614 global context and, 178 global context for, 611–614 historical perspective on, 599 horizontal restraint, 601–602 interlocking directorates, 610 mergers, 610 monopolization, 604–608 per se violations and rule of reason, 600–601 price discrimination, 608–609 restraints of trade and, 599 Sherman Antitrust Act, 599–608 television programmers, 640 vertical restraints, 602–604 Apparent authority, 474, 480 Apparent power, 476–477 Appeals filing, 55 notice of, 55 process of, in lawsuit, 55–56 Appearance-based discrimination, 509 Appellant, 20, 55 Appellate (reviewing) courts appellate review and, 55 decisions of, 14–15 defined, 14 federal, 40–41 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   higher, 55–56 state, 39 Appellate jurisdiction, 30 Appellate review, 55 Appellee, 20, 55 Application, in legal reasoning, 10 Appropriation, 290 Arbitrary and capricious test, 125–127 Arbitrary trademark, 323 Arbitration, 62–71 arbitrability issues, 66–67 award, 66 court-annexed, 72–73 defect in process, 71 defined, 62 disadvantages of, 71 enforcement of agreements to submit to, 66–70 as form of ADR, 62 hearing, 64, 66 international business and, 74 mediation-arbitration, 61 nonbinding, 62 process of, 64–66 service providers, 73 setting aside award, 70–71 statutes of, 62–64 submission, 64–65 Arbitration clause, 62, 74 Arbitrator, 62, 72 Aristotle, 11 Arrest, 157 Arson, 147 Arthur Andersen, 87 Articles of incorporation filing, 439 preparing, 438–439 Articles of organization, formation of LLC and, 418 Articles of partnership, 398–399 Artisan’s lien, 293, 359 Assault, 9, 145, 284 Assets accounting of, in partnerships, 400 acquiring by corporate officers/ directors, 463 distribution of in limited partnership, 427 in partnership dissolution, 404–405 valuation in limited partnership, 427 Assignment, 214–215 Assignor, assignee, 215 Assisted negotiation, 60–61 Assumption of risk defense, 299–300 to product liability, 315 Assurance, right of, 265 Attachment, writ of, 359–360 Attorneys consulting with, 42–44 types of fees for, 43 Attractive nuisance doctrine, 293 Auction fraud, online, 159 Authority actual, 474 of agent, 474–475 apparent, 474, 480 binding, certificate of, 434 equal dignity rule, 474 express, 474 implied, 474–475 of partners, 401 persuasive, Authorization card, 534 Automatic stay, 372–373 Avoidance, powers of, 373 Award, in arbitration, 66 setting aside, 70–71 B Bad faith, bankruptcy and, 373 Bailee, 261 goods held by, 262 Bailment, 261, 306 Bait-and-switch advertising, 547 Bankruptcy, 368–383 adequate protection doctrine, 372 agency termination and, 486 automatic stay, 372–373 bad faith, 373 courts, 368 cram-down provision, 379–380 credit counseling and, 370 creditors’ claims, 375 creditors’ committees, 378 creditors’ meeting, 375 I–3 as defense to surety/guarantor, 366 discharge in, 229, 369, 376–377, 380, 383 distribution of property in, 375–376 estate in property of, 373 exemptions in, 374–375 family farmers and fishermen, 383 fraudulent transfers, 374 good faith requirement, 380 individuals’ repayment plans, 380–383 involuntary, 371–372 law governing, 368 liquidation proceedings, 369–378 means test, 370–371, 373 order for relief, 371, 372 ordinary, 369 of partner in limited partnership, 427 petition in, 370 preferences in, 374 reaffirmation agreement, 377–378 reorganizations, 378–380 straight, 369 substantial abuse, 370–371 tax returns during, 370 trustee in, 369, 373–374 voluntary, 370–371 workouts, 378 Bankruptcy Code Chapter of (liquidation proceedings), 368, 369–378 Chapter 11 of (reorganization), 368, 378–380 Chapter 12 of (adjustment of debts by family farmers and family fisherman), 368, 383 Chapter 13 of (adjustment of debts by individuals), 368, 380–383 Bankruptcy court, 30 Bankruptcy fraud, 149 Bankruptcy Reform Act, 368 Bankruptcy Reporter (Bankr or B.R.), 15 Bargained-for exchange, 207 Bargaining, good faith bargaining by unions, 529–530 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–4  Index Bargaining representative, 532 Bargaining unit, 535 Barings Bank, 87 Basis of bargain, 272 Battery, 284–285 Beneficiary intended, 215–216 third party, 214, 215–216 Benefit corporation, 436 Bentham, Jeremy, 85 Berne Convention, 334–336 Best available control technology (BACT), 567 Best practical control technology (BPCT), 567 Beyond a reasonable doubt, 54, 140–141, 158 Bilateral agreement, 168 Bilateral contracts, 191–192 Bilateral (mutual) mistake, 220 Bill of lading, 193, 259 Bill of Rights See also individual amendments business and, 105–114 defined, 105 freedom of religion, 112–113 freedom of speech, 106–112 limits of federal and state actions, 105–106 search and seizure, 113–114 self-incrimination, 114 summary of, 106 Binding authority, Binding mediation, 61 Black-letter law, 388 Board of directors See Directors, corporate Bona fide occupational qualification (BFOQ), 519 Border searches, electronic devices and, 167 Botnets, 160 Brandeis, Louis, 116 Breach defined, of fiduciary duties, in partnership, 401 Breach of contract contract provisions limiting remedies for, 237–238 damages for, 230–235 defined, 225 equitable remedies for, 235–237 franchise and opportunity to cure, 410–411 material, 223, 225–226 minor, 225–226 sales or lease international goods, 274 remedies for, 266–271 risk of loss, 262 statute of limitations and, 229 waiver of, 237 Bribes of foreign officials, 91–92 types of, 148–149 as white-collar crime, 148–149 Brief, 55 Browse-wrap terms, 205 Bucklin, Leonard H., 87 Burden of proof, civil law compared to criminal law, 140–141 Bureaucracy, 125 See also Administrative agencies Burglary, 145 Business Bill of Rights and, 105–114 budget cuts for state courts and, 38 search and seizure in, 114 wrongful interference with, 292 Business ethics, 78–98 See also Ethics corporate social responsibility, 86–87, 97–98 decision making and, 79–80 defined, 78 importance of, 79–80 international business and, 90–92 leadership in, 88–90 making ethical, 87 moral minimum, 80 obstacles to ethical business behavior, 96–97 principles and philosophies of, 84–87 profit maximization, 78–79 social media and, 83–84 studying, 78–79 systematic approach to decision making, 87–88 triple bottom line and, 79 uncertainty and, 81–82 Business judgment rule, 447–448 Business necessity, as defense to employment discrimination, 519 Business organization franchises, 406–412 limited liability company, 416–424 limited liability partnership, 424–425 limited partnership, 425–428 major forms compared, 457–458 partnerships, 396–406 sole proprietorship, 394–396 Business Process Pragmatism, 87–88 Business torts, 291–292 Business trusts, 599 Buyer obligation of, 265–266 remedies for, 267–270 Buyout price, 403–404 Buy-sell agreement (buyout agreement), 405–406 Bylaws, 438, 439 C Capacity, contractual, 191, 210–211 Capper-Volstead Act, 612 Carbon dioxide, 566 Care due, 446–447, 463–464 product liability, 306 duty of breach of, 295–296 corporate directors, 446–447, 463–464 corporate officers, 446–447, 463–464 defined, 295 partnerships, 401 reasonable, 293 reasonable person standard, 295 standard of, 472 Carrier delivery via, 263–264 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   substitution of, 264 Carrier cases, 261 Case law common law doctrines and, 5–6 defined, 5–6 finding, 14–15 old, 15 as primary source of law, reading and understanding, 15–21 Cases briefing, 21 of first impression, on point, 10 sample, 20–24 terminology of, 20 titles of, 20 Categorical imperative, 85 Catfishing, 222 Causation in fact, 296 foreseeability, 297–298 legal cause, 296 negligence and, 296–297 proximate cause, 296 standing to sue, 37 Cause franchise termination for cause, 410 superseding cause, 300–301 Cease-and-desist order, 529, 550 Censorship, global companies and, 185–186 Central America–Dominican Republic–United States Free Trade Agreement (CAFTADR), 176 Certificate of authority, 434 Certificate of limited partnership, 426 Certification mark, 324 Chain-style business operation, 407 Chancellor, Chapter (liquidation proceedings) automatic stay, 372–373 creditors’ claims, 375 creditors’ meeting, 375 discharge in, 376–377 distribution of property in, 375–376 estate in property of bankruptcy, 373 exemptions in, 374–375 involuntary bankruptcy, 371–372 means test, 370–371, 373 order for relief, 371, 372 reaffirmation agreement, 377–378 schedules of, 370 substantial abuse, 370–371 tax returns during, 370 trustee in, 373–374 voluntary, 370–371 Chapter 11 (reorganization) best interests of creditors, 378 cram-down provision, 379–380 creditors’ committees, 378 debtor in possession (DIP), 378 fast-track procedure, 378 reorganization plan, 379–380 workouts, 378 Chapter 12 (adjustment of debts by family farmers and family fisherman) contents and confirmation of plan, 383 filing petition, 383 Chapter 13 (adjustment of debts by individuals) filing petition, 380 good faith requirement, 380 repayment plan, 382–383 Charges to jury, 54 Charging order, 400 Checks and balances, 101 Chevron deference, 129–131 Chick-fil-A restaurant chain, 84 Child labor, 493–494 Children’s Internet Protection Act (CIPA), 112 China, antitrust law and, 614 Choice-of-law clause, 71, 74, 204 C.I.F or C.&F (cost, insurance, and freight or just cost and freight), 261 CISG See Contracts for the International Sale of Goods (CISG) Citations case, 15 defined, 13 I–5 how to read, 17–19 parallel, 15 public domain citation system, 15 to U.S.C., 14 Civil law burden of proof, 140–141 civil liability for criminal acts, 141, 142 compared to criminal law, 13, 140–141 defined, 13 legal systems based on, 168–169 nations using, 168 Civil liability, RICO violations and, 150 Civil Rights Act of 1964, 102, 180 Title VII, 505–515 Claim, proof of, 375 Class action, 283 employment discrimination cases, 506 Class Action Fairness Act (CAFA), 283 Class-action waivers, in creditcard contracts, 68 Clayton Act, 608–610, 612 exclusionary practices, 609–610 interlocking directorates, 610 mergers, 610 price discrimination, 608–609 Clean Air Act, 122, 129, 565–567 Clean Water Act (CWA), 567–572 Clear and conspicuous disclosure, 547 Click-on agreement (clickon license or click-wrap agreement), 204 Close (closely held or family or privately held) corporation, 434–436 management of, 435 misappropriation of funds, 435–436 oppressive conduct, 456 pierce the corporate veil and, 441–443 preemptive rights, 454 transfer of shares, 435 Closed shop, 531 Closing, real estate sale, 584 Closing arguments, 53 Cloud computing, 346 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–6  Index Code law, 169 Code of conduct, 81 Code of Federal Regulations (C.F.R.), 14, 128 Coercion, by unions, 538–539 Collateral, 358, 375 Collective bargaining, 535–536 Collective mark, 324 Color, discrimination based on, 508–510 Comity, of principle, 169–171 Commerce, Department of, 123 National Export Initiative (NEI), 172 Commerce clause, 102–104 Commercial activity, 172 Commercial bribery, 148–149 Commercial impracticability, 230, 264–265 Commercial reasonableness, 252, 263, 388 Commercial speech, 110 Commercial use of land, 593 Commingled interests, 441–442 Common law defined, legal systems based on, 168–169 nations using, 168 remedies against environmental pollution, 563–565 restraints of trade and, 599 as source for contract law, 188 stare decisis, 8–10 today, 10–11 tradition of, 6–11 Commonly known dangers defense, 316 Communication of acceptance, 201–202, 253–254 of offer, 199 privileged communication and defamation, 289 stored electronic, 351 Communications Decency Act (CDA), 353 Community property, 373, 581 Comparative negligence, 301 as defense to product liability, 315–316 Compelling government interest, 108 Compensation See also Wages principal’s duty of, 473 Compensation committee, 633 Compensatory damages, 230–234, 282–283 Competitive practices, 292 Complaint elements of, 44 example of, 45 formal, in administrative law, 134 plaintiff’s, 44, 45 Composition agreements, 360 Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), 565, 574–575 Computer Fraud and Abuse Act (CFAA), 162, 475 Computers crime and, 158–162 search engine results and free speech, 107 Computer Software Copyright Act, 331–332 Concentrated industry, 602 Conclusion, in legal reasoning, 10 Concurrent jurisdiction, 31–32 Concurrent ownership, 580–581 Concurring opinion, 20 Condemnation power, 590 Condition, defined, 223 Conditional-use permits, 594 Condition precedent, 223 Conduct codes of, 81 outrageous, 285 Confederal form of government, 100 Confiscation, 171, 174 Conflicts of interest, corporate officers and directors, 449–450 Conforming goods, 253, 263 Congress See also Legislative branch enabling legislation, 122 taxing and spending powers, 105 Consent, voluntary, 191 Consequential damages, 234 Conservation districts, 593 Consideration bargained-for exchange, 207 defined, 207 lease contracts, 256 legally sufficient value, 207–208 past consideration, 209–210 preexisting duty, 208 as requirement of contract, 191 rescission and new contract, 208 sales contracts, 256 unforeseen difficulties and, 208 Consolidated Omnibus Budget Reconciliation Act (COBRA), 498–499 Constitutional law, See also United States Constitution Construction contracts, compensatory damages for breach of contract, 233 Constructive discharge, 511 Consumer-debtor defined, 369 special bankruptcy requirements for, 369, 370 Consumer-expectation test, 310 Consumer Financial Protection Bureau (CFPB), 121 Consumer law, 546–560 credit protection, 555–560 deceptive advertising, 546–551 defined, 546 health and safety protection, 553–555 labeling and packaging, 551–553 sales, 553 telemarketing, 550–551 Consumer Product Safety Act, 554–555 Consumer Protection Act, 121 Consumers arbitration agreements, 68 privacy bill of rights, 354 Contests, as unilateral contract, 192 Contingency fees, capping, 283 Continuity, sole proprietorship and lack of continuity, 396 Contracts, 188–216 See also Agreements; Lease contracts; Sales contracts acceptance in, 191, 200–203 adhesion, 68 agency relationship and, 478–479 agreement in, 191, 195–203 anticipatory repudiation, 227 assignments, 214–215 bilateral, 191–192 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   breach of damages for, 230–235 defined, 225 equitable remedies, 235–237 material, 223, 225–226 minor, 225–226 statute of limitations and, 229 waiver of, 237 capacity in, 210–211 consideration in, 191, 207–210 contractual capacity in, 191 contrary to public policy, 212–214 contrary to statute, 211–212 defined, 188–189 delegation, 214, 215 destination contract, 259, 261, 264 discharge of, 223–230, 388 e-contracts, 203–207 enforceability of, 194–195 enforcement of, defenses to, 191 exclusive-dealing contract, 609 exculpatory clauses, 213–214, 389 executed, 194 executory, 194 express, 193–194 formal, 193 formation of, 191–194 form of, 191, 214 franchise, 408–410 freedom of/from, 388 implied (implied-in-fact), 193–194 informal, 193 intoxication and, 211 investment, 619 law governing, 188, 257 legality of, 191, 211–214 limitation-of-liability clauses in, 238 mental incompetence, 211 minors and, 210–211 mirror image rule, 200–201, 254 objective theory of, 188–189 offer in, 191, 196–200 option contract, 199–200 output contract, 252–253 performance of, 194, 223–227 preincorporation, 418–419 privity of, 214, 306 promise, 189 proposed, supervening illegality, offer termination, 200 ratification of, 195 reading and analyzing, 242–243 requirements contract, 252 rescission, 208 in restraint of trade, 212–213 shipment contract, 259, 261, 263–264 simple, 193 terms in, 199 third party beneficiaries, 214, 215–216 types of, 191–195 unconscionable, 213, 388–389 unilateral, 192–193 valid, requirements for, 191 voidable, 211 voluntary consent in, 191, 219–222 writing requirements, 214 wrongful interference with, 291–292 Contracts for the International Sale of Goods (CISG) adoption of, 248 applicability of, 274 compared to UCC, 168, 274 remedies for breach, 274 Contract theory, exceptions to employment-at-will, 490–491 Contractual capacity, 210–211 as requirement of contract, 191 Contribution, right of, 367 Contributory negligence, 301 Control, in franchise operation, 410 Controlling the Assault of NonSolicited Pornography and Marketing (CAN-SPAM) Act, 341 Conversion, 293 Conveyance, 580 Cookies, 354 Cooling-off laws, 553 Cooperation duty of, 265 I–7 principal’s duty of, 473 Copyright, 328–333 compilation of facts, 328 defined, 328 digital information and, 345–348 fair use doctrine, 331 first sale doctrine, 331 idea exclusions, 328 infringement of, 329–331, 345 material that can be, 328 remedies for, 330–331 of software, 331–333 summary of, 334 works for hire, 469–470 Copyright Act, 328, 330, 331 Corporate governance, 463 aligning interests of officers with shareholders, 632–633 benefits of, 633 defined, 632 internal controls and accountability, 634 Sarbanes-Oxley Act, 633–634 stock option and, 632–633 Corporate officers See Officer, corporate Corporate social responsibility (CSR), 86–87, 97–98 Corporate veil, piercing, 417, 432, 441–443 Corporations agent of, 438, 466 alien, 434 alter-ego theory and, 443 benefit corporation, 436 bylaws of, 438, 439 classification of, 434–436 closely held (close, privately held), 434–436 compared to other major forms of businesses, 457–458 corporate blogs and securities fraud, 642 corporate governance, 463 corporate name, selecting, 437–438 criminal liability and, 144, 433–434 de facto, 439 defined, 431 de jure, 439 directors of, 431, 443–451 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–8  Index dividends, 432 domestic, 434 duration and purpose of, 438 duty to, community and society, 97–98 environment of, and ethics, 96–97 by estoppel, 439–440 executives, 446 foreign, 434 formation of, 437–440 free speech and, 184 holding company, 432 incorporation procedures, 437–439 jurisdiction over, 29–30 as legal person, 431 limited liability company similarities to, 416, 418 nature of, 431–436 nonprofit (not-for-profit), 434 officers of, 431, 443–451 parent company, 432 personnel of, 431 pierce corporate veil, 417, 432, 441–443 political speech, 109–110 powers of, 440–441 preliminary promotional activities of, 437 professional, 436 profit maximization and, 78–79 public, 434 publicly held, 434 registered agent of, 45 registered office of, 438 reorganizations, 378–380 retained earnings of, 432 S corporations, 436 shareholders of, 451–456 social responsibility, 86–87, 97–98 taxes and, 432 tort liability and, 432–433 triple bottom line, 79 ultra vires doctrine, 440–441 Cost-benefit analysis, 85–86 Co-sureties, 367 Counteradvertising, 550 Counterclaim, 46 Counterfeit Access Device and Computer Fraud and Abuse Act, 162 Counterfeit goods, 324–325 Counteroffer, 200 Court-annexed arbitration, 72–73 Court procedures, 41–56 ADR integration with, 72–73 appeals, 55–56 consulting with attorney, 42–44 enforcing judgment, 56 posttrial motions, 54–55 pretrial procedures, 44–51 procedural rules, 41–42 stages of litigation, 42, 43 trial procedures, 51–54 Courts, 28–59 of appeals See Appellate courts bankruptcy, 30, 368 early English, 6–7 of equity, federal courts, 40–41 Islamic law courts, 39 jurisdiction, 29–36 king’s (curiae regis), of law, probate, 30 procedures of, 41–56 role of, in government, 28–29 small claims, 39 standing to sue, 36–37 state courts, 37–39 venue, 36 Covenant not to compete, 212–213, 389–390 restrictive, 212–213, 592–593 warranty deeds and, 587 Cover, 268 Cram-down provision, 379–380 Credit cards, 556 consumer protection laws, 555–557 mandatory arbitration clauses with class-action waivers, 68 online theft and, 160 TILA rules for, 556–557 Truth-in-Lending Act (TILA) requirements, 555–557 Credit counseling, 370 Creditors bankruptcy property distribution, 375–376 best interests of, 378 claims of in bankruptcy, 375 dissolution of partnership and, 405 committees of, 378 credit protection laws, 555–559 Fair and Accurate Credit Transactions (FACT) Act, 557 fair debt-collection practices, 558–559 fiduciary duties of corporate directors to, 464 foreclosure, 361–363 garnishment, 360 guaranty, 364–367 laws assisting, 358–360 liens, 358–360 meeting of, 375 mortgage protection, 361 preferred, 374 suretyship, 364 Creditors’ composition agreements, 360 Credit report, notification and inaccurate information, 557 Crimes by agent, 484 civil liability for, 141, 142 classification of, 141–142 computer crime, 158–162 contract to commit, 211–212 corporate liability, 144 credit-card, 160 criminal act, 142–143 cyber, 140, 158–162 defined, 140 lying as federal crime, 450 organized crime, 149–150 property crime, 145–147 public order crime, 147–148 state of mind, 143–144 types of, 144–150 victimless, 147–148 violent crime, 145 white-collar, 147–149 Criminal act, 142–143 Criminal investigations, social media and, 349 Criminal law beyond a reasonable doubt, 140–141 burden of proof, 140–141 compared to civil law, 13, 140–141 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   criminal liability, 142–144 criminal procedure, 153–158 exclusionary rule, 155 Fourth Amendment protections, 153–155 Miranda rule, 155–156 sentencing guidelines, 158 steps in criminal case, 156–158 cyber crime and, 158–162 defenses for, 150–153 defined, 13 types of crimes, 144–150 Criminal liability corporate, 144, 433–434 defenses to, 150–153 elements of, 142–144 Criminal negligence, 143 Criminal process, 156–158 Cross-examination, 53 Cruel and unusual punishment, 153 Cure, 264 Customer restrictions, 602–603 Customs, international, 166 Cyber crimes, 140, 158–162 civil liberties and control of, 185 credit-card, 160 cyber attacks, 161 cyberterrorism, 160–161 employment fraud, 160 fraud, 159 hacking, 160–161 identity theft, 159 jurisdiction, 162 malware and worms, 160, 161 phishing, 159–160 prosecuting, 161–162 theft, 159–160 Cyberlaw, 13 Cybersquatting, 342–343 Cyber torts, 352–353 D Damages for breach of contract, 230–235 buyer’s or lessee’s right to recover, 268, 269–270 compensatory, 230–233 consequential, 234 contract provision limiting, 237–238 for defamation, 286 defined, general, 282, 283 incidental, 232 for libel, 286 liquidated, 234–235 mitigation of, 234 nominal, 234 punitive, 234, 283 seller’s or lessor’s right to recover, 267 from shareholder’s derivative suit, 456 for slander, 286 social media and awards, 349 special, 234, 282 substantial performance, 224–225 for tort action, 282–283 treble damages, 611 trespass to land, 293 types of, 230 Danger abnormally dangerous activities, 305–306 commonly known dangers, 316 dangerous animals, 306 notice of dangerous conditions, 483 unreasonably dangerous products, 309 Davis-Bacon Act, 493 Deadly force, 150 Death of partner in limited partnership, 427 of party to personal contract, 229 of principal or agent, agency termination and, 485 Debt-collection practices, 558–559 Debtors, 358 consumer-debtors, 368 credit protection laws, 555–559 default of, 358 guaranty, 364–367 mortgage, 360–363 in possession (DIP), 378 protection for, 367–368 (See also Bankruptcy) I–9 suretyship, 364 Deceptive advertising, 546–551 Decision making leadership for ethical, 88–90 systematic ethical approach to, 87–88 Deeds, 579 defined, 586 grant deed, 587 limited warranty deed, 587 quitclaim deed, 587 recording statutes, 587–588 requirements of, 586–587 special warranty deed, 587 warranty deed, 587 De facto corporation, 439 Defamation damages for, 286–287 defenses to, 287–289 defined, 286 liability of Internet service providers (ISPs) for, 353 online, 352–353 requirements of, 286 Defamatory, 79 Default, of debtor, 358 Default judgment, 44 Defendant answer, 46 defined, 7, 20 evidence of, 53 response of, to civil complaint, 46 Defense, Department of, 123, 564 Defense Production Act, 612 Defenses affirmative, 46, 299 to CERCLA, 574–575 to criminal liability, 151–153 to defamation, 287–289 defined, Ellerth/Faragher affirmative defense, 512 to employment discrimination, 519–520 to enforceability of contract, 191 for negligence, 299–301 for price discrimination, 608–609 to product liability, 315–316 for sexual harassment, 512 to surety/guarantor, 366 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–10  Index for tort, 284 trespass of land, 293 for violations of Securities Act (1933), 624 wrongful interference, 292 De jure corporation, 439 Delegation, 214, 215 Delegation doctrine, 124–125 Delegator, delegatee, 215 Delivery C.I.F or C.&F (cost, insurance, and freight or just cost and freight), 261 delivery ex-ship (delivery from the carrying vessel), 261 in destination contracts, 259, 261 F.A.S (free alongside), 261 F.O.B (free on board), 261 with movement of goods (carrier cases), 261 open delivery term, 252 place of, 263 seller’s or lessor’s right to withhold, 266–267 in shipment contract, 259, 261 substitution of carrier, 264 tender of, 259, 261–262, 263 via carrier, 263–264 without movement of goods, 259, 261–262 Deposited acceptance rule, 202 Depositions, 49 Design defects, 310–311 Destination contract, 259, 261, 264 Detour, scope of employment and, 483 Digital Millennium Copyright Act (DMCA), 345–346 Dilution, of trademark, 322, 344–345 Direct examination, 53 Directors, corporate, 443–451 acquiring assets, 463 business judgment rule, 447–448 committees of, 445 compensation committee, 633 compensation of, 445 conflicts of interest, 449–450 corporate governance and, 633 criminal liability of, 144 defined, 431 directors’ failure to declare dividend, 455 dissenting, 447 duties of, 446–450, 463–464 election of, 444–445 fiduciary duties, 463–464 inside vs outside, 445 interlocking directorates, 610 liabilities of, 450–451 management responsibilities of, 444 meetings of, 445 outside, 445 removal of, 444 rights of, 445–446 roles of, 443–446 vacancies on board, 444–445 voting, 445 Disability correctable conditions and, 518 defined, 517–518 discrimination based on, 517–519 health-insurance plans, 518–519 job applications and physical exams, 518 reasonable accommodations, 518–519 substance abusers, 518–519 Disaffirmance, 210 Discharge in bankruptcy, 369, 376–377, 380, 383 constructive, 511 effect of, 377 exceptions to, 376–377 objections to, 377 revocation of, 377 Discharge of contract, 388 by accord and satisfaction, 228 by agreement, 227–228 in bankruptcy, 229 defined, 223 by mutual rescission, 227–228 by novation, 228 by operation of law, 228–230 by performance, 223–227 by settlement agreement, 228 Disclosed principal, 478–479 Disclosure reaffirmation agreement, 378 seller’s duty to, 584–586 Disclosure law, 555–556 Discovery, 49–51 defined, 49 depositions, 49 electronic, 50–51 interrogatories, 49–50 rules of, 49 social media and, 349 Discrimination affirmative action, 520–521 appearance-based discrimination, 509 based on age, 515–517 color, 508–510 disability, 517–519 gender, 510–511 national origin, 508–510 pregnancy, 511 race, 102, 508–510 religion, 510 commerce clause and, 102 disparate-impact discrimination, 508 disparate-treatment discrimination, 506 intentional, 506–507 international business and, 180 reverse discrimination, 508–509 against transgender persons, 543 unintentional discrimination, 508 by unions, 539 against union workers, 538 wage discrimination, 511 Dismissals, 46–47 Disparagement of property, 294 Disparate-impact discrimination, 508 Disparate-treatment discrimination, 506 Disposable income, 371 Dispute resolution international, 176–178 online offers and, 203–204 Dissenting opinion, 20 wrongful, 403 Dissociation defined, 402 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   effects of, 403–404 events that cause, 403 of limited liability company, 422 of limited partnership, 427 of partners, 402–404 Dissolution of corporation, 455–456 of limited liability company, 422–424 of limited partnership, 427 of partnerships, 404–405 shareholders’ rights on, 455 Distributed network, 346 Distribution agreement, 172 Distribution of property, in bankruptcy, 375–376 Distributorship, 407 Diversity of citizenship, 31–32 Divestiture, 611 Dividends, 432 defined, 454 directors’ failure to declare, 455 illegal, 455 sources paid from, 455 Documents requests for, 50 of title, 259, 262 Dodd-Frank Wall Street Reform Act, 121 Domain names, 342 Domestic corporation, 434 Dominant estate, 582 Do Not Call Registry, 551 Dormant commerce clause, 103 Double jeopardy, 153 Down payment, 360–361 Dram shop acts, 299 Drinking water, 572 pharmaceuticals in, 640–641 Drug addiction, as disability, 518–519 Drugs consumer protection and, 554 employees addicted to, 518–519 pharmaceuticals in drinking water, 640–641 price fixing and manufacturers of, 601 testing of employees, 500–501 Due care, 446–447, 463–464 product liability and, 306 Due process, 153 procedural, 115 substantive, 115 Dumping, 175 Duress as defense for criminal liability, 152 defined, 221 voluntary consent and, 221–222 Duties of corporate directors, 446–450 of corporate officer, 446–450 delegation of, 214, 215 fiduciary, 401, 420–421 of partners, 401 of shareholders, 456 Duty in agency relationships, 472–473 of agent, 472–473, 542 antidumping, 175 of care corporate directors, 446–447 corporate officers, 446–447 partnerships, 401 reasonable, 293 of cooperation, 265 to exercise reasonable supervision, 447 of landowners, 295 in limited partnership, 427 of loyalty, 448–449, 463, 542 agent, 472 partnerships, 401 to make informed decisions, 447 preexisting duty and lack of consideration, 208 of professionals, 296 reasonable person standards, 295 of seller, to disclose hidden defects, 584–586 to warn business invitees of risks, 295–296 gun makers and, 390 Duty-based ethics, 84–85 DVDs, file-sharing and, 348 I–11 E E-agents, 479–480 Early neutral case evaluation, 61 Easements, 580 defined, 582 by implication, 582 by necessity, 582 by prescription, 582 termination of, 582 E-books, price fixing and, 601 Economic development, eminent domain used for, 590–592 Economic Espionage Act, 149 E-contracts, 203–207 acceptance, 204–205 browse-wrap terms, 205 choice-of-law clause, 204 click-on agreement, 204 e-signature, 205–206 forum-selection clause, 203–204 licensing and, 203 offers, 203–204 requirements of, 203 shrink-wrap agreement, 204–205 Uniform Electronic Transactions Act, 206–207 writing requirements of, 214 E-discovery, 50–51 advantages and disadvantages of, 50–51 procedures, 50 Education, Department of, 123 E-evidence, 50 Eighth Amendment, 106, 153 Elderly, undue influence in, 221 Electronic agent, 479–480 Electronic Communications Privacy Act (ECPA), 351, 499 Electronic data, breaching company policy on use of, 475 Electronic devices, border searches and, 167 Electronic discovery, 50–51 Electronic monitoring, employee privacy rights and, 499–501 Electronic Signatures in Global and National Commerce Act (E-SIGN Act), 205–206 Eleventh Amendment, 517 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–12  Index Ellerth/Faragher affirmative defense, 512 E-mail contract acceptance, 202 fraudulent and investment scams, 635 spam, 341–342 Embezzlement, 148 Emergency power, 477 Eminent domain, 590–592 Emotional distress, intentional infliction of, 285 Employee Polygraph Protection Act, 500 Employee Retirement Income Security Act (ERISA), 498 Employees agency relationship, 466–470 child labor, 493–494 discrimination of See Employment discrimination drug testing of, 500–501 electronic monitoring of, 499–500 employer-employee relationships, 466–467 family and medical leave, 495–496 frolic vs detour in employment, 483 genetic testing of, 502 health and safety, 496–497 immigration law and, 525–529 income security, 497–499 layoffs, 494–495 lie-detector tests, 500 overtime, 494 privacy rights, 499–502 replacing older workers with younger, 516–517 scope of employment, 481–483 sexual harassment of, 511–514 social media and, 351 status as, determining, 467–469 travel time, 483 unions See Unions wages of, 493–494 workers’ compensation laws, 496–497 works for hire, 469–470 wrongful discharge, 493 Employers agency relationship, 466–470 employer-employee relationships, 466–467 employer–independent contractor relationships, 467 layoff notification requirements, 495 notice of dangerous conditions, 483 reasonable accommodations for employees with disability, 518–519 for religious practices, 510 retaliation by, for sexual harassment complaints, 512–514 social media and, 351 unfair labor practices, 537–538 discrimination against union workers, 538 domination of union, 538 interference with unions, 538 refusal to recognize or negotiate with union, 538 wrongful discharge, 493 Employment determining status of, 467–469 discrimination in See Employment discrimination distinction between detour and frolic, 483 immigration law and, 525–529 scope of, respondeat superior and, 481–483 wages, hours and layoffs, 493–495 at will, 490–493 Employment contracts arbitration clause in, 67–68 covenant not to compete, 212–213, 389–390 implied, 490–491 Employment discrimination, 505–522 affirmative action, 520–521 appearance-based discrimination, 509 based on age, 515–517 color, 508–510 disability, 517–519 gender, 510–511 national origin, 508–510 race, 508–510 religion, 510 class-action limitations, 506 constructive discharge, 511 defenses to, 519–520 disparate-impact discrimination, 508 disparate-treatment discrimination, 506 intentional discrimination, 506–507 international business and, 180 reverse discrimination, 508–509 Title VII of Civil Rights Act, 505–515 against transgender persons, 543 unintentional discrimination, 508 wage discrimination, 511 Employment fraud, 160 Enabling legislation, 122 Encumbrances, 578 Endangered Species Act, 565 Energy, Department of, 123 Energy Policy and Conservation Act, 551 Enforceability, of contract, 194–195 Entrapment, as defense for criminal liability, 152 Entrepreneur/entrepreneurship defined, 394 franchises, 406–412 partnerships, 396–406 sole proprietorship, 394–396 Enumerated powers, 100 Environmental impact statement (EIS), 564–565 Environmental law, 563–575 air pollution, 565–567 common law actions, 563–564 defined, 563 environmental impact statement (EIS), 564–565 federal, state, and local regulation, 564–565 hazardous waste, 573–575 toxic chemicals, 572–573 water pollution, 567–572 Environmental Protection Agency (EPA), 573 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   air pollution and, 565–567 Chevron deference, 129–131 creation of, 564 duties of, 124 functions of, 121, 122 Equal Credit Opportunity Act (ECOA), 556 Equal Employment Opportunity Commission (EEOC) duties of, 124 functions of, 121 role of, 505–506 Equal Pay Act, 511 Equal protection clause intermediate scrutiny, 116 rational basis test, 116 strict scrutiny, 115–116 Equitable maxims, Equitable remedies, 7, 235–237 reformation, 236–237 rescission and restitution, 235–236 specific performance, 235–236 Equity action in, procedural differences between action at law and, courts of, defined, remedies in, Escrow account, 584 E-signature, 205–206 Establishment clause, 112–113 Estate(s) in bankruptcy, 373 dominant, 582 in land, 579 leasehold, 581–582 life, 580 servient, 582 Estoppel agency formation by, 471 corporations by, 439–440 partnership by, 398 Ethical reasoning, 84 Ethics, 78–98 See also Business ethics appearance-based discrimination, 509 breaching company policy of electronic data use, 475 business decision making and, commercial environment issues, 388–391 corporate governance, 463 cost-benefit analysis, 85–86 defined, 3, 78 duty-based, 84–85 fiduciary duties, 463–464 franchise relationships, 464 franchisor’s potential earnings disclosure, 409 international business and, 184–186 Kantian principles, 85 laws and relationship to, 80–82, 96 lying as federal crime, 450 outcome-based, 84, 85–86 principle of rights, 84–85 regulatory environment, 640–642 religious ethical principles, 84 reselling textbooks purchased abroad, 332 utilitarianism, 85–86 video game warning labels, 314 European Patent Office, 326 European Union (EU), 175 antitrust law and, 614 Evidence admissible, 49 defendant’s, 53 e-evidence, 50 exclusionary rule, 155 hearsay, 52–53 preponderance of, 54 relevant, 52 rules of, 52–53 E visa, 528 Examinations cross-examination, 53 direct, 53 request for, 50 of witnesses, 53 Exclusionary practices, 609–610 Exclusionary rule, 155 Exclusive-dealing contract, 609 Exclusive jurisdiction, 31–32 Exculpatory clauses, 213–214, 389 Executed contract, 194 Execution, writ of, 360 Executive agencies, 122–123 defined, I–13 Executive branch checks and balances, 101 control over administrative agencies, 125 Executive employees, overtime wages, 494 Executives, corporate, 446 Executory contract, 194 Exemptions antitrust law, 611, 612 in bankruptcy, 374–375 homestead, 367–368, 375 overtime provision, 494 personal property, 368 Exhaustion doctrine, 125 Expert witnesses, 53 manufacturing defects and, 309–310 Export Administration Act, 174 Export-Import Bank of the United States, 173 Exporting controls on, 174 direct or indirect, 172 distributorship, 172 national export initiative, 172–173 Export Promotion Cabinet, 172 Export Trading Company Act, 174 Express authority, 474 of agent, 474 Express contracts, 193–194 Express powers, 440 Express warranty, 271–272 Expropriation, 171 F Facebook, 2–3 Facilitation, 61 Fact affirmation of, 271, 272 causation in, 296 compilation of, and copyright, 328–329 mistake of, 152, 219–220 statement of, 272, 286 Fair and Accurate Credit Transactions (FACT) Act, 557 Fair Credit Reporting Act (FCRA), 557 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–14  Index Fair dealing, termination of franchise, 411–412 Fair Debt Collection Practices Act (FDCPA), 558–559, 640 Fair Labor Standards Act (FLSA), 493 Fair Packaging and Labeling Act, 552 Fair use doctrine, 331 Fair value of goods, 175 False imprisonment, 285 False light, 289 Family and medical leave, 495–496 Family and Medical Leave Act (FMLA), 495 Family limited liability partnership (FLLP), 425 Fanciful trademark, 323 Farmers, family, bankruptcy, 383 F.A.S (free alongside), 261 Featherbedding, 531 Federal Arbitration Act, 63, 71 Federal Circuit, 41 Federal Communications Commission (FCC), Federal court system, 40–41 See also United States Supreme Court appellate courts of, 40–41 citations of, 17–18 decisions of, 15 jurisdiction of, 30–33 trial (district) courts of, 30, 40 Federal Food, Drug, and Cosmetic Act (FDCA), 554 Federal government, 100–105 environmental preservation and protection regulation, 564–565 expansion of powers of, under commerce clause, 102 labor laws, 529–532 limits on, and Bill of Rights, 105–106 powers of, 100–101 separation of powers, 101 supremacy clause, 104–105 taxation, 105 trade secrets an, 333 Federal Insecticide, Fungicide, and Rodenticide Act, 565, 572–573 Federal Insurance Contributions Act (FICA), 497 Federal question, 30–31 Federal Register, 14, 128 Federal Reporter (F., F.2d, or F.3d), 15 Federal Reserve System Board of Governors (the Fed), duties of, 124 Federal Rules of Bankruptcy Procedure, 368 Federal Rules of Civil Procedure (FRCP), 42, 44, 46, 50 Federal Rules of Evidence, 52 Federal Supplement (F.Supp or F.Supp.2d), 15 Federal Trade Commission (FTC), 5, 107, 123, 354 bait-and-switch advertising, 547 cease-and-desist order, 529, 550 clear and conspicuous disclosure, 547 cooling-off laws, 553 counteradvertising, 550 creation of, 122 duties of, 124 enforcement of antitrust law, 611 formal complaint, 550 Franchise Rule, 408 functions of, 121 Mail-Order Rule, 553 order and restitution, 550 telemarketing, 550–551 Federal Trademark Dilution Act, 322 Federal Unemployment Tax Act (FUTA), 498 Federal Water Pollution Control Act, 565 Fee simple absolute, 579 Felonies, 141 Fiduciary duties acquiring assets and, 463 to creditors, 464 disclose improper conduct, 463 duty of loyalty, 463 limited liability company, 420–421 of majority of shareholders, 456 of partners, 401 Fiduciary relationship agency relationship as, 466 defined, 466 undue influence in, 221 Fifth Amendment, 106, 114, 152, 153 File-sharing methods of, 346 MP3 and, 346–348 Filtering software, 112 Final order, 134 Financial Stability Oversight Council, 121 Firm offer, 253 First Amendment, 79, 106–113, 285 First impression, cases of, First sale doctrine, 331 Fisheries Cooperative Marketing Act, 612 Fishermen, bankruptcy, 383 Fixed-rate mortgage, 361 Fixed-term tenancy, 581 F.O.B (free on board), 261 Food and Drug Administration (FDA), 5, 552–553, 564 food safety, 554 safety of new drugs, 554 Food labeling, 552–553 Food Safety Modernization Act (FSMA), 554 Forbearance, 207, 361 Force deadly and nondeadly, 150 justifiable use of, 150 reasonable, 285 Foreclosure artisan’s lien and, 359 defined, 359, 361 mechanic’s lien and, 359 procedure, 362–363 redemption rights, 363 short sale, 361–362 ways to avoid, 361–362 workout agreement, 361 Foreign corporation, 434 Foreign Corrupt Practices Act (FCPA) accounting requirements, 92 historical perspective, 91 penalties for violations, 92 prohibition against bribery of foreign officials, 91–92 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   Foreign investors, limited liability company and, 419 Foreign persons, 612 Foreign Sovereign Immunities Act (FSIA), 171–172 Foreign state, 172 Foreseeability, 297–298 Forgery, 147 Formal contracts, 193 Forum-selection clause, 74, 203–204, 254 Forum shopping, 283 Fourteenth Amendment, 106, 114, 115, 359 Fourth Amendment, 106, 113, 132–133 probable cause, 153 protections under, 153–154 search warrant, 153 Franchise Disclosure Document (FDD), 408 Franchisee, franchisor, 406 Franchise Rule, 408 Franchises, 406–412 chain-style business operation, 407 contracts for, 408–410 control of, 410 defined, 406 disclosure of potential earnings, 409 distributorship, 407 Franchise Rule, 408 good cause for termination, 408 laws governing, 407–408 location of, 409–410 manufacturing abroad, 173 manufacturing or processingplant arrangement, 407 payment for, 409 pricing arrangements, 410 regulation of, 407–408 termination of, 408, 410–412 types of, 407 Fraud bankruptcy, 149, 374 catfishing, 222 cyber, 159 employment, 160 fraudulent misrepresentation, 221, 222 mail and wire fraud, 148 offshore, 636 online auction, 159 online retail, 159 online securities fraud, 634–636 Ponzi schemes, 636 reformation and, 236–237 risk-free investments, 636 surety/guarantor defense, 366 Fraudulent misrepresentation, 221, 222, 290 Freedom from contract, 388 of contract, 388 of religion, 112–113 of speech, 106–112, 184 trademark protection and, 390 trade secrets and, 391 Freedom of Information Act (FOIA), 136 Free exercise clause, 113 Free-writing prospectus, 620 Frivolous litigation, 290–291 Frolic, scope of employment and, 483 Frustration of purpose, 230 Full faith and credit clause, 101 Future goods, 258 G Gambling, 212 Garnishment, 360 Gender discrimination based on, 510–511 pregnancy discrimination, 511 wage discrimination, 511 General damages, 283 General jurisdiction defined, 30 state trial courts and, 39 General partner, 425 Generic terms, 324 Genetic Information Nondiscrimination Act (GINA), 502 Genetic testing, of employees, 502 I–15 Gifts, agent’s accounting duty and, 472–473 Global environment antitrust laws in, 611–614 border searches and electronic devices, 167 bribery and Foreign Corrupt Practices Act, 92 smartphones and cyber attacks, 161 Good cause, for termination of franchise, 408 Good faith, 388 bankruptcy, 380 collective bargaining and, 536 defined, 263 dissolving partnership and, 404 good faith bargaining by unions, 529–530 sales contracts and, 263 termination of franchise, 411–412 UCC and, 252, 263 Goods associated with real estate, 249 buyer’s right to obtain goods on insolvency, 267 to recover, 268 to reject, 268–269 to replevy, 268 compensatory damages for breach of contract, 232–233 conforming, 253, 263 counterfeit, 324–325 defined, 249 destruction of, 265 fair value of, 175 future, 258 goods and services combined, 249–250 held by bailee, 262 held by seller, 261–262 identification, 258–259 intangible property, 249 international goods, 273–274, 278–281 lessee’s rights to obtain goods on insolvency, 267 to recover, 268 to reject, 268–269 to replevy, 268 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–16  Index lessor’s rights, to resell of dispose of, 267 location of, 263 merchantable, 272 nonconforming, 253 obtaining under false pretense, 145–147 prohibited from importing, 174 receiving stolen, 147 seller’s rights, to resell of dispose of, 267 specially manufactured, exception to Statute of Frauds, 256 tangible property, 249 Good Samaritan statutes, 298–299 Goodwill, domain names and, 342 Google, 107 Government See also Federal government; States/state government administrative agencies throughout, 121 form of confederal, 100 federal, 100–101 judiciary’s role in, 28–29 powers of, constitutional, 100–105 Government in the Sunshine Act, 136 Government regulation See Regulations Gramm-Leach-Bliley Act, 117 Grand jury, 158 Grand theft, 145 Grant deed, 587 Gratuitous agent, 472 Great Depression, 79 Green card, 528 Greenhouse gases, 566 Gross negligence, 283 Group boycott, 601 Guarantor, 364 Guaranty, 364–367 actions that release, 366 defenses of, 366 rights of, 366–367 Guilty act, 142 Gun makers, duty to warn, 390 H H1-B visa, 528 H2 visa, 528 Hacking, 160–161 Harassment hostile-environment harassment, 512 online, 514 quid pro quo harassment, 512 same-gender harassment, 514 sexual, 511–514 sexual orientation harassment, 514 Hardship situations, 594 Harm, standing to sue, 37 Hazardous air pollutants (HAPs), 566 Hazardous waste, 573–575 Health consumer protection and, 553–555 food safety, 554 Health and Human Services, Department of, 123 Health insurance Affordable Care Act, 499 COBRA, 498–499 controlling costs of, 555 employee-sponsored, 499 expanded coverage, 555 Medicare, 497–498 workers with disabilities, 519 Health Insurance Portability and Accountability Act (HIPAA), 117, 499 Hearsay, 52–53 Herbicides, 572–573 Hiring procedures, social media and ethics, 83 Historical school, 12 Holding company, 432 Homeland Security, Department of, 123 Immigration and Customs Enforcement (ICE), 526 Homestead exemption, 367–368, 375 Homicide, involuntary manslaughter, 143 Horizontal mergers, 610 Horizontal restraints, 601–602 Hostile-environment harassment, 512 Hot-cargo agreements, 531 Housing and Urban Development, Department of, 123 I I-9 verifications, 525–526, 543 I-551 Alien Registration Receipt, 528 Idea, copyright and, 328 Identification, 258–259 Identified goods, 258–259 defined, 258 destruction of, 265 insurable interest in, 262–263 Identity theft, 159 Immigration Act, 527–528 Immigration and Customs Enforcement (ICE), 526 Immigration law, 525–529 H1-B visa, 528 I-9 verifications, 525–526, 543 I-551 Alien Registration Receipt, 528 Immigration Act, 527–528 Immigration Reform and Control Act (IRCA), 525–527 Labor Certification application, 528 reform of, 543 state legislation on, 528–529 Immigration Reform and Control Act (IRCA), 525–527 Immunity as defense for criminal liability, 152–153 sovereign, 171–172 Impeach, 49 Implication, easements by, 582 Implied authority, 474–475, 480 Implied contracts, 193–194 Implied-in-fact contract, 193–194 Implied powers, 440 of agent, 474–475 Implied warranties, 272–273 of authority, 479 defined, 272 of fitness for particular purpose, 273 of habitability, 584 of merchantability, 272–273 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   from prior dealings or trade custom, 273 Imports dumping, 175 prohibited goods, 174 quotas and tariffs, 174–175 Impossibility agency termination and, 485 defined, 229–230 objective, 229 of performance, 229–230 subjective, 229 temporary, 230 Incidental damages, 232 Income disposable, 371 means test in Chapter 7, 370–371 Income security, 497–499 Incorporation procedures improper, 439 prepare/file articles of incorporation, 438–439 secure corporate name, 437–438 select state of incorporation, 437 Incorporators, 438 Indemnification by partners, 402 principal’s duty of, 473 right to, 446 Independent contractors agency relationship and, 467 defined, 467 employer–independent contractor relationships, 467 IRS criteria, 469 tort liability, 468–469, 484 Independent regulatory agencies, 5, 123–124 Indictment, 158 Industrial use of land, 593 Informal contracts, 193 Information, in criminal process, 158 Information return, 398 Infringement of copyright, 329–331, 345 file-sharing, 346 of patents, 326–327 of trademark, 322–323, 344 warranty of title and, 271 Initial order, 134 Initial public offerings (IPOs), 620 Injunction, Injury legally recognizable, 298 negligence and requirement of, 298 Insanity See also Mental incompetence as defense for criminal liability, 151–152 tests for, 151–152 Inside director, 445 Insider, preferences to, 374 Insider trading, 149, 626 duty of loyalty and, 448 misappropriation theory, 628 tipper/tippee theory, 627–628 Insider Trading and Securities Fraud Enforcement Act, 631 Insolvency, 486 right to obtain goods on, 267 Inspections by administrative agencies, 132 by OSHA, 496 right of, 445, 455 buyer or lessee, 265 Insurance insurable interest in identified goods, 262–263 mortgage, 361 title, 584 Insurance agent, 467 Intangible property, 249 Intellectual property, 320–337 budget cuts for state courts and, 38 copyright, 328–333 digital information, 345–348 counterfeit goods, 324–325 defined, 320 international protection for, 334–337 licensing, 325 patents, 325–328 service, certification, and collection marks, 324 summary of, 334 theft of, 149 trademarks, 320–324 trade names, 325 I–17 trade secrets, 333 Intended beneficiary, 215–216 Intent, intention advertisements, 197 contract and, 196–198 expressions of opinion, 196 monopoly and, 607 offer and, 196–198 preliminary agreement and, 197–198 statements of future intent, 196 tort law, 284 transferred, 284 Intentional discrimination, 506–507 Intentional infliction of emotional distress, 285 Intentional torts of agent, 483–484 against person abusive or frivolous litigation, 290–291 assault, 284 battery, 284–285 defamation, 286–289 defined, 284 false imprisonment, 285 fraudulent misrepresentation, 290 intentional infliction of emotional distress, 285 invasion of privacy, 289–290 against property conversion, 293 disparagement of property, 294 trespass to land, 292–293 trespass to personal property, 293 Interest, usury and, 212 Interior, Department of, 123, 564 Interlocking directorates, 610 Intermediate scrutiny, 116 Internal Revenue Code independent-contractor status and, 469 Subchapter S of, 436 Internal social networks, 352 International business business ethics and, 90–92 contracts for sale of goods, 273–274, 278–281 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–18  Index dispute resolution in, 74, 176–178 distributorship, 172 dumping, 175 ethical considerations, 184–186 exporting, 172–173 Foreign Corrupt Practices Act, 91–93 franchising, 173 joint venture, 173 jurisdiction and, 34 licensing, 173 manufacturing abroad, 173 monitoring employment practices of foreign suppliers, 91 protection for intellectual property, 334–337 regulations on, 173–176 wholly owned subsidiary, 173 International Centre for the Settlement of Investment Disputes (ICSID), 74 International contracts arbitration clauses, 176–177 choice-of-law clauses, 177–178 forum-selection clauses in, 177–178 International law anitdiscrimination law, 180 border searches and electronic devices, 167 civil law system, 168, 169 common law system, 168, 169 customs and, 166 defined, 166 export controls, 174 import controls, 174–175 international organizations and, 167–168 investment protections, 174 Islamic legal system, 169 minimizing trade barriers, 175–176 principles and doctrines act of state doctrine, 171 comity principle, 169–171 sovereign immunity doctrine, 171–172 sources of, 166–168 tort claims, 178–180 treaties and agreements, 168 U.S antitrust law, 178 International organizations, 167–168 International Trade Administration (ITA), 175 International Trade Commission (ITC), 174, 175 International treaties, arbitration and, 74 Internet catfishing, 222 civil liberties and control of terrorist activities, 185 consumer privacy bill of rights, 354 copyright and, 345–348 corporate reputation and, 79 cybersquatting, 342–343 data collection and cookies, 353–354 deceptive advertising, 547–550 domain names, 342 DVDs and file-sharing, 348 e-contracts, 203–207 Internet companies’ privacy policies, 354 investment scams, 634–636 jurisdiction and, 33–34 licensing on, 345 meta tags, 343–344 MP3 and file-sharing technology, 346–348 obscene materials on, 112 online defamation, 352–353 online dispute resolution (ODR), 73–74 online harassment, 514 online securities fraud, 634–636 online travel companies (OTCs), 250 privacy rights, 184, 353–354 sales online, 553 sliding-scale standard, 33–35 social media and legal issues, 348–352 software and patent infringement, 112 software copyright protection, 331–333 spam, 341–342 taxes on Internet sales, 250 trademark dilution, 344–345 trade secrets and, 333 typosquatting, 343 video game warning labels, 314 Internet Corporation for Assigned Names and Numbers (ICANN), 342 Internet service providers (ISPs), 342 liability for online defamation, 353 Interpretive rules, 124, 129 Interrogatories, 49–50 Interstate commerce, 102 Sherman Act and, 600 Interstate Oil Compact, 612 Intoxication, contractual capacity and, 211 Intrastate commerce, 102 Invasion of privacy, 289–290 Inverse condemnation, 592 Investigations, by administrative agencies, 132–144 Investment company, 621 Investment contract, 619 Investments, in foreign nations, 174 Investor protection corporate governance, 632–634 online securities fraud, 634–636 securities acts, 619–632 Securities and Exchange Commission, 618–619 state securities laws, 632 Invitation to submit bids, 197 Involuntary bankruptcy, 371–372 Involuntary manslaughter, 143 IRAC method of legal reasoning, 9–10 Islamic law courts, 39 Islamic legal system, 169 Issue, in legal reasoning, J Japan, antitrust law and, 614 Joint and several liability, 402, 574 Joint liability, 402 Joint tenancy, 580 Joint venture, 173 Judge-made law, Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   Judges administrative law, 133–134 defined, 20 justice versus, 20 state courts, 39 Judgments default, 44 enforcing, 56 as a matter of law, 53, 55 n.o.v (notwithstanding the verdict), 55 on the pleadings, 48 summary, 49 before trial, 46 Judicial branch checks and balances, 101 control over administrative agencies, 125 Judicial lien, 359–360 Judicial review defined, 28 origins of, 28–29 Jurisdiction, 29–36 appellate, 30 concurrent, 31–32 cyber crimes and, 162 in cyberspace, 33–34 defined, 8, 29 diversity of citizenship, 31–32 exclusive, 31–32 of federal courts, 30–33 general (unlimited), 30 international issues and, 34 limited, 30 limited liability company and, 419 long arm statute, 29 minimum contacts, 29, 30 original, 30 over corporations, 29–30 over person (in personam), 29–30 over property (in rem), 29–30 over subject matter, 30 sliding-scale standard, 33–35 Jurisprudence defined, 11 schools of legal thought, 11–12 Jury charges to, 54 grand, 158 instructions for, 53–54 right to trial by, 51 selection, 51 Justice defined, 20 judge versus, 20 Justice, Department of, 123 enforcement of antitrust law, 611 K Kant, Immanuel, 85 Knowledgeable user defense, 316 Korea–United States Free Trade Agreement (KORUS FTA), 176 Krehmeyer, Dean, 84 L Labels food labeling, 552–553 fuel economy labels on automobiles, 551–552 Labor, Department of, 123, 564 Labor Certification application, 528 Labor law See also Unions child labor, 493–494 collective bargaining, 535–536 ethical issues, 542–544 federal labor laws, 529–532 right to-work laws, 531 strikes and lockouts, 536–537 unfair labor practices, 537–539 union organization, 532–535 Labor-Management Relations Act (LMRA), 531 Labor-Management Reporting and Disclosure Act (LMRDA), 531–532 Laches, Land See also Real property compensatory damages for breach of contract, 233 defined, 578 permissible uses of, 593 request for entry upon, 50 sale of, as specific performance, 236 structures on, 578 subsurface rights, 578–579 trespass to, 292–293 I–19 waste, 580 zoning laws, 593–595 Landowners, duty of, 295 Lanham Act, 322 Larceny, 145 Law(s) action at, procedural differences between action in equity and, administrative See Administrative law affecting single business transaction, 2–3 areas of, affecting business decision making, 3, bankruptcy, 368–369 case See Case law choice-of-law clause, 71, 74 civil See Civil law classifications of, 12–13 common See Common law consumer See Consumer law cooling-off laws, 553 criminal See Criminal law cyberlaw, 13 defined, disclosure, 555–556 due process of See Due process environmental, 563–575 franchises and, 407–408 immigration, 525–529 international See International law judge-made, labor, 529–539 mistake of, 152 national, 166 natural, 11–12 operation of See Operation of law positive, 12 procedural, 12 remedies at, right to-work laws, 531 schools of legal thought, 11–12 sources of, 3–7 statutory See Statutory law substantive, 12 tort See Torts uniform, zoning, 593–594 Lawsuits See also Cases appeals, 55–56 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–20  Index enforcing judgment, 56 parties to, 20 posttrial motions, 54–55 pretrial procedures, 44–51 procedural rules, 41–42 settlement considerations, 43 stages of litigation, 42, 43 standing to sue, 36–37 trial procedures, 51–54 Lawyers’ Edition of the Supreme Court Reports (L.Ed or L.Ed.2d), 15 Layoffs, 494–495 Lease agreement, 251 Lease contracts, 248–274 acceptance, 253–256 breach of remedies for, 266–271 risk of loss, 262 consideration, 256 formation of, 251–258 law governing, 188 lease defined, 251 offer, 251–253 performance of, 263–266 right to cancel, 266, 267 Statute of Frauds, 256–257 UCC Article 2A and, 251 unconscionability, 257–258 warranties, 271–273 Leasehold estate, 581–582 Legal cause, 296 Legality, of contracts, 211–214 Legally sufficient value, 207–208 Legal malpractice, 296 Legal positivism, 12 Legal realism, 12 Legal reasoning defined, IRAC method of, 9–10 Legislative branch checks and balances, 101 control over administrative agencies, 125 Legislative rules, 124, 129 Lessee defined, 251 obligation of, 265–266 remedies for, 267–270 Lessor defined, 251 obligation of, 263–265 remedies for, 266–267 Letters of credit, 193 Liability agency relationships for contracts, 479–480 for torts and crimes, 480–484 of corporate directors, 450–451 of corporate officer, 450–451 joint, 402 joint and several, 402 limitation-of-liability clauses, 238 in limited liability partnership, 424–425 of members of LLC, 416–417, 419 of partners, 402 of partners in limited partnership, 426–427 potentially responsible party and, 574 of shareholders, 431–432, 456 sole proprietorship and, 395–396 strict, 143–144 vicarious, 481 without fault, 305 Libel, 286 trade libel, 294 License, licensing click-on license, 204 contracts with unlicensed person, 212 defined, 325 e-contracts and, 203 of intellectual property, 325 manufacturing abroad, 173 online, 345 of real property, 583 shrink-wrap license, 204–205 Licensee, 293, 325 Licensor, 325 Lie-detector tests, of employees, 500 Liens, 271, 358–360 artisan’s, 293, 359 defined, 358 judicial, 359–360 mechanic’s, 358–359 Life estates, 580 Lilly Ledbetter Fair Pay Act, 511 Limitation-of-liability clauses, 238 Limited jurisdiction defined, 30 state trial courts, 39 Limited liability company (LLC), 416–424 advantages of, 419 alter-ego theory and, 417–418 compared to other major forms of businesses, 457–458 defined, 416 disadvantages of, 420 dissociation of, 422 dissolution of, 422–424 fiduciary duties, 420–421 foreign investors and, 419 formation of, 418–419 jurisdictional requirements of, 419 liability of members, 416–417, 419 management of, 420–421 nature of, 416–418 operating agreement, 421–422 partnership law applied to, 422 similarities to corporations, 416, 418 taxation, 419 winding up, 424 Limited liability limited partnership (LLLP), 428 Limited liability partnership (LLP), 424–425 compared to other major forms of businesses, 457–458 defined, 424 family limited liability partnership (FLLP), 425 formation of, 424 liability in, 424–425 Limited partner, 425 Limited partnership (LP), 425–428 compared to other major forms of businesses, 457–458 defined, 425 dissociation and dissolution, 427 formation of, 426 liability of, 426–427 rights and duties in, 427 Limited warranty deed, 587 Liquidated damages, 234–235 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   Liquidation proceedings, 369–378 Litigation appeals, 55–56 defined, 60 enforcing judgment, 56 posttrial motions, 54–55 pretrial procedures, 44–51 settlement considerations, 43 stages of, in lawsuit, 42, 43 trial procedures, 51–54 Local government, regulation by, for environmental protection, 564 Lockouts, 537 Long arm statute, 29 Loss of a bargain, 230–232 risk of, 259–262 Losses, sharing of, in partnerships, 397 Loyalty defined, 448 duty of, 448–449, 463, 542 agent, 472 partnerships, 401 L visa, 528 Lying, as federal crime, 450 M Madrid Protocol, 336–337 Mail and wire fraud, 148 Mailbox rule, 202 Mail-order sales, 553 Majority opinion, 20 Malice, actual, 289 Malicious prosecution, 290 Malpractice, 296 Malware, 160, 161 Management leadership in ethics, 87–90, 96–97 of limited liability company, 420–421 management rights of partners, 399–400 Manslaughter, involuntary, 143 Manufacturing abroad, 173 arrangement as type of franchise, 407 Manufacturing defects, 309–310 Marijuana, medical, commerce clause and, 102–103 Market, relevant, 606–607 Marketable title, 584 Market concentration, 610 Market Place Fairness Act, 250 Market power, 600 Market-share liability, 313–314 Maximum achievable control technology (MACT), 566 McCarran-Ferguson Act, 612 Means test, bankruptcy, 370–371, 373 Mechanic’s lien, 358–359 Mediation advantages of, 61 binding, 61 court-related, 73 defined, 61 disadvantages of, 61–62 as form of ADR, 61 mediation-arbitration, 61 service providers, 73 Mediation-arbitration, 61 Mediator, 61 Medical information, privacy rights and, 117 Medical leave, 495–496 Medical malpractice, 283, 296 Medicare, 497–498 Members (of LLC), 416 Mens rea, 143 Mental incompetence contractual capacity and, 211 as defense for criminal liability, 151–152 of principal or agent, agency termination and, 485 Merchant both parties as, 254 defined, 251 firm offer, 253 special rules for contract between, 256 Merchantability, implied warranty of, 272–273 Mergers, 610 Metadata, 50 Meta tags, 343–344 Metes and bounds, 587 Mill, John Stuart, 85 Minimum contacts, 29, 30, 33, 34 I–21 Minimum wages, 494 Mini-trials, 60–61 Minors age of majority, 210 contractual capacity and, 210–211 emancipation and, 210 undue influence in, 221 Miranda rule, 155–156 Mirror image rule, 200–201 UCC and, 254 Misappropriation theory, 628 Misconduct, after-acquired evidence of employee misconduct, 520 Misdemeanors, 141 Misrepresentation by agents, 480–481 fraudulent, 221, 290 injury, 221 innocent, 480–481 product liability based on, 306–307 voluntary consent and, 221 by words or action, 221 Mistake bilateral (mutual), 220 as defense for criminal liability, 152 of fact, 152, 219–220 of law, 152 reformation and, 236–237 unilateral, 219–220 of value, 219, 220 voluntary consent and, 219–220 Mitigation of damages, 234 M’Naghten test, 152 Model Business Corporation Act (MBCA), 431 Model Penal Code, substantialcapacity test, 151–152 Money laundering, 149 Monopoly/monopolization, 604–608 attempted, 608 defined, 600 intent requirement, 607 monopoly power, 605–606 relevant market, 606–607 unilateral refusals to deal, 607–608 Monopoly power, 600, 605–606 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–22  Index Monopsony power, 608 Moral minimum, 80 Mortgage, 360–363 adjustable-rate, 361 creditor protections in, 361 defined, 360 down payment, 360–361 fixed-rate, 361 foreclosure, 361–363 insurance for, 361 recording of, 361 Most-favored-nation status, 175 Motions defined, 46 for directed verdict, 53 to dismiss, 46 for judgment as matter of law, 53 for judgment n.o.v., 55 for judgment on the pleadings, 48 as matter of law, 55 for new trial, 54–55 posttrial, 54–55 pretrial, 46–49, 48 for summary judgment, 49 Motion to dismiss, 46–49 MP3, file-sharing and, 346–348 Multilateral agreement, 168 Multiple product order, 550 Music, file-sharing of, 346–348 Mutual assent, 195 Mutual fund, 621 Mutual rescission, 227–228 N National Association of Securities Dealers (NASD), 625 National Conference of Commissioners on Uniform State Laws (NCCUSL), 5, 206 National Environmental Policy Act, 564, 565 National Export Initiative (NEI), 172–173 National Labor Relations Act (NLRA), 529–531 coverage and procedures of, 532 social media policies, 530 union election supervision, 534 National Labor Relations Board (NLRB), 83 cease-and-desist order, 529 duties of, 121, 124 function of, 529 workers protected by, 530–531 National law, 166 National origin, discrimination based on, 508–510 National Pollutant Discharge Elimination System (NPDES), 567 National Reporter System (Thompson Reuters), 15, 16 Natural law, 11–12 Natural rights, 11 Necessity as defense for criminal liability, 150–151 easements by, 582 Negligence, 294–301 of agents, 481–483 causation, 296–298 comparative, 301 as defense to product liability, 315–316 contributory, 301 criminal, 143 damages, 298 defenses to, 299–301 defined, 294 dram shop acts, 299 duty of care and its breach, 295–296 elements of, 295 environmental pollution and, 563–564 Good Samaritan statutes, 298–299 gross, 283 injury requirements, 298 malpractice, 296 negligence per se, 298 product liability based on, 306 Negotiable instruments, 193 Negotiated settlement, 133 Negotiation assisted negotiation, 60–61 defined, 60 early neutral case evaluation, 61 facilitation, 61 as form of ADR, 60–61 mini-trials, 60–61 preliminary, 196–197 preparing for, 60 Net profits, as source for dividends, 455 New York Convention, 176–177 Ninth Amendment, 106 Nominal damages, 234 Noncompete agreements, 213 Noncompete covenant, 212–213, 389–390 Nonconforming goods, 253 Nondeadly force, 150 Nonmerchant, contract rules for, 254 Nonpossessory interests, 582–583 Nonprofit (not-for-profit) corporation, 434 Normal trade relations (NTR) status, 175 Norris-LaGuardia Act, 529 North American Free Trade Agreement (NAFTA), 175–176 Notary public, 474 Notice of agency termination, 495 posting OSHA notices, 496 validation, 558 Notice-and-comment rulemaking, 128 Notice of motion, 46 Notification agent’s duty to, 472 collection agency and, 558 of CPSC of product safety, 555 of franchise termination, 410 layoffs, 495 Novation, 418 discharge by, 228 Nuclear Regulatory Commission (NRC), 124, 564 Nuisance, 579 defined, 563 environmental pollution and, 563 Nutrition Labeling and Education Act, 552 O Obedience, agent’s duty to, 472 Objective theory of contracts, 189–190 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   Objects, requests for, 50 Obscenity defined, 111 online, 112 Occupational Safety and Health Act, 496 Occupational Safety and Health Administration, 121, 122 Ocean Dumping Act, 565, 572 Offer communication of, 199 contractual, 191, 196–200 counteroffer, 200 defined, 196 definiteness of terms, 198–199 elements of, 196–199 firm, 253 intention, 196–198 irrevocable, 199–200 lease contracts, 251–253 online for e-contracts, 203–204 open terms, 252 output contract, 252–253 preliminary negotiations, 196–197 rejection, 200 as requirement of contract, 191 requirements contract, 252 revocation of, 199–200 for unilateral contract, 192–193 sales contracts, 251–253 termination of, 199–200 by operation of law, 200 Offeree agent of, 200 counteroffer by, 200 death or incompetence of, offer termination and, 200 defined, 191, 196 rejection of offer by, 200 Offeror death or incompetence of, offer termination and, 200 defined, 191, 196 revocation of offer by, 199–200 Officer, corporate, 443–451 acquiring assets, 463 aligning interests of officers with shareholders, 632–633 business judgment rule, 447–448 compensation committee, 633 conflicts of interest, 449–450 corporate governance and, 632–634 criminal liability of, 144 defined, 431 duties of, 446–450, 463–464 fiduciary duties, 463–464 liabilities of, 450–451 roles of, 446 stock option and, 632–633 Offshore fraud, 636 Oil Pollution Act, 565, 572 Online contracts See E-contracts Online dispute resolution (ODR), 73–74 Online travel companies (OTCs), 250 Open delivery term, 252 Opening statements, 51–52 Open payment term, 252 Open price term, 252 Open term, open quantity, 252 Operating agreement, 421–422 Operation of law agency formation by, 471 contract discharge by, 228–230 termination by, 485–486 Opinions concurring, 20 defined, 20 dissenting, 20 expression of, 196 majority, 20 per curiam, 20 plurality, 20 statement of, 272, 286 unpublished, 15 Oppressive conduct, 456 Option contract, 199–200, 253 Order for relief, 371, 372 Orders final, 134 initial, 134 Ordinances, Organized crime, 149–150 Original jurisdiction, 30 Outcome-based ethics, 84, 85–86 Output contract, 252–253 Outrageous conduct, 285 Outside director, 445 Overcriminalization, 143–144 Overtime, 494 O visa, 528 I–23 Ownership in real property concurrent ownership, 580–581 in fee simple, 579 leasehold estate, 581–582 life estates, 580 transfer of adverse possession, 588–589 deed, 586–588 real estate sales contract, 584–585 P Parallel citation, 15 Parent company, 432 Paris Convention, 334 Partially disclosed principal, 478–479 Participation, right of, 445 Partners See also Partnerships authority of, 401 buyout price, 403–404 compensation of, 400 dissociation of, 402–404 fiduciary duties of, 401 general, 425 inspection of books, 400 liability of, 402 limited, 425 property rights, 400 rights of, 399–400, 403 Partnerships (traditional general), 396–406 See also Partners accounting of assets/profits, 400 agency concept and, 396–397 agreement, 398–399 articles of, 398–399 buy-sell agreement (buyout agreement), 405–406 compared to other major forms of businesses, 457–458 defined, 397 dissolution, 404–405 duration of, 398 entity vs aggregate of individuals, 397–398 essential elements of, 397 by estoppel, 398 formation of, 398–399 joint ownership and, 397 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–24  Index laws governing, 396–397 limited compared to, 425–428 limited liability limited partnership, 428 limited liability partnership, 424–425 limited partnership, 425–428 management rights, 399–400 taxes and, 398 for a term, 398 termination of, 404–405 Uniform Partnership Act (UPA), 397 at will, 398 winding up and distribution of assets, 404–405 Party, in interest, 370 Pass-through entity, 398, 419 Password protection, for social media, 351–352 Past consideration, 209–210 Patents, 325–328 defined, 325 infringement of, 326–327 remedies for, 327–328 patentable requirements, 326 searchable database for, 326 Patriot Act, 185 privacy rights and, 117 Pattern of conduct exception, 237 Payment lessor’s right of recover when due, 267 obligation of buyer or lessee, 265 open payment term, 252 tender of, 366 Peer-to-peer (P2P) networking, 346 Penalties, 234–235 Pension Benefit Guaranty Corporation (PBGC), 498 Pension plans, private, 498 Per curiam opinion, 20 Perfected security interest, 358 Perfection, security interest, 358 Perfect tender rule, 264 Performance accord and satisfaction, 228 agent’s duty to, 472 anticipatory repudiation, 266 complete, 223–224 conditions of, 223 of contract, 194 defined, 223 discharge of contract by, 223–227 impossibility of, 229–230, 388 of lease contracts, 263–266 obligations of buyer or lessee, 265–266 obligations of seller or lessor, 263–265 partial, exception to Statute of Frauds, 257 right to obtain specific, 267 of sales contract, 263–266 to satisfaction of another, 225 specific, 235–236 substantial, 224–225 tender of, 223 time for, 227 Periodic tenancy, 581 Per se violations, 600–601, 602, 603 Person corporation as, 431 foreign, 612 jurisdiction over, 29–30 legal, 431 natural, 431 Personal information, increased value of, 184 Personal property defined, 292 exemption, 368 trespass to, 293 Personal service contract, specific performance and, 236 Persuasive authorities, Pesticides, 572–573 Petition, in bankruptcy, 370 Petitioner, 7, 20, 55 Petty offenses, 141 Petty theft, 145 Phishing, 159–160 Pierce corporate veil, 417, 432, 441–443 Plaintiff complaint, 44 defined, 7, 20 Plant life, real property, 579 Plea bargaining, 153 Pleadings, 44–46 Plurality opinion, 20 Police powers, of states, 100–101 Pollution air, 565–567 hazardous waste, 573–575 toxic chemicals, 572–573 water, 567–572 Ponzi schemes, 636 Pornography, online, 112 Positive law, 12 Possession, artisan’s lien and, 359 Posttrial motions, 54–55 Potentially responsible party (PRP), 574 Power of attorney of agent, 474 defined, 474 general, 474 special, 474 Powers apparent, 476–477 of avoidance, 373 condemnation, 590 corporate, 440–441 emergency, 477 enumerated, 100 express, 440 implied, 440 market, 600 monopoly, 600, 605–606 monopsony, 608 police, 100–101 of shareholders, 451 strong-arm, 373 trustee in bankruptcy, 373 Precedent controlling, defined, departures from, Predatory behavior, 292 Predatory pricing, 604, 608 Predominant-factor test, 249–250 Preemption, 105 as defense to product liability, 315 Preemptive rights, 454 Preference, in bankruptcy, 374 Pregnancy Discrimination Act, 511 Preincorporation contracts, 418–419 Prepayment penalty clause, 361 Preponderance of evidence, 54, 140 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   Prescription, easements by, 582 Pretexting, 116–117 Pretrial conference, 51 Pretrial motion, 46 Pretrial procedures, 44–51 discovery, 49–51 jury selection, 51 motion to dismiss, 46–49 pleadings, 44–46 pretrial conference, 51 right to jury trial, 51 Price buyout price, 403–404 franchise pricing arrangements, 410 open price terms, 252 predatory pricing, 604, 608 price discrimination, 608–609 resale price maintenance agreement, 603–604 seller’s right to recover purchase price, 267 Price fixing, 601 Price-fixing agreement, 601 Prima facie case, 506–507, 515 Primary sources of law defined, how to find, 13–15 Principal agent’s duties to, 472–473, 542 bankruptcy, agency termination and, 486 death or insanity, agency termination and, 485 defined, 466 disclosed, 478–479 duties of, to agent, 473, 543 compensation, 473 cooperation, 473 reimbursement and indemnification, 473 safe working conditions, 473 partially disclosed, 478–479 rights and remedies of, 473–474 termination of agency, 484–486 torts of, 480 undisclosed, 479 Principle of rights, 84–85 Privacy Act, 116 Privacy/privacy rights Constitution and, 116 consumer privacy bill of rights, 354 data collection and cookies, 353–354 drug testing, 500–501 electronic monitoring, 499–500 of employees, 499–502 Fair Debt Collection Practices Act (FDCPA) and, 640 genetic testing, 502 Internet and, 184, 353–354 Internet companies’ privacy policies, 354 invasion of, 289–290 lie-detector tests, 500 medical information and, 117 Patriot Act and, 117 pretexting and, 116–117 statutes affecting, 116–117 in workplace, 184–185 Privately held corporation, 434–436 Private placement exemption, 623 Private Securities Litigation Reform Act (PSLRA), 628–629 Privilege, 289 Privileges and immunities clause, 101 Privity of contract, 214 product liability and, 306 Probable cause arrest and, 157 search warrants and, 113–114, 153 Probate court, 30 Procedural due process, 115 Procedural law, defined, 12 Procedural rules, 41–42 Processing-plant arrangement, 407 Product liability based on misrepresentation, 306–307 based on negligence, 306 consumer-expectation test, 310 defenses to, 315–316 defined, 305 due care, 306 inadequate warnings, 312–313 market-share liability, 313–314 privity of contract and, 306 public policy and, 307–308 I–25 requirements for, 309 risk-utility analysis, 310 statute of limitations and, 316 suits of, 283 video game warning labels, 314 Product misuse, 315 Products defective condition, 309 defects of, 309–313 design, 310–311 manufacturing, 309–310 unreasonably dangerous, 309 Professional association, 436 Professional corporation, 436 Professionals, duty of, 296 Profit maximization, 78–79 Profit(s) accounting of, in partnerships, 400 appurtenant, 582 in gross, 582 as nonpossessory interest in land, 582 sharing of, in partnerships, 397 short-swing, 628 Promise absolute, 223 for an act, 192 consideration and, 207–210 defined, 188 express warranty and, 271 Promotional activity, prior to incorporation, 437 Property community, 373, 581 conversion, 293 crimes involving, 145–147 disparagement of, 294 distribution of, in bankruptcy, 375–376 estate in, 373 homestead exemption, 367–368 intangible property, 249 intellectual See Intellectual property intentional tort against conversion, 293 disparagement of property, 294 trespass to land, 292–293 trespass to personal property, 293 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–26  Index joint ownership, and partnership, 397 jurisdiction over, 29–30 ownership of partnership and, 400 real, 579–581 personal, 292 exemption, 368 private, taken by foreign governments, 171, 174 real, 292 land-use control and zoning, 593–595 limitations on rights of property owners, 590–593 nature of, 578–579 ownership in, 579–581 transfer of ownership, 584–589 secured, and automatic stay, 372–373 surrender of, to release surety/ guarantor, 366 tangible property, 249 Property crime, 145–147 Prosecutorial Remedies and Other Tools to end the Exploitation of Children Today Act (Protect Act), 112 Pro se representation, 41 Prospectus, 620 Protected class, 505 Proximate cause, 296 Proxy, 456–457 Proxy statements, 629 Publication requirement of libel, 286 Public corporation, 434 Public figures, defamation and, 289 Public hearing, for variance, 594 Publicly held corporation, 434 Public order crime, 147–148 Public policy contracts contrary to, 212–214 defined, exceptions to employment-atwill, 492–493 respondeat superior and, 481 strict product liability and, 307–308 Puffery, 272, 290, 546 Punitive damages, 234, 283 Purpose frustration of, 230 particular, 273 Q Quality, slander of, 294 Quantity, open term, 252 Question of fact, 39 Question of law, 39 Quid pro quo harassment, 512 Quitclaim deed, 587 Quorum, 445, 452 Quotas, 174–175 R Race affirmative action, 520–521 bona fide occupational qualification (BFOQ) and, 519 discrimination based on, 102, 508–510 as suspect trait, 115–116 Racketeer Influenced and Corrupt Organizations Act (RICO), 526 federal crimes under, 150 implications of, 150 Racketeering, 149–150 Railway Labor Act, 532 Ratification agency formation by, 470–471 of agent’s unauthorized acts, 477 of contract, 195 Rational basis test, 116 Reaffirmation agreement, 377–378 Real estate goods associated with, 249 sales contract for closing date and escrow, 584 implied warranties in sale of new homes, 584 marketable title, 584 seller’s duty to disclose hidden defects, 584–586 Real property defined, 292 land-use control and zoning, 593–595 limitations on rights of owners eminent domain, 590–592 inverse condemnation, 592 restrictive covenants, 592–593 nature of, 578–579 nonpossessory interests easement or profit, 582 license, 583 ownership in concurrent ownership, 580–581 in fee simple, 579 leasehold estate, 581–582 life estates, 580 transfer of ownership adverse possession, 588–589 deed, 586–588 real estate sales contract, 584–585 zoning laws, 593–595 Reasonable accommodations for employees with disability, 518–519 for religious practices, 510 Reasonable person standard, duty of care, 295 Rebuttal, 53 Recklessness, 143 Record, electronic e-signature and, 206 writing requirements of, 214 Recording statute, 587–588 Record on appeal, 55 Recross-examination, 53 Redemption rights, 363 Redirect examination, 53 Reformation, 213, 236–237 Registration, of trademark, 322 Registration statement, 620 Regulations administrative agencies, 122–124 environmental preservation and protection, 564–565 ethical issues of, 640–642 of franchises, 407–408 independent regulatory agencies, 123–124 as primary source of law, Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   of securities, 618–619 by states, 100–101 Regulation Z, 556 Regulatory Flexibility Act, 136 Reimbursement principal’s duty of, 473 right of, 367 Rejoinder, 53 Relevant evidence, 52 Relevant market, 606–607 Religion discrimination based on, 510 establishment clause, 112–113 ethical principles and, 84 freedom of, 112–113 free exercise clause, 113 reasonable accommodations, 510 religious displays, 112–113 Remedy(ies) for agents and principals, 473–474 for breach of contract, 235–237 sales or lease contracts, 266–271 contract provision limiting, 237–238 for copyright infringement, 330–331 defined, 6, 219 equitable, 7, 235–237 in equity, at law, of lessor, 266–267 limitation-of-liability clauses, 238 for patent infringement, 327–328 prejudgment, 359 reformation, 236–237 rescission and restitution, 235 of seller, 266–267 specific performance, 235–236 standing to sue, 37 ultra vires acts, 441 for violations of Securities Act (1933), 624 for WARN violations, 495 Renunciation, agent’s termination of agency relationship, 484 Reorganization, 378–380 Repayment plan, Chapter 13, 382–383 Replevin, 268 Reporters, reports, 8, 14 Requirements contract, 252 Resale price maintenance agreement, 603–604 Rescission of contract, 235 defined, 7, 208 discharge of contract by, 227–228 as equitable remedy, 235 mutual, 227–228 new contract and, 208 restitution and, 235 Residential use of land, 593 Resource Conservation and Recovery Act, 565, 573–574 Respondeat superior, 481, 543 Respondent, 7, 20 Responsible corporate officer doctrine, 144 Restatement (Third) of Agency, 466 independent contractor, 467 Restatement (Second) of Contracts, 204 Restatement (Third) of Contracts, 11 Restatement of the Law of Contracts, 11 Restatement of Torts, 333 Restatement (Second) of Torts, 309 Restatement (Third) of Torts: Products Liability, 309 Restatements of the Law clarify and illustrate common law, 11 as secondary source of law, Restitution, 235 for deceptive advertising, 550 Restraint of trade common law and, 599 contracts in, 212–213 covenant not to compete, 212–213 defined, 599 horizontal, 601–602 vertical, 602–604 Restrictive covenant, 212–213, 592–593 Retail fraud, online, 159 Retained earning, 432 I–27 as source for dividends, 455 Retaliation claim, 512–513 Reverse discrimination, 508–509 Revised Model Business Corporation Act (RMBCA), 431, 445 Revised Uniform Limited Partnership Act (RULPA), 425 Revocation of buyer’s and lessee’s acceptance of goods, 269 defined, 193, 199 of offers, 199–200 of offers for unilateral contract, 192–193 principal’s termination of agency relationship, 484 Rights of agents, 473–474 airspace, 578 of contribution, 367 of directors, corporate, 445–446 to indemnification, 446 of inspection, 445, 455 in limited partnership, 427 natural, 11 of ownership, 579–581 of participation, 445 of partners, 399–400 preemptive rights, 454 of principals, 473–474 principle of, 84–85 privacy See Privacy/privacy rights of redemption, 363 of reimbursement, 367 of shareholders, 454–456 to strike, 536 of subrogation, 367 subsurface, 578–579 of surety and guarantor, 366–367 of survivorship, 580 of trustee in bankruptcy, 373, 374 voidable, 373–374 Right to-work laws, 531 Risk assumption of, as defense, 299–300, 315 of loss, 259–262 of personal assets and sole proprietorship, 396 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–28  Index product warnings and, 312–313 to warn business invitees of risks, 295–296 Risk-free investments, 636 Risk-utility analysis, 310 Rivers and Harbors Appropriations Act, 565, 567 Robbery, 145 Rule, 10, 127 Rule 144, 623 Rule 144A, 623 Rule 504, 621–622 Rule 505, 622–623 Rule 506, 623 Rulemaking, 127–129 Rule of four, 41 Rule of reason per se violations and, 600–601 territorial or customer restrictions, 603 Rules of evidence, 52–53 S Safe Drinking Water Act, 565, 572 Safety drug safety, 554 food safety, 554 principal’s duty of safe working conditions, 473 Safe Web Act, 341–342 Sales consumer protection and, 553 cooling-off laws, 553 defined, 249 of goods, 232–233 of land, 232–233, 236 mail-order, 553 of ongoing business, and covenant not to compete, 212–213 online, 553 taxes on Internet sales, 250 telephone, 553 Sales contracts, 248–274 acceptance, 253–256 agreements to rescind sales contract, 228 breach of compensatory damages, 232–233 remedies for, 266–271 risk of loss, 262 choice-of-law clauses, 177–178 consideration, 256 defined, 248 firm offer, 253 formation of, 251–258 forum-selection clause, 177–178 good defined, 249 good faith, 263 good faith limitation, 253 identification, 258–259 insurable interest, 262–263 for international goods, 273–274, 278–281 law governing, 188, 257 letters of credit, 193 limitation of remedies for, 238 merchant defined, 251 mirror image rule, 254 offer, 251–253 output contract, 252–253 performance of, 263–266 predominant-factor test, 249–250 for real estate, 584–585 requirements contract, 252 right to cancel, 266, 267 risk of loss, 259–262 sales defined, 249 Statute of Frauds, 256–257 taxes on Internet sales, 250 UCC Article and, 248–251 unconscionability, 257–258 warranties, 271–273 Same-sex marriage, full faith and credit clause, 101 Sarbanes-Oxley Act, 90, 463, 464 increasing criminal penalties, 158 key provisions of, 633–635 Satisfaction, accord and, 228 Scienter requirement, 629–631 S corporations, 436 Search and seizure by administrative agencies, 132 in business context, 114 Fourth Amendment protections, 153 probable cause and, 113–114 Search warrant, 113–114 administrative agencies and, 132–133 Fourth Amendment protections, 153 probable cause and, 153 scope of, 154 Seasonably, 253 Second Amendment, 106 Secondary boycott, 536–537 Secondary meaning of trademark, 323–324 Secondary sources of law, Section 12 companies, 625 Secured creditors, distribution to, 375 Securities corporate governance and, 632–634 defined, 618 Howey test, 619 insider trading, 626 misappropriation theory, 628 online investment scams, 635–636 prospectus, 620 registration process, 620 registration statement, 620 regulation of, by SEC, 618–619 restricted, 623 state securities laws, 632 testing the waters, 621 tipper/tippee theory, 627–628 well-known seasoned issuer (WKSI), 621 Securities Act (1933), 619–625 exempt securities and transactions, 621–623 registration process, 620 securities defined, 619 violations of, 623–625 Securities and Exchange Commission (SEC), 5, 123 corporate blogs and securities fraud, 642 corporate governance and, 463 duties of, 121, 124 EDGAR database, 620 expanding powers of, 619 insider trading, 626–628 proxies and shareholder proposals, 452 Regulation A, 621 Regulation D, 621–623 resale and safe harbor rules, 623 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   updating regulatory process of, 618 Securities Exchange Act (1934) insider reporting and trading, 628 regulation of proxy statements, 629 scienter requirement, 629–631 Section 10b, 625–628 Section 16b, 628 violations of, 629–632 Security interest defined, 262, 358 perfected, 358 warranty of title and, 271 Self-defense, as defense for criminal liability, 150 Self-incrimination, 114, 152, 153 Seller goods held by, 261–262 obligation of, 263–265 place of business, 263 remedies for, 266–267 residence, 263 Seniority system, as defense to employment discrimination, 519–520 Sentencing guidelines, 158 Sentencing Reform Act, 158 Service corporation, 436 Service mark, 324 Service of process, 45–46 method of, 44–45 waiver of formal, 45–46 Services goods and services combined, 249–250 predominant-factor test, 249–250 Servient estate, 582 Settlement agreement, 228 Settlements, negotiated, 133 Seventh Amendment, 51, 106 Sexual harassment by co-workers, 514 Ellerth/Faragher affirmative defense, 512 forms of, 511–512 retaliation by employers, 512–514 same-gender harassment, 514 sexual orientation harassment, 514 by supervisors, 512 tangible employment action, 512 Sexual orientation harassment, 514 Shareholder agreement, 435 Shareholders, 451–456 aligning interests of officers with shareholders, 632–633 corporate governance and, 632–634 defined, 431 derivative suit of, 455–456 dividends and, 432, 454–455 duties of, 456 liability of, 431–432, 456 majority of, fiduciary duties of, 456 meetings of, 451–452 minority, 456 powers of, 451 preemptive rights, 454 proposals, 452 rights of, 454–456 stock certificates, 454 stock warrants, 454 transfer of shares, 455 voting by, 452–454 Shares of corporation, 438 transfer of, in closely held corporation, 434–436 Sharia, 39, 169 Sherman Antitrust Act, 178, 599–608 historical perspective on, 599 horizontal restraint, 601–602 jurisdictional requirements of, 600 monopolization, 604–608 overview of, 599–600 per se violations and rule of reason, 600–601 vertical restraints, 602–604 Shipment, date of, 265 Shipment contract, 259, 261, 263–264 Short sale, 361–362 Shrink-wrap agreement (shrinkwrap license), 204–205 Signatures, electronic, 205–207 Silence, as acceptance, 201 Simple contracts, 193 I–29 Sixth Amendment, 106, 153 Slander, 286–287 damages for, 286 defined, 286 of quality, 294 slander per se, 286–287 of title, 294 Sliding-scale standard, 33–35 Small Business Administration (SBA) franchises, 406–412 Office of the National Ombudsman, 136 partnerships, 396–406 Small Business Administration Act, 612 Small businesses franchises, 406–412 partnerships, 396–406 sole proprietorship, 394–396 Small Business Liability Relief and Brownfields Revitalization Act, 565 Small Business Regulatory Enforcement Fairness Act (SBREFA), 136 Small claims courts, 39 Smartphones, cyber attacks and, 168 Social media bankruptcy court live chats, 369 business ethics and, 83–84 corporate blogs and securities fraud, 642 defined, 348 discussing work-related issues on, 83–84 Electronic Communications Privacy Act (ECPA), 351 hiring procedures and, 83 internal networks, 352 legal issues and, 349–351 NLRA and company policies of, 530 password protection, 351–352 Social Security, 497 Social Security Act, 497 Social Security Administration, 497 Sociological school, 12 Software cloud computing and, 346 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–30  Index copyright protection of, 331–333 filtering, 112 patents for, 327 Sole proprietorship, 394–396 advantages of, 394–395 compared to other major forms of businesses, 457–458 defined, 394 disadvantages of, 395–396 flexibility of, 394–395 lack of continuity, 396 personal assets at risk, 396 taxes and, 395 Sovereign immunity, doctrine of, 171–172 Sovereignty, 100 Spam, 341–342, 547–550 Special damages, 234, 282 Special-use permits, 594 Special warranty deed, 587 Specific performance, 235–236 defined, right to obtain, 267–268 Speech commercial, 110 compelling government interest, 108 computers and, 107 corporate political, 109–110 freedom of, 106–112, 184 trademark protection vs., 390 trade secrets vs., 391 outrageous conduct and, 285 reasonable restrictions, 107–108 symbolic, 106–107 unprotected, 111–112 Stakeholders, corporate social responsibility and, 87 Standing to sue, 36–37 Stare decisis, 169 aspects of, common law tradition and, legal reasoning and, 9–10 legal stability and, 8–9 State, Department of, 123 State codes, 14 State court system, 37–39 appellate courts, 39 budget cuts to, effect on business, 38 citations of, 17 decisions of, 14–15 judge selection for, 39 supreme (highest) courts of, 39 trial courts of, 30, 39 Statements of fact, 286 of future intent, 196 of opinion, 272, 286 of value, 272 States/state government commerce clause, 102–104 full faith and credit clause, 101 immigration law, 528–529 laws of layoff notification, 495 ordinances, trade secrets, 333 uniform laws, limited liability companies, 422 limited liability partnerships and, 424–425 limits on, and Bill of Rights, 105–106 police powers, 100–101 privileges and immunities clause, 101 recording statute, 587–588 regulation by, 100–101 agencies of, environmental preservation and protection, 564 of franchises, 408 spam, 341 securities laws of, 632 selecting state of incorporation, 437 sovereignty of, 100 supremacy clause, 104–105 Statute of Frauds defined, 214 exceptions to, 256–257 UCC and, 256–257 writing requirement, 364 of contracts, 214, 256 Statute of limitations contracts and, 229 as defense for criminal liability, 152 surety/guarantor defense, 366 Statutes arbitration, 62–64 contracts contrary to, 211–212 federal, Good Samaritan statutes, 298–299 long arm statute, 29 as primary source of law, 4, recording statutes, 587–588 state, Statutes of limitations defined, 7, 116 product liability defense, 316 Statutes of repose, 316 Statutory law citations, 18 defined, finding, 14 as primary source of law, 3, as source for contract law, 188 trademark protection and, 322 Stock certificates, 454 Stock option, 632–633 Stocks See also Securities shares of, and article of incorporation, 438 stock certificates, 454 transfer of shares, 455 watered stock, 456 Stock warrants, 454 Stop Counterfeiting in Manufactured Goods Act (SCMGA), 324–325 Strict liability, 305–314 abnormally dangerous activities, 305–306 bailment, 306 crime and, 143–144 defined, 305 environmental pollution and, 563–564 historical perspective on, 305 potentially responsible party and, 574 product liability, 306–316 wild animals and, 306 Strict product liability consumer-expectation test, 310 defenses to, 315–316 inadequate warnings, 312–313 market-share liability, 313–314 product defects, 309–313 public policy and, 307–308 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   requirements for, 309 risk-utility analysis, 310 statute of limitations and, 316 Strict scrutiny, 115–116 Strike defined, 536 illegal, 536–537 right to, 536 strikers’ rights after end of, 537 Strong-arm power, 373 Subchapter S of IRS code, 436 Submission, in arbitration process, 64–65 Subpoena administrative agencies and, 132 ad testificandum, 132 duces tecum, 132 Subrogation, right of, 367 Substance abuse, as disability, 518–519 Substantial abuse, of bankruptcy, 370–371 Substantial-capacity test, 151–152 Substantial performance, 224–225 Substantive due process, 115 Substantive law, 12 Substantive rules, 124 Subsurface rights, 578–579 Suggestive trademark, 323 Summary judgment, 49 Summary jury trial, 73 Summons, 45 Sunshine Act, 136 Superfund, 574 Superseding cause, 300–301 Supervisors, sexual harassment by, 512 Suppliers, monitoring employment practices of foreign, 91 Supreme Court, U.S See United States Supreme Court Supreme Court Reporter (S.Ct.), 15 Suretyship, 364 actions that release, 366 defenses of, 366 defined, 364 rights of, 366–367 Surplus, as source for dividends, 455 Suspect trait, 115–116 Symantec, 86 Symbolic speech, 106–107 T Taft-Hartley Act, 531 Taking, 590, 641 Tangible employment action, 512 Tangible property, 249 Tariffs, 175 Taxes/taxation congressional power to, 105 corporations, 432 double taxation, 432 holding companies and, 432 on imported goods, 175 information return, 398 on Internet sales, 250 of limited liability company, 419 Medicare, 497–498 partnerships and, 398 pass-through entity, 398, 419 S corporations, 436 Social Security, 497 sole proprietorship and, 395 tariffs, 175 tax returns during bankruptcy, 370 Telemarketing, 550–551 Telemarketing and Consumer Fraud and Abuse Prevention Act, 550 Telephone Consumer Protection Act (TCPA), 550 Telephone Records and Privacy Protection Act, 117 Telephone sales, 553 Tenancy in common, 580 by the entirety, 580–581 fixed-term, 581 joint, 580 periodic, 581 at sufferance, 581–582 at will, 581 for years, 581 Tender of delivery, 259, 261–262, 263 of payment, 366 perfect tender rule, 264 of performance, 223 I–31 Tenth Amendment, 4, 100, 106 Termination of agency, 484–486 of easement or profit, 582 of franchise, 408, 410–412 notice of, 485 of offer, 199–200 by operation of law, 485–486 of partnerships, 404–405 wrongful, 411, 484–485 Term(s) additional, 254–256 browse-wrap, 205 definiteness of, 198–199 generic, 324 open, 252 open delivery term, 252 open payment term, 252 open price term, 252 partnership for a, 398 shrink-wrap and agreement, 205 Territorial restrictions, 602–603 Territorial rights of franchise, 409–410 Terrorism civil liberties and control of crime, 185 cyberterrorism, 160–161 Testing the waters, 621 Textbooks, reselling textbooks purchased abroad, 332 Theft, 145 cyber, 159–160 identity, 159 of trade secrets, 149 Third Amendment, 106 Third party defined, 214 liability to, and partner dissociation, 404 third party beneficiary contract, 214, 215–216 Tie-in sales agreement, 609 Time acceptance and, 202 for performance, 227 reasonable, 200, 227, 252, 262, 263, 285 Tipper/tippee theory, 627–628 Title defined, 258 document of, 259, 262 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–32  Index identified goods and, 258 marketable, 584 passage of, 258–259 slander of, 294 warranties, 271 Title insurance, 584 Title VII of Civil Rights Act, 505–515 class-action limitations, 506 constructive discharge, 511 discrimination, based gender, 510–511 on race, color, and national origin, 508–510 religion, 510 Equal Employment Opportunity Commission (EEOC), 505–506 intentional and unintentional discrimination, 506–508 online harassment, 514 remedies, 514 sexual harassment, 511–514 Tolled, 316 Tortfeasor, 480 defined, 284 Torts, 282–284, 282–301 of agent, 483–484 business wrongful interference with a contractual relationship, 291–292 wrongful interference with business relationship, 292 classification of, 284 corporations and, 432–433 cyber torts, 352–353 damages available to, 282–283 defenses, 284 defined, 282 exceptions to employment-atwill, 492 of independent contractor, 484 intentional against person abusive or frivolous litigation, 290–291 assault, 284 battery, 284–285 defamation, 286–289 defined, 284 false imprisonment, 285 fraudulent misrepresentation, 290 intentional infliction of emotional distress, 285 invasion of privacy, 289–290 intentional against property conversion, 293 disparagement of property, 294 trespass to land, 292–293 trespass to personal property, 293 international claims, 178–180 of principal, 480 purpose of, 282 reform of, 283–284 toxic, 563 unintentional (negligence) causation, 296–298 defenses to, 299–301 dram shop acts, 299 duty of care and its breach, 295–296 Good Samaritan statutes, 298–299 injury requirements and damages, 298 negligence per se, 298 Toxic chemicals, 572–573 Toxic Substances Control Act, 565, 573 Toxic torts, 563 Trade contracts in restraint of, 212–213 minimizing barriers to, 175–176 restraints of, 599 usage of, 273 Trade associations, 602 Trade dress, 324 Trade libel, 294 Trademark, 320–324 counterfeit goods and, 324–325 defined, 320 dilution of, 322, 344–345 distinctiveness of mark, 323–324 fanciful and arbitrary, 323 generic terms, 324 infringement of, 322–323 meta tags and, 343–344 protection of, vs free speech rights, 390 registration of, 322 secondary meaning of, 323–324 statutory protection of, 322 suggestive, 323 summary of, 334 Trademark Dilution Revision Act (TDRA), 322 Trade name, 325 securing corporate name and, 438 Trade secrets company-wide social networks and protection of, 352 in cyberspace, 333 defined, 333 free speech rights vs., 391 state and federal law on, 333 summary of, 334 theft of, 149 Trading with the Enemy Act, 174 Traditional general partnership See Partnerships (traditional general) Transferred intent, 284 Transfers in bankruptcy, 374 fraudulent, 374 Transgender persons, discrimination against, 543 Transportation, Department of, 123 Travel time, scope of employment and, 483 Treasury, Department of, 123 Treaty, 168 Treble damages, 611 Trespass to chattels, 293 to land, 292–293 to personal property, 293 to personalty, 293 Trial courts closing arguments, 53 defined, 15 federal (district), 30 state, 30, 39 Trials closing arguments, 53 examination of witnesses, 53 jury instructions to, 53–54 right to, 51 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   selection of, 51 motion for new, 54–55 opening statements, 51–52 posttrial motions, 54–55 potential motions and judgment, 53 pretrial procedures, 44–51 rules and procedures of, 51–54 rules of evidence, 52–53 summary jury trial, 73 verdict, 54 Triple bottom line, 79 TRIPS agreement, 336 Trustee bankruptcy, 369, 373–374 United States, 370 Truth-in-Lending Act (TILA), 555–557 Tying arrangement, 609 Typosquatting, 343 U Ultra vires doctrine, 440–441 Unconscionability of contracts or clauses, 213, 388–389 procedural, 213 of sales or lease contracts, 257–258 substantive, 213 under UCC, 213 Undertaking Spam, Spyware, and Fraud Enforcement with Enforcers Beyond Borders Act, 342 Undisclosed principal, 479 Undue hardship reasonable accommodations for disabilities, 518 reasonable accommodations for religious practices and, 510 Undue influence, voluntary consent and, 221 Unemployment compensation, 498 Unenforceable contract, 195 Unequivocal acceptance, 200–201 Unfair labor practices, 537–539 Uniform Arbitration Act, 63 Uniform Commercial Code (UCC) adoption of, 5, 248 agreements to rescind sales contract, 228 anticipatory repudiation, 266 Article 2, franchises under, 407 Article (sales contracts), scope of, 248–251 Article 2A (leases), scope of, 251 commercial reasonableness, 252, 263, 388 communication of acceptance, 253–254 compared to CISG, 168, 274 consideration, 256 creation of, firm offer, 253 goal of, 248 good faith and, 252, 263, 388 good faith limitation, 253 identification, 258–259 insurable interest, 262–263 mirror image rule, 254 open terms, 252 passage of title, 258–259 perfect tender rule, 264 risk of loss, 259–262 sales contract and limited remedies, 238 as source for contract law, 188 Statute of Frauds, 256–257 terms between merchants, 254 unconscionability, 213, 257–258, 388 warranties under, 271–273 Uniform Electronic Transactions Act (UETA), 202, 479–480 E-SIGN Act and, 206 scope and applicability, 206 signatures on electronic records, 206–207 Uniform laws, Uniform Negotiable Instruments Law, Uniform Partnership Act (UPA), 397, 422 Uniform Source Locators (URLs), citations to, 19 Uniform Trade Secrets Act, 333 Unilateral contracts, 192–193 Unilateral mistake, 219–220 I–33 Unintentional discrimination, 508 Unintentional torts (negligence) causation, 296–298 defenses to, 299–301 dram shop acts, 299 duty of care and its breach, 295–296 Good Samaritan statutes, 298–299 injury requirements and damages, 298 negligence per se, 298 Unions authorization card, 534 closed shop, 531 collective bargaining, 535–536 decision to form or select, 532, 534 elections, 534–535 employer’s discrimination against union workers, 538 employer’s domination of union, 538 employer’s interference with, 538 employer’s refusal to recognize or negotiate with, 538 as exclusive bargaining representative, 535 featherbedding, 531 federal laws regarding, 529–532 good faith bargaining, 529–530, 536 hot-cargo agreements, 531 lockouts, 537 negotiating terms and conditions, 535–536 right-to-work laws, 531 strikes, 536–537 unfair labor practices, 537–539 coercion, 538–539 discrimination by, 539 union shop, 531 Union shop, 531 United Nations Commission on International Trade Law, 168 Contracts for the International Sale of Goods (CISG), 168 Convention on the Recognition and Enforcement of Foreign Arbitral Awards, 74, 176–177 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it I–34  Index General Assembly of, 168 United States Code (U.S.C.), 14 citation to, 14 Section 1001 of Title 18, 450 United States Code Annotated (U.S.C.A.) (West), 14 United States Constitution administrative agencies and, 124–125 affirmative action programs, 520 checks and balances, 101 commerce clause, 102–104 delegation doctrine, 124–125 due process clause, 114–115 equal protection clause, 115–116 establishment clause, 112–113 federal courts under, 28, 30–31 federal form of government, 100–105 freedom of religion, 112–113 freedom of speech, 106–112 free exercise clause, 113 full faith and credit clause, 101 health-insurance requirement, 100 powers of government, 100–105 as primary source of law, 3, privacy rights and, 116–118 privileges and immunities clause, 101 search and seizure, 113–114 self-incrimination, 114 separation of powers, 101 supremacy clause, 104–105 as supreme law of the land, 4, 100 taxation, 105 United States Reports (U.S.), 15 United States Statutes at Large, 14 United States Supreme Court appeals to, 41 decisions of, as binding authority, judicial review, 29 petitions granted by, 41 rule of four, 41 United States trustee, 370 Unprotected speech, 111–112 Unreasonably dangerous products, 309 Unsecured creditors, distribution to, 375–376 USA Patriot Act, 117 U.S circuit courts of appeals, 40 U.S courts of appeals, geographic boundaries of, 40 U.S Department of Agriculture (USDA), 552–553 U.S Department of Health and Human Services, U.S district courts geographic boundaries of, 40 jurisdiction, 40 U.S Patent and Trademark Office, 322 searchable database, 326 U.S Safe Web Act, 341–342 Usury, 212 Utilitarianism, 85–86 V Validation notice, 558 Valid contract, 194 Value mistake of, 219, 220 statement of, 272 Variance, 594 Vegetation, real property, 579 Venue, 36 Verdict, 54 Vertically integrated firms, 602 Vertical merger, 610 Vertical restraints, 602–604 Vesting, 498 Veterans Affairs, Department of, 123 Vicarious liability, 481 Victimless crimes, 147–148 Video games, warning labels for, 314 Violent crime, 145 Virus, computer, 160 Visas H1-B visa, 528 H-2, O, L and E, 528 Voidable contract, 194–195 Voidable rights, 373–374 Void contract, 195 Voir dire, 51 Voluntary bankruptcy, 370–371 Voluntary consent defined, 219 duress, 221–222 fraudulent misrepresentation, 221 mistake, 219–220 undue influence, 221 Voting, by shareholders, 452–454 Voting lists, 452–453 W Wages collective bargaining and, 535 garnishment, 360 laws governing, 493–494 minimum, 494 overtime provision and exemptions, 494 wage discrimination, 511 Waiver of breach of contract, 237 class-action waiver in creditcard contracts, 68 defined, 237 of formal service of process, 45–46 of right to challenge arbitration award, 71, 72 Walsh-Healey Act, 493 Walt Disney Company, 87 War, agency termination and, 486 Warehouse receipt, 259 Warnings, product liability and, 312–313 Warranties disclaimers, 273 express, 271–272 implied, 272–273, 479 implied warranty of habitability, 584 in sales and lease contracts, 271–273 title, 271 Warrants search, 113–114, 132–133, 153–154 stock warrants, 454 Warranty deed, 587 Waste, 580 Watered stock, 456 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Index   Water pollution, 567–572 Clean Water Act (CWA), 567–572 drinking water, 572 ocean dumping, 572 oil pollution, 572 Webb-Pomerene Act, 612 Well-known seasoned issuer (WKSI), 621 Westlaw, citations to, 19 Wetlands, 569–570 Whistleblowing, 492–493 White-collar crime, 147–149 bankruptcy fraud, 149 bribery, 148–149 defined, 148 embezzlement, 148 increased criminal penalties for, 158 insider trading, 149 mail and wire fraud, 148 theft of trade secrets and other intellectual property, 149 Wildcat strikes, 537 Will, 579 partnerships at, 398 Winding up of limited liability company, 424 of partnerships, 404–405 Witnesses cross-examination, 53 direct examination of, 53 expert, 53 Women gender discrimination, 510–511 pregnancy discrimination, 511 sexual harassment of, 511–514 wage discrimination, 511 Worker Adjustment and Retraining Notification (WARN) Act, 494–495 Workers’ compensation, 496–497 Workout agreement, 361 Workouts, 378 Workplace electronic monitoring in, 499–500 principal duties to provide safe working conditions, 473 privacy rights in, 184–185 safety, OSHA requirements, 496 Works for hire, 469–470 World Trade Organization (WTO), 175 Worm, 160 Writing, requirements assurance of due performance, 265 I–35 confirmation between merchants and, 256 equal dignity rule, 474 guaranty, 364 merchant’s firm offer, 253 mortgage, 361 Statute of Frauds, 256 Writs of attachment, 359–360 of certiorari, 41 of execution, 56, 360 Wrongful discharge, 493 Wrongful dissociation, 403 Wrongful interferences, 291–292 Wrongful termination, of franchise, 411 Y Year Books, Z Zoning laws exceptions to, 594–595 purpose and scope of, 593–594 Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it Copyright 2013 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s) Editorial review has deemed that any suppressed content does not materially affect the overall learning experience Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it  ... within the scope of the partnership agreement Each partner is also a general agent of the partnership in carrying out the usual business of the firm “or business of the kind carried on by the partnership”... service Rather, as mentioned, a partner’s income from the partnership takes the form of a distribution of profits according to the partner’s share in the business Partners can, of course, agree otherwise... to the partnership and to the other partners for damages caused by the dissociation This liability is in addition to any other obligation of the partner to the partnership or to the other partners