b'This text was adapted by The Saylor Foundation under a Creative\nCommons Attribution-NonCommercial-ShareAlike 3.0 License without\nattribution as requested by the work\xe2\x80\x99s original creator or licensee.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n1\n\n\x0cChapter 1\n\nIntroduction to Law\nLEARNING OBJECTIVES\nAfter reading this chapter, you should be able to understand the nature and sources of law, and the\nconcept of the rule of law and how it affects business and economic prosperity. At the conclusion of this\nchapter, you should be able to answer the following questions:\n1.\n\nWhat is the law?\n\n2.\n\nWhere does our law come from?\n\n3.\n\nWhat is a rule of law?\n\n4.\n\nHow is the law relevant to business?\n\n5.\n\nHow does the study of the legal environment of business create a foundation for future business courses?\n\nYou might be wondering what the law has to do with you. You try to follow the rules. You don\xe2\x80\x99t get into\nany trouble. You want to engage in honest dealings in business. Besides, you can always hire an attorney if\nyou need legal help.\nThis may all be true. However, it is imperative for those in the business world to understand the legal\nenvironment in which they are operating. While you may have the best intentions and be truly diligent in\nyour efforts to do business fairly, inevitably conflicts will arise in everyday business dealings. For example,\nwhat does it mean to do business \xe2\x80\x9cfairly\xe2\x80\x9d? Fair to whom? Fair to your shareholders? Fair to your\nemployees? Fair to the consumers who will purchase your products? Through which ethical lens will you\ncontemplate these issues? Trade-offs are a part of business. If you want to increase shareholder profits,\nyou may need to reduce labor costs. One way to reduce labor costs is to use cheaper labor. If you pay your\nemployees less, your employees will be less well off, but your shareholders may be happier.\nConsider the credit crisis that came to the world\xe2\x80\x99s attention in October 2008 and nearly toppled the U.S.\neconomy into depression. Hundreds of thousands of homes were foreclosed by banks (Figure 1.1 "The\nCredit Crisis"), leading to a vicious cycle of depressed housing prices, shattered consumer confidence, and\nbusiness retrenchment. You may be thinking that this has little to do with you or with the study of the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n2\n\n\x0clegal environment of business. Think again. The credit crisis affected everyone. And the nature of the\ncrisis implicated several legal environment issues.\nFigure 1.1 The Credit Crisis\n\nSource: Photo courtesy of Brendel, http://en.wikipedia.org/wiki/File:Foreclosedhome.JPG.\n\nIn a nutshell, the U.S. financial system nearly collapsed under the weight of high default rates among\nmortgagees, the issuance of excessive subprime mortgages to unqualified debtors, collateralized debt\nobligations (CDOs) that were not being serviced and could not be sold, and a mortgage banking system\nwith flawed incentive structures from the bottom to the top. The mortgage industry created incentives for\nthose who worked in that industry to act in their own self-interest to make a profit, even at the expense of\nthe long-term health of the institutions for which they were working.\nConsidering this flawed incentive system, the results were not surprising to many economists, who know\nthat people tend to act in their own self-interest, even at the expense of their institutions\xe2\x80\x99 goals. Mortgage\nbrokers had very strong incentives to approve every mortgage applicant, regardless of creditworthiness or\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n3\n\n\x0cability to service the mortgage. This was because the lenders were pressuring them for more mortgages, so\nthat the lenders themselves could sell those mortgages for a profit. And this pressure for \xe2\x80\x9cmore\xe2\x80\x9d was\nendemic at every level of the mortgage industry, from the would-be homeowner who wanted more house\nthan he or she could afford to the investment bankers who wanted more CDOs on which they could profit.\nHowever, excessive risk was undertaken, and when mortgagees began defaulting on their mortgages, the\nmarket became flooded with houses that had been foreclosed. As supply of houses increased and demand\nfor them fell, housing prices plummeted, which meant that not only were the investors not receiving\nincome on their investments, but also homeowners were losing the value of their investments, since their\nhouse prices were plummeting. The end result was that many homeowners were \xe2\x80\x9cupside down\xe2\x80\x9d on their\nobligations, meaning that they owed more on their houses than what the houses were worth. This created\nan incentive for mortgagees to abandon their debt obligations. When the investors did not receive income\non their investments, they also were not receiving the cash flow to cover their debts, and they could not\nservice their obligations under their CDOs. Parties at every level began clamoring for protection from\ntheir creditors from the U.S. bankruptcy courts by filing petitions for bankruptcy.\n\nHyperlink: Credit Crisis\nhttp://vimeo.com/3261363\nThis video explains the credit crisis and will help you begin thinking about the intersection between the\nlegal environment of business and the role of government in regulating business.\nAfter watching the video in Note 1.2 "Hyperlink: Credit Crisis", consider the intersection between law and\neconomics. Former Federal Reserve Chairman Alan Greenspan had consistently maintained that private\nregulation (that is, self-regulation by private industry) was better at containing risk than government\nregulation. But when the 2008 credit crisis manifested, Greenspan retracted this belief, at least in part.\nHe expressed that he was in \xe2\x80\x9ca state of shocked disbelief\xe2\x80\x9d concerning the financial institutions\xe2\x80\x99 inabilities\nto self-regulate.\n\n[1]\n\nHe always believed that the incentive of survival of the institution itself would force\n\nbanks to self-regulate. However, this \xe2\x80\x9cshocked disbelief\xe2\x80\x9d underscored a fissure within the discipline of\neconomics\xe2\x80\x94namely, whether the same economic principles that apply to individuals also apply to\norganizations. While we know from our study of economics that individuals act in their own self-interest,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n4\n\n\x0cthe 2008 credit crisis perhaps illustrated that people continue to act in their own self-interest, even when\nworking within a firm. The firm itself is only a collection of individual people, and so the firm itself does\nnot act in any type of organizational self-interest.\nYou might be wondering why we are discussing economics. This is because economic principles are\nintertwined with economic prosperity, and economic prosperity is intertwined with business, as the\npreceding example illustrates. To understand what happened in the credit crisis and, more importantly,\nhow to prevent something like this from happening in the future, we have to understand economic\nprinciples that impel behavior. Additionally, we have to understand how our laws can embody the\nknowledge that we have from economics to prevent situations like this from happening in the future.\nSpecifically, while a basic principle of economics is that individuals act in their own self-interest, they do\nso within the rules of the game. That is, they do so within the parameters of the law. Additionally,\nsometimes individuals weigh the penalties of violating the law against the chances of getting caught to\ndetermine how they should behave. In both instances, the law is a restraint on behavior.\nReflect on the credit crisis and how our laws could have entirely averted or seriously mitigated the fallout\nthat resulted from it. For example, if the laws regulated the incentive structures that exist within private\nindustry, the individual incentive to make a profit would not have been allowed to overtake the financial\ninstitutions\xe2\x80\x99 need to self-preserve by limiting risk. Likewise, if our banking regulations limited the types of\nservices that banks could offer, perhaps the exotic financial instruments that were created as a precursor\nto the credit crisis would not have been permitted in the first place. If the size of our financial institutions\nhad been limited by law, the dangerous fallacy that the financial institutions were too large to fail could\nnot have been perpetuated. If compensation packages were legally restricted by limitations on size or\nsevered from linkages to performance, then individual incentives to maximize profit could have been\nrestrained. Additionally, this situation raises several ethics questions. For example, was it ethical to loan\nmoney to people who were not able to service those debts?\nAs you think about these questions and the many other questions that will arise during your study of the\nlegal environment of business, try to set aside any fixed ideas that you have already formulated about law\nand the legal system. Many students who are new to the study of law find themselves sharply swayed by a\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n5\n\n\x0cparticular type of fiction that has grown around the legal system. Specifically, many students find that\nthey harbor a sense of repugnance to law, because they have heard that it is filled with frivolous lawsuits\nbrought by a litigious public waiting to pounce at the smallest slight, along with money-grubbing\nattorneys waiting to cash in. We ask that you set aside those and any other preconceived notions that you\nmay harbor about the law and the legal system. The law is a dynamic, sophisticated field. Frivolous\nlawsuits are not permitted to advance in our legal system, and most attorneys are committed to justice\nand fairness. They work hard to protect their clients\xe2\x80\x99 legal interests and simply do not have the desire or\nthe time to pursue frivolous claims. Indeed, there is no incentive for them to pursue such claims, because\nour legal system does not reward such behavior.\nMost people want to conduct themselves and their business dealings within the parameters of the law.\nEven if we are very cynical, barring any other compunction to behave well, we can see that it makes the\nmost economic sense to do so. Following the rules of the game saves us money, time, and aggravation, and\nit preserves our individual and professional reputations. So if most people recognize that they have an\nincentive not to run afoul of the law, why are there so many legal disputes? There are many reasons for\nthis, such as the fact that many of our laws are ambiguous, and reasonable people may disagree about\nwhat is \xe2\x80\x9cright.\xe2\x80\x9d Additionally, legal injuries happen even under the best of conditions, and the aggrieved\nparties need a method to press their claims to be compensated for their damages.\nA common theme in the study of the legal environment is responsibility. Much of our legal wrangling\nseeks to answer the questions, \xe2\x80\x9cWho is responsible, and what should be done about this injury?\xe2\x80\x9d\nAdditionally, and perhaps more importantly for business, is the concern of how to limit liability exposure\nin the first place. A solid understanding of the legal environment of business should help limit the risk of\nliability and thus avoid legal disputes. Moreover, it should help you recognize when you need to contact\nyour attorney for assistance in defining the contours of the law, which are the rules of the game. The law\nprovides continuity and a reasonable expectation of how things will be, based on how they have been in\nthe past. It provides predictability and stability.\nThis book does not teach you how to practice law or to conduct legal research. That is the work of\nattorneys. Legal research is a sophisticated method of research that seeks to determine the current state of\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n6\n\n\x0cthe law regarding narrowly defined legal issues. Legal research helps guide our behavior to help us comply\nwith the rules of the game. When you need an answer regarding a specific legal issue, you will contact your\nattorney, who will research the issue, inform you of the results of that research, and advise you of the\ndecisions you must make with respect to that issue.\nThe goals of this book are practical. Try to conceptualize your study of the legal environment of business\nas a map by which you must navigate your business dealings. We want to teach you how to read this map\nso that you are able to understand the law and how it affects your business and your life. Besides limiting\nlegal liability proactively, an understanding of the law can also help you avoid serious missteps. After all,\nignorance of the law is no defense for violating the law.\nThis chapter provides an overview of the legal system. We begin with a discussion of what the law is, and\nthen we turn our attention to the sources of law, the rule of law, the reasons why rule of law is important\nto business, and how law affects business disciplines such as management, marketing, finance, and\naccounting. The chapter concludes with a discussion of the link between rule of law and economic\nprosperity.\n\nKey Takeaways\nLaw is a dynamic and ever-changing field that affects everyone, both in their individual capacities as\npeople and in their business interactions. Studying the legal environment of business helps us understand\nhow to reduce liability risks, identify legal problems that require an attorney\xe2\x80\x99s assistance, and identify the\nlinks between business and the law.\n\n[1] Brian Knowlton and Michael M. Grynbaum, \xe2\x80\x9cGreenspan \xe2\x80\x98Shocked\xe2\x80\x99 That Free Markets Are Flawed,\xe2\x80\x9d New York\nTimes, October 23, 2008,http://www.nytimes.com/2008/10/23/business/worldbusiness/23ihtgspan.4.17206624.html (accessed August 18, 2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n7\n\n\x0c1.1 What Is Law?\nLEARNING OBJECTIVES\n1.\n\nUnderstand the meaning of jurisprudence and how its study can lead to greater understanding of our laws\nand legal system.\n\n2.\n\nDistinguish among law as power, legal positivism, legal realism, and natural law.\n\n3.\n\nExamine strengths and criticisms of several theories of jurisprudence.\n\n4.\n\nExplore examples of several theories of jurisprudence.\n\nIf you were asked to define \xe2\x80\x9cthe law,\xe2\x80\x9d what would you say? Is \xe2\x80\x9cyou should eat five fruits and\nvegetables a day\xe2\x80\x9d a law? What distinguishes law from mere suggestions or good advice? The key\ndifference is obviously enforcement and consequence. If you don\xe2\x80\x99t eat five fruits and vegetables a\nday, you are not going to be imprisoned or fined. If you steal or embezzle, however, you may be\nprosecuted and face stiff financial penalties and imprisonment. Law, therefore, is a set of rules that\nare enforced by a government authority.\nNow consider the nature of law. Would you say that the law includes only the actual words that are\nwritten, or does it also include reading between the lines to discern the spirit of the law? Would you\nfollow a law that you disagreed with, or would you ignore such a law? Do you believe that what the\nlaw actually is matters as much as who enforces it? Do you think that morality is a part of legality, or\ndo you think that morality is wholly separate from the law?\nBased on the particular system of jurisprudence to which one ascribes, these questions will generate\ndifferent answers. Not only will the answers to these questions differ, but the potential outcomes of\nlegal disputes can also vary widely, depending on one\xe2\x80\x99s conception of what the law is. These\ndifferences highlight fundamental disagreements over the nature of law.\nJurisprudence is the philosophy of law. The nature of law has been debated for centuries, giving rise\n\nto a general coalescence of ideas to create particular schools of thought. Several different theories of\njurisprudence are explored in the paragraphs that follow.\nAt a most basic interpretation, some believe that law is simply power. That is, the law is followed\nbecause the sovereign issues orders that are backed by threats. Consider tyrannical rulers who create\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n8\n\n\x0carbitrary laws or bad laws. If the sovereign has the power to enforce those \xe2\x80\x9claws,\xe2\x80\x9d then regardless of\nthe \xe2\x80\x9cbadness\xe2\x80\x9d of the law, it is still law. The Nazis executed six million Jews pursuant to German law\nduring World War II. Saddam Hussein routinely tortured and executed political opponents and\nminority Sunni Muslims in Iraq under Iraqi law. The military in Myanmar (known euphemistically\nas the State Peace and Development Council) imprisoned the democratically elected and Nobel Peace\nPrize\xe2\x80\x93winning prime minister of the country, Aung San Suu Kyi (Figure 1.2 "Aung San Suu Kyi"),\nunder color of authority. (Actions taken under the law are said to be under the color of authority.)\nThose who ascribe to the idea that law is power often argue that coercion is an essential and\nnecessary feature of law.\nFigure 1.2 Aung San Suu Kyi\n\nSource: Photo courtesy of the U.S. Department of State, http://en.wikipedia.org/wiki/File:Burma_3_150.jpg.\n\nLet\xe2\x80\x99s explore whether the law is nothing more than power. If an armed person robs your store, you\nwill very likely hand over whatever it is that he or she wants. The robber has exercised power over\nyou but has not exercised the law. This is because, as you might point out, an armed robber is not the\nsovereign power. But compare this to a sovereign who exercises power over you. For instance,\nimagine a government that institutes compulsory military service (the draft) under threat of\nimprisonment for failing to comply. The sovereign would have the power to deprive us of our liberty\nif we did not follow the rules; such a law certainly has the force of power behind it.\nMany have criticized the understanding of law as nothing more than power backed by threats. For\nexample, some point out that if law is nothing more than power, then the subjects of the law are\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n9\n\n\x0csimply at the mercy of whoever is in power. If we look at the U.S. system of government, however,\ncitizens generally do not feel that they are \xe2\x80\x9cat the mercy\xe2\x80\x9d of the government. This is because people\nalso have power. People can elect their government officials, and they can vote \xe2\x80\x9cout\xe2\x80\x9d government\nofficials who aren\xe2\x80\x99t doing a good job. In this way, those in power are accountable to the people. Other\ncriticisms include the more piercing observation that not all law requires the exercise or threat of\novert power. For instance, many of our laws rely on economic incentives, rather than force of power,\nto encourage compliance. Though penalty provisions may exist for violating those laws, those\npenalties may not be driving compliance itself.\nA competing view is that of legal positivism, whose proponents disagree that law is simply power.\nLegal positivists believe that the law is what the law says. The laws are written, human-made rules.\nThe law is not drawn from any source higher than man. Legal positivists do not try to read between\nthe lines. They may disagree with the law as it is written, but they will acquiesce to the sovereign\npower and follow the law as it is written. They reject any belief that they have an individual right to\ndisobey a law that they happen to oppose, providing that the law is from a legitimate source.\nPositivists believe that law is wholly separate from any consideration of ethics. Moreover, they do not\nbelieve that people have intrinsic human rights other than those created by the law. This is very\ndifferent from a natural rights perspective, which is discussed in the following paragraphs.\nPositivists differ from the view that law is simply power, because they believe that valid law must be\ncreated pursuant to the existing rules that allow the sovereign to create law. Under this way of\nthinking, an arbitrary declaration of law by a sovereign who did not follow the rules for creating the\nlaw would not be viewed as valid law. Additionally, positivists would not consider any rule or \xe2\x80\x9claw\xe2\x80\x9d\ncreated by an illegitimate ruler as valid law. Consequently, a legal positivist would feel no need to\nobey an illegitimately created \xe2\x80\x9claw.\xe2\x80\x9d\nConsider the example of the draft again. Some people have a strong moral objection to engaging in\narmed conflict with other human beings. However, a legal positivist would most certainly comply\nwith a law that required compulsory conscription, though he or she might use other legal channels to\ntry to change the law.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n10\n\n\x0cA common criticism of legal positivism is that it prohibits individuals from remaining true to their\nown consciences when their consciences conflict with the laws of the sovereign. However, for a\npositivist, the desirability of enacting a law that might be viewed as \xe2\x80\x9cgood\xe2\x80\x9d or \xe2\x80\x9cbad\xe2\x80\x9d is not relevant\nfor determining what the law is.\nSome critics point out that legal positivism is too limited in its conception of law. For instance, at\nleast some laws seem to reflect a moral stance. The prohibition against insider trading (using\nnonpublic information to buy or sell a stock to make money) might be said to encompass the idea of\nfairness, which is a moral consideration. Likewise, due process (fundamental fairness and decency in\ngovernment actions) might be said to encompass the ideas of both fairness and a moral position\nagainst cruelty. Moreover, not all law is the result of a sovereign-issued, written rule. For\nexample,international customary law has developed through customary practices. It is valid law, but it\nis not a set of rules handed down from a sovereign ruler.\nA different viewpoint is legal realism, which is the belief that the law itself is far less important than\nthe consideration of who is in the position to enforce the law. Like positivists, legal realists believe\nthat law is the product of human making. However, unlike positivists, they believe that the outcome\nof any issue that arises under law is dependent on the person, such as a judge, who is in the position\nto exercise power under the mantle of the law. Additionally, realists believe that social and economic\nconsiderations should be brought to bear in legal disputes, which may very well be \xe2\x80\x9cextra\xe2\x80\x9d\nconsiderations that are not captured by the written law itself.\nIf a realist brought a dispute before a particular judge who was known to be unsympathetic to that\nparticular type of dispute, the realist would believe that the judge\xe2\x80\x99s decision would reflect that\nleaning. For example, if a dispute arose under the Clean Water Act, and the defendant was a legal\nrealist who believed that the judge was unduly harsh with environmental offenders, the legal realist\nwould not look to the actual words of the Clean Water Act itself to determine a likely outcome.\nInstead, the defendant would view the judge\xe2\x80\x99s personal and professional beliefs about water\npollution as determinative factors. Moreover, if the plaintiff in the same case were a realist who did\nnot believe that the Clean Water Act was very strong, that plaintiff might hope that the judge would\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n11\n\n\x0cconsider the social importance of clean water to human health, natural environment, and nonhuman\nanimals.\nCritics of legal realism point out that those who are in the position to exercise the power of the law\nover others should not circumscribe the checks and balances of our system of government by\nconsidering factors outside of legitimate sources of law when making decisions. For instance, they\nargue that judges should not use any factors other than the written law when rendering decisions.\nLegal realists, however, point out that judicial interpretation not only is necessary but also was\ncontemplated by our Founding Fathers as a built-in check and balance to our other branches of\ngovernment.\nNatural law is the idea that humans possess certain inalienable rights that are not the products of\n\nhuman-made law. Therefore, we can say that natural law differs from both positivism and realism in\nthis important respect. Humans are able to reason, and therefore they are able to discover moral\ntruths on their own. They are not automatons who require a sovereign power to tell them right from\nwrong. Natural law adherents do not reject human-made law. However, they recognize that humanmade law is subordinate to natural law if the two types of law conflict.\nCivil rights activists often rely on natural law arguments to advance their platforms. This is true\ntoday as well as historically. For example, a civil rights advocate might point out that regardless of\nwhat the law \xe2\x80\x9csays,\xe2\x80\x9d discrimination based on race is simply wrong. If the written law allowed racial\ndiscrimination, natural law adherents would not recognize the law as valid.\nEach theory of jurisprudence can inform our understanding of legal issues by allowing us to see the\nsame thing from many different perspectives. Moreover, depending on philosophical perspective,\nthere may be several possible outcomes to the same legal dispute that are equally supportable. This\nunderstanding can help us identify common ground among disputants as well as points of departure\nin their reasoning.\n\nKEY TAKEAWAYS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n12\n\n\x0cDifferent theories of jurisprudence inform our understanding of what the law is. Examining legal issues\nthrough the lenses of different theories of jurisprudence allows us to see how different outcomes can be\ndefended.\n\nEXERCISES\n1.\n\nRead \xe2\x80\x9cThe Case of the Speluncean Explorers\xe2\x80\x9d at http://www.nullapoena.de/stud/explorers.html. Identity\nthe justice\xe2\x80\x99s opinion with which you most closely agree. Name the different theories of jurisprudence used\nby each justice in reaching his or her opinion.\n\n2.\n\nWhat are some examples of natural law in our legal system or system of governance?\n\n3.\n\nIs it more important for you to follow the letter of the law or to follow the spirit of the law? In what\ncircumstance would you believe the opposite to be true?\n\n4.\n\nCan you think of any examples of law in which the threat of force or power is not needed?\n\n5.\n\nDo you believe that morals are a part of our law, or do you believe that morality and law are separate\nconcepts?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n13\n\n\x0c1.2 Sources of Law\nLEARNING OBJECTIVES\n1.\n\nDifferentiate between social customs and law.\n\n2.\n\nBecome familiar with primary sources of law in the United States.\n\n3.\n\nUnderstand the difference between public law and private law.\n\n4.\n\nUnderstand the relationship between state and federal systems of government.\n\nHyperlink: Supreme Court Friezes\nhttp://www.supremecourt.gov/about/north&southwalls.pdf\nAlong the north and south walls of the Great Hall at the U.S. Supreme Court, friezes representing the\ngreat lawgivers in history are carved in marble. Among them are Hammurabi, Moses, Solomon, Draco,\nConfucius, Muhammad, Napoleon, and one American. Click the link to find out who he is.\n\nWhere does the law come from? How do you know right from wrong? Certainly your caretakers\ntaught you right from wrong when you were a child. Your teachers, community elders, and other\npeople who were in the position to help shape your ideas about appropriate manners of behavior also\ninfluenced your understanding of which behaviors are acceptable and which are not. Additionally,\nemployers often have very firm ideas about how their employees should comport themselves. Those\nideas may be conveyed through employers\xe2\x80\x99 codes of ethics, employee handbooks, or organizational\ncultures.\nOf course, actions that are considered \xe2\x80\x9cwrong\xe2\x80\x9d and inappropriate behavior are not violations of the\nlaw. They simply may represent social norms. For example, it is generally not acceptable to ask\nstrangers about their income. It is not illegal to do such a thing, but it is considered impolite.\nImagine that you are interviewing for a position that you really want. Can you imagine yourself\nasking your potential employer how much money he or she makes? It would not be illegal for the\nemployer to refuse to hire you based on your lack of social skills. However, it would be illegal for the\nemployer not to hire you based solely on your race.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n14\n\n\x0cSo what is the difference? One type of \xe2\x80\x9cright from wrong\xe2\x80\x9d is based on societal norms and cultural\nexpectations. The other type of \xe2\x80\x9cright from wrong\xe2\x80\x9d is based on a source recognized as a holding\nlegitimate authority to make, and enforce, law within our society. These are two types of rules in our\nsociety\xe2\x80\x94social norms and laws.\n\nA Question of Ethics\nIn January 2010, Haiti, the poorest country in the Western Hemisphere, was struck by a massive\nearthquake that killed tens of thousands\xe2\x80\x94maybe even hundreds of thousands\xe2\x80\x94of people. Rescue workers\nrushed to remove survivors from the rubble, but in the days following the earthquake thousands of people\nwandered the streets without food or shelter. Some instances of looting and violence occurred as survivors\ngrew desperate for sustenance.\nIn the meantime, Royal Caribbean operated a cruise line that made a regular stop at Haiti, at a private\nbeach where it had previously spent millions of dollars in improvements to ensure that the vacationers on\nits cruise ships would enjoy themselves during their overnight stops. Within a week of the disaster, Royal\nCaribbean was seeking to assure its customers that the stop in Haiti was not unethical. It pointed out that\nbringing tourist dollars to Haiti was actually an ethical thing to do, despite the thousands of dying and\ninjured just a short distance away.\nIf you were scheduled to begin a vacation on a Royal Caribbean cruise ship that docked at its private beach\nduring the week following the earthquake, would you go? If you decided to go, how would your friends\nand family react to your choice? If Royal Caribbean was not legally required to issue refunds for\nnonrefundable tickets, should it be willing to issue refunds anyhow?\nCheck out a video of Royal Caribbean\xe2\x80\x99s CEO discussing his company\xe2\x80\x99s involvement in bringing emergency\nsupplies to Haiti, as well as the potential for using ships as hotels or hospitals in the interim.\nhttp://cnn.com/video/?/video/world/2010/01/18/ct.anderson.haiti.cruise.cnn\n\nSocial customs may be violated on pain of embarrassment or ostracism. Someone may choose to\nignore social customs, but there are usually negative social or professional consequences to doing so.\nA person who violates social customs may be said be a boor, or people may try to avoid that person\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n15\n\n\x0cbecause his or her actions and comments make others uncomfortable. However, no legal\nrepercussions follow violating social customs.\nViolations of law are different. Violating the law carries penalties, such as liability or loss of liberty,\ndepending on the type of violation. While we may generally decide whether or not to conform to\nsocial customs, we are compelled to obey the law under threat of penalty.\nLaw can generally be classified as public law or private law. Public law applies to everyone. It is law\nthat has been created by some legitimate authority with the power to create law, and it has been\n\xe2\x80\x9chanded down\xe2\x80\x9d to the people within its jurisdiction. In the United States, the lawmaking authority\nitself is also subject to those laws, because no one is \xe2\x80\x9cabove\xe2\x80\x9d the law. If the law is violated, penalties\ncan be levied against the violator. These penalties are also \xe2\x80\x9chanded down\xe2\x80\x9d from some recognized\nsource of authority, like the judiciary. Of course, people in the United States may participate in many\nlaw-creating activities. For instance, they may vote in elections for legislators, who, in turn, create\nlegislation. Likewise, if people have a legal claim, their case may be heard by the judiciary.\nIt\xe2\x80\x99s important to note, however, that not all law is public law. Private law is typically understood to be\nlaw that is binding on specific parties. For instance, parties to a contract are involved in a private law\nagreement. The terms of the contract apply to the parties of the contract but not to anyone else. If the\nparties have a contract dispute, they will be able to use dispute-resolution methods to resolve it. This\nis because both parties of the contract recognize the judiciary as a legitimate authority that can\nresolve the contract dispute. However, regardless of the resolution, the terms of the contract and the\nremedy for breach will apply only to the parties of the contract and not to everyone else.\nAdditionally, some law is procedural and some law is substantive. Procedural law describes the legal\nrules that must be followed. In other words, it details the process or rules that are legally required.\nFor instance, the U.S. government must generally obtain a warrant before searching someone\xe2\x80\x99s\nprivate home. If the process of obtaining the warrant is ignored or performed illegally, then\nprocedural law has been violated. Substantive law refers to the actual substance of the law or the\nmerits of the claim, case, or action. Substantive law embodies the ideas of legal rights and duties and\nis captured by our different sources of law, like statutes, the Constitution, or common law.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n16\n\n\x0cSources of Law\nIn the United States, our laws come primarily from the U.S. Constitution and the state constitutions; from\nstatutory law from Congress, the state legislatures, and local legislative bodies; from common law; and\nfrom administrative rules and regulations. Executive orders and treaties are also important sources of law.\nThese are all primary sources of law. As is true in any democracy, U.S. law reflects the will of the people\nwho vote for representatives to make the law. In this way, U.S. law is also a reflection of public policy.\nSecondary sources of law include restatements of the law, law review and journal articles, uniform codes,\nand treatises. These sources are created by legal scholars rather than by a recognized, legitimate lawcreating authority. However, these sources are read by and often influence those who are in the position\nto create law. Members of the judiciary, for example, may consult a restatement of law or law-review\narticles when making decisions. Likewise, state legislatures often adopt whole or parts of uniform acts,\nsuch as theUniform Commercial Code (UCC). When a body of secondary law is formally adopted by a\nlegitimate lawmaking authority, then it becomes primary law. In this example, adoption of the UCC by a\nstate legislature transforms the UCC from a secondary source of law (a model code) to a primary source of\nlaw in that state\xe2\x80\x94namely, a statute.\n\nHyperlink: The U.S. Constitution\nhttp://www.archives.gov/exhibits/charters/constitution_transcript.html\nRead the U.S. Constitution at this link.\nThe U.S. Constitution created the structure of our federal government. Among other things, it sets forth\nthe three branches\xe2\x80\x94the legislative, executive, and judicial branches.\nIt provides organizational and procedural requirements, defines the boundaries of each branch\xe2\x80\x99s\njurisdiction, and creates \xe2\x80\x9cchecks\xe2\x80\x9d on each branch by the other branches. For example, look at Note 1.26\n"Hyperlink: The U.S. Constitution". As you can see, in Article II, Section 2 the president is the commander\nin chief of the several armed forces, but he does not have the power to declare war. That duty falls to\nCongress.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n17\n\n\x0cThe first ten amendments to the U.S. Constitution are known as the Bill of Rights. Some of the Founding\nFathers did not believe that a Bill of Rights was necessary because the power granted to the federal\ngovernment created by the U.S. Constitution was expressly limited. Any powers not expressly granted to\nthe federal government by the U.S. Constitution are reserved to the states. This means that if the U.S.\nConstitution does not state that one of the federal branches of government has jurisdiction over a\nparticular area, then that area falls to the states to regulate.\nDespite the limited power granted to the federal government by the U.S. Constitution, as a condition of\nratification, many states insisted on a written Bill of Rights that preserved certain individual civil rights\nand liberties. Today, business entities that are treated as legal persons under the law, such as\ncorporations, enjoy many of these rights and liberties, just as if they were natural human beings.\nEach state also has its own constitution, and those constitutions serve essentially the same function for\neach individual state government as the U.S. Constitution serves for the federal government. Specifically,\nthey establish the limits of government power, create protections for fundamental rights, and establish the\norganization and duties of the different branches of government at the state level.\nThis dual system of government present in the United States is called federalism, which is a governance\nstructure whereby the federal government and the state governments coexist through a shared power\nscheme. State laws may not conflict with federal laws, including the U.S. Constitution. This is because the\nU.S. Constitution is the supreme law of the land.\nStatutory law is law created by a legislative body. Congress is the legislative body at the federal level. The\nstates also have legislative bodies, most of which are bicameral, like our federal system. The state\nlegislatures\xe2\x80\x99 names vary by state. For instance, in Indiana, the legislature is known as the General\nAssembly. In North Dakota, it is the Legislative Assembly. In New York, it is called the Legislature.\nNevertheless, their purposes are the same. They are the legislative branches of their respective state\ngovernments.\nCongress is composed of a Senate, with 100 members, and a House of Representatives, with 435\nmembers. The forefathers who wrote the Constitution deliberated and argued over how to compose the\nlegislature, and the result is a deliberative body that doesn\xe2\x80\x99t always respond quickly to the will of the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n18\n\n\x0cmajority. Since population numbers from the census taken every ten years determine how many House\nseats a state receives, smaller states are sometimes disproportionately represented in the Senate. Alaska\nand Delaware, for example, have only one representative in the House, but each has two senators.\nSenators serve six-year terms, and members of the House of Representatives serve two-year terms. There\nare no term limits for either senators or members of the House. One benefit of having no term limits is\nthat institutional knowledge and wisdom can be carried forward in perpetuity. One drawback is that\nelected officials may hedge their votes on important issues in a calculated way, to ensure reelection. If\nterm limits were imposed, then vote pandering would not be a problem, but the Congress would be\nforever laboring with many inexperienced lawmakers.\nAs you can see from Note 1.32 "Hyperlink: How a Bill Becomes a Law", a bill may be introduced in\nCongress through the Senate or through the House of Representatives. Both the House of Representatives\nand the Senate have many committees, and these are related to all areas under the purview of Congress to\nlegislate. After a bill is introduced, it is sent to an appropriate committee in the chamber of the Congress\nwhere the bill originated. If the committee moves forward with the bill, it modifies the bill as it sees fit to\ndo, and then it sends the bill to the house of origination (either the Senate or the House of\nRepresentatives) for a vote. If the bill passes, then it is sent to the other house (again, either the Senate or\nthe House of Representatives), where it undergoes the same process. If the other house votes to approve\nthe bill, then the bill goes to the joint committee, which is composed of members of both the House of\nRepresentatives and the Senate, where final work is completed. After that, the bill is sent to Congress for a\nfull vote. If the bill passes, it is sent to the president. If the president signs the bill, then it becomes a\nstatute.\nThe president may veto a bill. A presidential veto is an executive \xe2\x80\x9ccheck\xe2\x80\x9d on the legislative body. However,\nif the president vetoes a bill, the legislature can override the veto by a supermajority vote. A congressional\noverride is a legislative \xe2\x80\x9ccheck\xe2\x80\x9d on the executive branch. These checks are built into our U.S. Constitution.\n\nHyperlink: How a Bill Becomes a Law\nhttp://www.lexisnexis.com/help/CU/The_Legislative_Process/How_a_Bill_Becomes_Law.htm\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n19\n\n\x0cCheck out the interactive flowchart for how a bill becomes law. Be sure to click on the different boxes for\nadditional information about each step.\nImportantly, Congress may not act outside of its enumerated powers. Many people wrongfully believe that\nCongress can do anything. That is simply not true. Look at Article I, Section 8, accessible through Note\n1.26 "Hyperlink: The U.S. Constitution", for the enumerated powers of Congress. Remember that any\npower not granted to the federal government by the U.S. Constitution is reserved to the states. This means\nthat if Congress passed a law in an area that was actually reserved to the states to regulate, Congress\nwould have acted outside the scope of its powers. If challenged, the law would be struck down as\nunconstitutional.\nAs a practical matter, this means that many U.S. states have state laws that are very different from each\nother. For instance, in Oregon, certain terminally ill patients may legally commit suicide under the state\xe2\x80\x99s\nDeath with Dignity Act. However, in many other states, such an act would be illegal.\nCommon law is judge-made law. Common law is a feature of most countries previously colonized by Great\nBritain, where it originated. In continental Europe, an alternative system called civil law developed, where\njudges do not have the power to create law through interpretation. In civil-law jurisdictions, only the\nlegislature may create law. A jurisdiction is an area where power may be exercised.\nIn a common-law system, when an appellate court hears cases and writes opinions, rules of law are\ncreated, formed, and shaped. After a particular legal issue has been decided in a jurisdiction, there is a\nhigh probability that subsequent cases that present the same legal issue will use the same rule of law\ngenerated from already-decided cases regarding the same legal issue. This policy is known as stare decisis,\nor \xe2\x80\x9clet the decision stand.\xe2\x80\x9d This is how a precedent is formed, though precedents may shift or change over\ntime. Precedents also may be entirely overturned, though that is rare. Precedents and stare decisis allow\nus to anticipate the behavior of others and to gauge the legality of our own actions.\nLegal reasoning is used by attorneys to argue for a particular outcome in a case and by judges when\nrendering decisions. At its most basic form, legal reasoning involves first identifying the legal question,\nwhich is the issue in dispute. Then, the rule of law that applies to that issue is identified. The rule of law\nmay be drawn from precedent, for example. The facts of the case are analyzed against the rule of law to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n20\n\n\x0creach a supportable conclusion. This method of legal reasoning is referred to as the IRAC method, which\nis an acronym for issue, rule, analysis, and conclusion.\nCommon law is an important source of law in those many areas that are reserved to the states to regulate.\nA state may exercise its police powers to regulate the safety, health, and welfare of its citizens, for\nexample. The laws implemented in these areas may give rise to laws in divergent areas, such as property\nlaw (e.g., zoning regulations), so-called vice laws (e.g., restrictions on vice business activities in certain\nareas or during certain days), and domestic relations (e.g., laws relating to marriage and adoption). It\xe2\x80\x99s\nalso important to note that precedents vary among different jurisdictions because precedents created by\none jurisdiction are not binding in other jurisdictions.\nMost administrative agencies are created by the legislature. At the federal level they are created by\nCongress, and at the state level they are created through the state legislative bodies. Administrative\nagencies may be thought of as a delegation of congressional authority to area experts in particular fields,\nso that those experts can engage in limited lawmaking, adjudicative procedures, and investigations within\ntheir particular purviews. Laws made by administrative agencies are called rules or regulations.\nAdministrative agencies are created by enabling legislation, which sets forth the agencies\xe2\x80\x99 jurisdictional\nboundaries, rule-making procedures, and other information relating to agencies\xe2\x80\x99 scopes of power.\n\nKEY TAKEAWAYS\nThe legal system in the United States is composed of multiple jurisdictions at the local and state levels and\none federal jurisdiction. Local and state laws may not conflict with federal laws. Primary sources of law in\nthe United States include constitutional law, statutory law, common law, and administrative law.\n\nEXERCISES\n1.\n\nIdentify an action that would violate social norms but would not violate any laws. Can you identify any\nviolations of law that would not violate any social norms?\n\n2.\n\nWhat are three specific powers of Congress? What are three specific powers of the executive branch? Do\nyou think that the powers of the judicial branch are well defined? Why or why not?\n\n3.\n\nWhat areas of law have been reserved to the states to regulate? How do you know?\n\n4.\n\nIdentify a bill in either the House of Representatives or the U.S. Senate. What stage(s) of the bill process\nhas it passed through? To be passed into law, what stages must it still pass through?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n21\n\n\x0c5.\n\nWhich three federal administrative agencies affect you or your family the most? Why?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n22\n\n\x0c1.3 The Rule of Law\nLEARNING OBJECTIVES\n1.\n\nUnderstand what a rule of law system is.\n\n2.\n\nExplore the U.S. rule of law system.\n\nWhen you hear the term \xe2\x80\x9crule of law,\xe2\x80\x9d what comes to mind? It may seem like an ambiguous term, but\nit is used frequently in legal and governance circles. Rule of law is a system of laws under which the\npeople and the government are bound, which allows predictability and restraint of government\naction.\nA rule of law legitimizes the law. It establishes clear rules of behavior, establishes (or captures)\nprecedent, and seriously undermines any defense of ignorance of the law. Moreover, it holds people\nto the same standards, though in many ancient rules of law, the standards differed depending on the\nperson\xe2\x80\x99s classification. For instance, men often had different rights than women. Slaves were a\ndifferent legal class than those who were free, and indentured servants were often a different\nclassification altogether. When people are held to the same standards, we can see systems of fairness\n(that is, equal justice under the law) emerging, at least for those within the same class.\nThe Founding Fathers of the United States did not create our rule of law system out of thin air. Many\nrule of law systems existed prior to the founding of the United States. The U.S. rule of law system has\nmany similarities with prior rule of law systems from which our Founding Fathers drew their ideas.\nWe can trace elements of our legal genealogy back to ancient Babylon. For example, who has the\nright to govern, the legitimate sources of law, the organization of government, substantive and\nprocedural legal responsibilities, processes for dispute resolution, and consequences for legal\ntransgressions are all common foci for rule of law systems.\nCan you imagine if we had no way to determine these things? Imagine that we did not know who had\nthe legitimate right to govern or that we did not know which sources of law were legitimate. If we did\nnot have a rule of law system that specified and legitimized these and other foundational issues,\nchaos would rule. There would likely be competing claims of authority between different factions of\npower if our U.S. Constitution and our state constitutions did not create our systems of government.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n23\n\n\x0cLikewise, there would be competing sources of law\xe2\x80\x94such as those based on religious texts, or others\ncreated by modern human beings\xe2\x80\x94if our constitutions did not legitimize the manner in which laws\nwere to be created. Also, there would be different methods of dispute resolution. Perhaps some\npeople would favor a vigilante system, while others would prefer a procedural system. This type of\nunpredictability would result in a very unstable society. We should not take the American rule of law\nsystem for granted. It provides predictability and stability to our lives.\nRule of law systems establish authority, create expectations for behavior, and establish redress for\ngrievances and penalties for deviance. Governance of conflict and the attainment of peace among the\ngoverned are primary goals of rule of law systems. For example, securing peace is a goal within the\nU.S. rule of law system. The U.S. Constitution\xe2\x80\x99s preamble states, \xe2\x80\x9cWe the People\xe2\x80\xa6in Order to\xe2\x80\xa6insure\ndomestic Tranquility.\xe2\x80\x9d We see this same notion in the English Bill of Rights of 1689, though the words\nused are somewhat different.\n\nAccording to many rule of law systems, the attainment of peace relies on the establishment of a\nhierarchical authority structure. This recognition of the right to govern provides legitimacy. For\ninstance, in the Code of Hammurabi and the Magna Carta, these rights are derived from religious\nauthority. In the U.S. Constitution and the English Bill of Rights of 1689, the power is derived from\nthe people.\nNote the difference between power and authority. Power is the ability to make someone behave in a\npredictable manner. Authority draws its strength from legitimacy. Imagine that your friend told you\nthat his mother granted him the right to govern others. Would you believe him? Probably not. Why?\nBecause it is unlikely that you would recognize your friend\xe2\x80\x99s mother as having a legitimate authority\nto bestow the right to govern on anyone, including your friend. Imagine, instead, the governor of\nyour state. You probably recognize the authority of the governor to govern, because you recognize\nthat the people, through representative government, have the authority to elect the governor to do\nso.\nThe rule of law of the federal government in the United States is composed of many different sources\nof law, including constitutional law, statutory law, rules and regulations promulgated by\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n24\n\n\x0cadministrative agencies, federal common law, and treaties. Additionally, within the United States,\nseveral state and local jurisdictions exist, each having its own rule of law systems. Moreover, the U.S.\nsystem of governance is one of federalism, which allows different rule of law systems to operate side\nby side. In the United States, these systems are the federal government and the state governments.\nOrganizational structures for government\xe2\x80\x94including who has the right to govern\xe2\x80\x94are also set out in\nrule of law systems. For instance, the Code of Hammurabi identified a ruler: Hammurabi himself.\nThe English Bill of Rights of 1689 required representative bodies. The U.S. Constitution organized\nthe U.S. government by creating the legislative, executive, and judicial branches. These models\nminimally provide order and, in some cases, provide opportunities for the governed to participate in\ngovernment, both of which create role expectations of the governed.\nNotably, even though our Founding Fathers relied on prior rule of law systems when creating our\nConstitution, they were unable to resolve all challenges that exist when people live together. Today,\nfor instance, one unresolved challenge is reflected in the tension between personal liberty and\nresponsibility to state. We have many individual rights and personal liberties, but as some argue, we\ndo not have many responsibilities to the state. We could have a system that requires greater duties\xe2\x80\x94\nsuch as the legal duty to vote, to serve in public office or in the military, or to maintain public lands.\nUnresolved challenges highlight the fact that rule of law systems are not perfect systems of\ngovernance. Nevertheless, these systems create expectations for conduct, without which governance\nof conflict could not reasonably exist and peace could not be attained.\nThe U.S. Constitution is the foundation on which the U.S. federal rule of law system rests. It asserts\nthe supremacy of law. \xe2\x80\x9cWe the people\xe2\x80\x9d is a very important part of the preamble, because it confers\npower on the people as well as on the states. Notably, unlike the Magna Carta and the English Bill of\nRights of 1689, it does not focus on individual rights. Of course, the Bill of Rights does focus on\nindividual rights, but those amendments were passed after the Constitution was written. (That is why\nthey are called amendments to the constitution.) The U.S. Constitution implemented the supremacy\nof law using structure and processes. The Founding Fathers were particularly concerned about giving\nthe government the power to do its job without encouraging tyranny. They built in processes to\nensure the supremacy of law. Indeed, ours is \xe2\x80\x9ca government of laws and not of men,\xe2\x80\x9d John Adams\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n25\n\n\x0cwrote in the Massachusetts Constitution. Thomas Paine noted the same sentiment in Common Sense,\nwhen he wrote, \xe2\x80\x9cthe law is king.\xe2\x80\x9d\n\nKEY TAKEAWAYS\nRule of law is a system of published laws under which the people and the government are bound, which\nallows predictability and restraint of government action. A rule of law system allows people to understand\nwhat is expected of them. It provides a system that allows many people with different beliefs and cultures\nto live together in peace, by providing methods by which conflicts can be resolved. The U.S. rule of law\nsystem contains many elements of prior rule of law systems.\n\nEXERCISES\n1.\n\nView the Code of Hammurabi athttp://avalon.law.yale.edu/ancient/hamframe.asp. Scroll down slightly\nuntil you see the subheading \xe2\x80\x9cCode of Laws.\xe2\x80\x9d Find three laws that you believe are similar to laws that we\nhave in the United States.\n\n2.\n\nGiven the long history of rule of law systems, why hasn\xe2\x80\x99t any rule of law system been developed that\nresolves all problems? Name three social problems that our rule of law system does not address, or does\nnot address adequately.\n\n3.\n\nAre the Ten Commandments a rule of law system? How many of the Ten Commandments are illegal in\nyour state today?\n\n4.\n\nWhat problems would exist without a rule of law?\n\n5.\n\nHow does the rule of law affect business?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n26\n\n\x0c1.4 Importance of Rule of Law to Business\nLEARNING OBJECTIVES\n1.\n\nDetermine why the rule of law is important to business.\n\n2.\n\nIdentify several areas of law that are especially relevant to business and the importance of the rule of law\nto those areas.\n\n3.\n\nIdentify how the rule of law limits government.\n\n4.\n\nIdentify how the rule of law protects people from harmful business practices.\n\nAs you may have guessed by now, the rule of law is important to business. Can you imagine trying to\ndo business without being able to have any reasonable expectations of other people\xe2\x80\x99s behavior?\nWould you be willing to conduct business if you had no legal means by which to protect your\nproperty interests? And in the case of a dispute, without a rule of law system, there would be no\nestablished way of resolving it. Without the rule of law, business would be chaotic. This section\nprovides some overarching examples of why the rule of law is important to business.\nBefore getting to those examples, imagine this: What if you did not know how to play chess, but you\ntried to play anyhow? You would probably become frustrated very quickly, because you would see no\nlogic in the movement of your opponent\xe2\x80\x99s pieces, and you would not be permitted to move some\npieces like you might wish to. Sometimes you would see your opponent move his or her knight two\nspaces in one direction and then one space in another. Other times, you would see your opponent\nmove his or her bishop diagonally. Moreover, you would not understand what you were and were not\npermitted to do. You would also not know how to penalize an opponent who moved his or her pieces\nincorrectly to gain advantage or to take something of yours. This is analogous to what it\xe2\x80\x99s like to do\nbusiness without understanding the rules of the game.\nThe rule of law establishes rules that people\xe2\x80\x94and businesses\xe2\x80\x94must follow to avoid being penalized.\nThe rule of law not only allows people to understand what is expected of them in their personal\ncapacities but also sets forth rules for businesses so that they, too, know what is expected of them in\ntheir dealings and transactions. In addition, it restrains government and others from infringing on\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n27\n\n\x0cproperty rights. Should disputes arise, the rule of law provides a peaceful and predictable means by\nwhich those disputes can be resolved.\nThe rule of law provides guidance and direction in every area of business. For example, it provides a\nmeans to bring a complaint against another party to a neutral decision maker so that a decision can\nbe made regarding the dispute. Because of our rule of law system, we know that we are permitted to\nfile a complaint in the proper court to commence litigation. Or we can try an alternative method of\ndispute resolution if we do not wish to engage in litigation. We know that we are permitted to do\nthese things because our rule of law system allows us to do them. Moreover, we can expect some sort\nof resolution when we institute such a proceeding. This expectation is reasonable only because we\nhave a rule of law.\nAdditionally, in the United States, the rule of law provides a sophisticated system of federalism,\nwhere state and federal laws coexist. This allows people and businesses to determine which system of\ngovernment pertains to them and which jurisdiction they belong to. Imagine that you sell firearms in\na retail capacity. You would be subject to both state and federal laws. You would be required to carry\na federal permit from the federal administrative agency known as the Bureau of Alcohol, Tobacco,\nFirearms, and Explosives. You would be forbidden from engaging in illegal arms trading. According\nto state laws, you would likely have to ensure that each purchaser of a firearm held a valid permit for\na firearm. You would be required to check identification, enforce waiting periods, and refuse to sell\nguns to people who were not permitted to carry them according to your state\xe2\x80\x99s laws. If we did not\nhave a rule of law system, you might be uncertain how to conduct your business, and you would be\nsubject to arbitrary enforcement of unstated or ex post facto (retroactive) laws that affected your\nbusiness.\nThe rule of law also governs contracts between people and between merchants. Under the common\nlaw system, certain elements of a contract must exist for the contract to be enforceable. Under the\nUniform Commercial Code (UCC), merchants are governed by a separate set of rules that anticipate\nand allow for flexibility in contractual terms, to facilitate business needs. In the event that terms\nconflict in an offer and acceptance between merchants, the UCC allows \xe2\x80\x9cgap fillers\xe2\x80\x9d to complete the\nterms of the contract without need for the contract to be rewritten or for formal dispute resolution.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n28\n\n\x0cMoreover, businesses rely on the rule of law to help them enforce contracts against contractors who\nfail to perform.\nAdditionally, because we have a rule of law system, employers know the rules of the game regarding\ntheir relationship to employees, and employees know the rules with respect to their obligations to\nemployers. Likewise, business partners, members of boards of corporations, and members of limited\nliability companies all know what is expected of them in their roles vis-\xc3\xa0-vis the business and other\npeople within their organizations. When someone does something that is not permitted, there is legal\nrecourse.\nThe rule of law also provides protection for property. Imagine if we did not have protection for\nnontangible property, such as intellectual property like trade secrets, trademarks, or copyrights. It\nwould be very difficult to protect this type of property if we did not know the rules of the game.\nPeople would not have the incentive to create or share new intellectual property if they had no\nreasonable expectation of being able to protect it or of being rewarded for their creations. Likewise,\nthe rule of law allows us to protect tangible property without having to go to extraordinary measures.\nFor instance, if we had no rule of law system to convey and maintain legal ownership to us for our\nreal or personal property, we might be forced to hire expensive private security forces to guard our\nproperty when we could not be there to physically protect it ourselves.\nBusinesses also rely on the rule of law to govern their debtor and creditor relationships. And, if\nfinancial matters do not go as anticipated, our legal system allows businesses to ask the court for\nprotection from creditors under our bankruptcy law. This allows businesses to protect their property\nfrom creditor repossessions or foreclosures while they get back on track financially.\nThe rule of law also protects people from businesses. For example, Congress has enacted antitrust\nlegislation that prevents certain anticompetitive practices, such as colluding and price fixing.\nAdditionally, businesses are prohibited from using deceptive advertising and are held responsible\nwhen they manufacture or sell defective products that cause injury.\nThe rule of law also protects businesses from government. Since everyone is subject to the rule of\nlaw, this means that government itself may not overextend its reach when regulating or investigating\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n29\n\n\x0cbusinesses. Government must play by the rules, too. For example, imagine that our government\ncould do anything, without any limits or jurisdictional restraints. A business operating in such a\nclimate might find itself subject to government closure on a whim, or excessive taxes, or\nrequirements to pay bribes to gain permits to do business. Our rule of law system prevents such\nabuses.\nWithout a rule of law system, people would have to exact satisfaction for the wrongs committed\nagainst them on their own. They would have to physically protect their own property. This would\nlead to a breakdown in social structure, and it would result in vigilante justice and physical strength\nplaying primary roles in dispute resolution.\n\nKEY TAKEAWAYS\nThe rule of law system in the United States sets the rules of the game for doing business. It creates a\nstable environment where plans can be made, property can be protected, expectations can exist,\ncomplaints can be made, and rights can be protected. Violation of the law can result in penalties. The rule\nof law protects business, protects consumers from harmful business practices, and limits government from\nengaging in abusive practices against businesses.\n\nEXERCISES\n1.\n\nHave you ever played a game in which you did not know all the rules? Have you ever tried to speak a\nlanguage in which you weren\xe2\x80\x99t fluent? What was the outcome?\n\n2.\n\nWhat incentive or motivation would exist to work for your employer if you were not certain that you\nwould be paid for your efforts and your time? What incentive would you have to invent something new,\ncreate a work of art, or write a book if you had no legal expectation that you would be able to protect your\ncreation?\n\n3.\n\nImagine that you are an entrepreneur. What type of business would you open? Would you know what\ntypes of permits were required to conduct your business and which government entities had jurisdiction\nover your business? If not, how could you find out?\n\n4.\n\nWhat would business be like in a land without any rule of law system? Be specific.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n30\n\n\x0c1.5 How Law Affects Business Disciplines\nLEARNING OBJECTIVES\n1.\n\nIdentify the relevance of law to business disciplines.\n\n2.\n\nUnderstand the relevance of law to the study of business.\n\n3.\n\nIdentify how the rule of law protects people from harmful business practices.\n\nFoundational courses taken by undergraduate business students usually include accounting, finance,\nmanagement, and marketing. An understanding of the legal environment of business is relevant\xe2\x80\x94\nindeed, essential\xe2\x80\x94to functioning well within each of those disciplines. Additionally, a solid\nunderstanding of the legal environment can help avoid liability or at least minimize risk. In business,\nit is not enough to comport yourself and your business ethically. You must also ensure that you\nunderstand the legal environment in which you are working. Therefore, it is important to you, to\nyour employer, and to all the other people who may be relying on your business expertise\xe2\x80\x94such as\nyour employees and your family\xe2\x80\x94to understand the legal environment. Such an understanding will\nhelp you avoid or lessen the likelihood of liability exposure, enabling you to manage your business\naffairs successfully, unhampered by unmanaged legal liability risks. This section provides some\nexamples of how law affects specific business disciplines.\nDuring the last several years, accountants have been in the limelight due to culpable behavior of\nsome members of the profession during well-known business scandals, such as Enron. Largely as a\nresult of the fallout from the Enron case, Congress passed the Sarbanes-Oxley Act (SOX) of 2002,\nwhich imposed stringent oversight requirements on accounting and auditing firms. The\nrequirements seek to ensure competence, compliance with security laws, and conduct consistent\nwith generally accepted accounting principles.\nOf course, the Enron scandal and SOX were both fairly dramatic examples of how law can affect\naccounting. Other ways in which law affects this discipline are through regulation. For example, the\nU.S. Securities and Exchange Commission\xe2\x80\x99s (SEC) mission is to protect investors and to maintain a\nfair market, among other things. Accordingly, the SEC enforces accounting and auditing policies to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n31\n\n\x0callow investors to make decisions based on accurate information. The SEC pursues charges of\naccounting fraud and oversees private regulation of the accounting profession.\nThe law also affects finance. Like accounting professionals, many who work in finance are also\nregulated by the SEC. The SEC is concerned that investors receive accurate information to make\ninvestment decisions. Moreover, the SEC enforces prohibitions against insider trading and pursues\nclaims of other types of securities fraud, such as Ponzi schemes.\nSimilarly, several statutes protect consumers in financial transactions. For example,\nthe Truth in Lending Act (TILA) requires lenders to accurately provide information concerning the\ncosts involved in offers of credit. TILA and its corresponding Regulation Z are administered by\nfederal banking agencies.\nLaw also affects those in management. For instance, knowledge of employment law is essential to\nthose in human resources.Title VII of the Civil Rights Act prohibits discrimination related to protected\ncharacteristics in hiring and employment practices. Those in management also must be aware of the\npotential liability that demands on employees might create. For example, in Oregon, McDonald\xe2\x80\x99s was\nfound to be liable for injuries resulting when an off-duty, off-premises worker fell asleep while\ndriving. [1] The employee had worked three shifts during a twenty-four-hour period. The court held\nthat employers have a duty to avoid conduct that creates a foreseeable risk of harm to others.\nIf your field is marketing, the law also relates to your work. Marketers must be particularly attuned\nto tort law, consumer protection law, and intellectual property law. For example, to avoid charges of\nlibel, those in advertising need to take care not to defame another person, business, or product. It\nmight be tempting to do so, especially if you were engaged in serious competition with another\ncompany that sold a similar product. Likewise, marketers must take great care not to engage in\ndeceptive advertising practices, lest their employer run afoul of\nthe Federal Trade Commission\xe2\x80\x99s (FTC) policies or the FTC Act. Additionally, marketers must be aware\nof other people\xe2\x80\x99s intellectual property to avoid copyright or trademark infringement in their own\nwork product.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n32\n\n\x0cThese are a few examples of how the law relates to specific business disciplines. Of course, this is just\nan overview. It is incumbent on each business professional to become familiar with the legal\nenvironment in his or her profession. Employers may provide training regarding legal environment\nissues, such as anti\xe2\x80\x93sexual harassment training or anti\xe2\x80\x93insider trading training, but ultimately,\nbecoming familiar with the legal environment is each person\xe2\x80\x99s individual responsibility. Remember\nthat a defense of \xe2\x80\x9cI didn\xe2\x80\x99t know the law!\xe2\x80\x9d is no defense at all.\n\nKEY TAKEAWAYS\nThe law is relevant to every business discipline. Minimizing liability exposure is a primary concern of\nbusiness, and an understanding of the legal environment relevant to each disciplinary perspective helps\nbusiness practitioners minimize their risk of incurring liability to themselves or to their employers.\n\nEXERCISES\n1.\n\nWhich business discipline is your favorite? Find a newspaper article that illustrates a legal problem\npertaining to that discipline that could have been avoided with a better understanding of the legal\nenvironment of business.\n\n2.\n\nHow can employers use knowledge of the legal environment of business to minimize liability exposure?\nIdentify three concrete ideas.\n\n3.\n\nHow can employers stay current with the legal environment of business? For example, how would other\nemployers in Oregon find out about the case of the off-duty, off-premises worker mentioned in this\nsection? If you were an employer in Oregon, how might this case change your business practices?\n\n4.\n\nDo you think that if employers train their employees how to behave on the job, those employers should be\nabsolved from legal liability resulting from employees\xe2\x80\x99 actions? For example, imagine that an employer\nprovides training to its employees regarding how to avoid sexual harassment in the workplace, but an\nemployee ignores the training and sexually harasses a colleague. Should the employer bear liability in that\nsituation? Why or why not?\n\n[1] Faverty v. McDonald\xe2\x80\x99s, 892 P.2d 703 (Or. Ct. App. 1995).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n33\n\n\x0c1.6 Concluding Thoughts\nThis chapter provides an introduction to the legal environment of business. Knowledge of the legal\nenvironment of business is essential to successful business practices. This involves understanding\nwhat the law is, where it comes from, and specifically how it relates to business. Moreover, different\nphilosophies of law exist. Approaching a problem from different perspectives allows for multiple\noutcomes to be explored. Additionally, when people approach the same problem from different legal\nphilosophies, reasonable minds can disagree on the outcome. Familiarity with government structure\nand an understanding of rule of law are essential to successful business operations. Ultimately,\nbusinesspeople should be able to recognize legal situations, minimize liability exposure, and know\nwhen to consult an attorney.\nAs you embark on your study of the legal environment, try to remain oriented. Ask yourself questions\nlike \xe2\x80\x9cWhere does this piece of law fit in the business world?\xe2\x80\x9d and \xe2\x80\x9cWhy is it important for me to know\nthis?\xe2\x80\x9d Studying the law can, at times, seem like studying pieces of a very large jigsaw puzzle. You may\nnot immediately see how individual pieces fit together, but with protracted study of law, it will\nbecome clear. Often, with that understanding, the depth of law becomes apparent.\nAdditionally, it is very helpful if you try to find contemporary examples of the concepts that are\ndiscussed in this book. When surfing the Internet, watching movies, or reviewing current events, try\nto \xe2\x80\x9cissue spot.\xe2\x80\x9d In other words, try to identify the legal issue raised by the particular problem\npresented. Try to figure out which jurisdiction would have authority over the issue. State\ngovernment? Federal government? Both? Try to determine which type of law would control or be\ndeterminative of the outcome. Is it a statutory issue? A constitutional issue? A regulatory issue?\nAlso, try to ask yourself why the dispute was raised. Will the parties involved be able to work it out on\ntheir own? If not, why not? Has the issue entered into litigation? How could the issue have been\navoided with better planning and greater familiarity with the legal environment?\nThis little game can give you practice in orienting yourself as you gain footing in the study of law and\nthe legal environment of business. We wish you every success in your course!\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n34\n\n\x0cSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n35\n\n\x0cChapter 2\n\nThe Court System\nLEARNING OBJECTIVES\nAfter reading this chapter, you should have a thorough understanding of the U.S. court system and how it\naffects the conduct of businesses and individuals. Specifically, you should be able to answer the following\nquestions:\n1.\n\nWhat role does each of the three branches of government play?\n\n2.\n\nHow do the other two branches of government balance the judiciary?\n\n3.\n\nHow are the state and federal courts structured?\n\n4.\n\nWhat are the primary differences between trial and appellate courts?\n\n5.\n\nHow does the Supreme Court do its work?\n\nAs you now know, laws are meaningless if they are not enforced. Companies have to make a barrage\nof decisions daily, from product development to marketing to strategies to maintain growth, but\nmost of these are based on sound business acumen rather than legal requirements. If a company\ndoes violate a law, however, it must be held accountable. Typically, that accountability comes in the\nform of a lawsuit heard in court. Whether a suit is brought by a supplier, customer, employee,\nshareholder, or other stakeholder, litigation is a fact of life for companies. As future business\nprofessionals, being familiar with our court system will lay the foundation for your understanding of\nthe litigation process.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n36\n\n\x0c2.1 The Third Branch\nLEARNING OBJECTIVES\n1.\n\nUnderstand the constitutional basis for the judicial branch.\n\n2.\n\nExplore the differences among the three branches of government.\n\n3.\n\nLearn about the chief justice\xe2\x80\x99s role in judicial administration.\n\n4.\n\nExplore the concept of judicial review.\n\n5.\n\nBecome familiar with how the other two branches check and control the judiciary.\n\nUnder the federal Constitution, power is separated among three branches of government. Article I of\nthe Constitution allocates the legislative power to Congress, which is composed of the House of\nRepresentatives and the Senate. Congress makes laws and represents the will of the people in doing\nso. Article II of the Constitution creates the executive power in the president and makes the president\nresponsible for enforcing the laws passed by Congress. Article III of the Constitution establishes a\nseparate and independent judiciary, which is in charge of applying and interpreting the meaning of\nthe law. The U.S. Supreme Court sits at the top of the federal judiciary as the supreme court of the\nland. There are nine judges on the Supreme Court. (See Figure 2.1 "The U.S. Supreme Court in\n2009".)\nFigure 2.1 The U.S. Supreme Court in 2009\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n37\n\n\x0cJustice Stevens has since retired and was replaced by Justice Kagan in 2010.\nSource: Photo courtesy of Steve Petteway, Collection of the Supreme Court of the United\nStates,http://en.wikipedia.org/wiki/File:Supreme_Court_US_2009.jpg.\nThe Constitution is remarkably short in describing the judicial branch. The president, under Article\nII, has the power to nominate judges with the advice and consent of the Senate. Article III also\nprovides the following: \xe2\x80\x9cThe judicial power of the United States, shall be vested in one Supreme\nCourt, and in such inferior courts as the Congress may from time to time ordain and establish. The\njudges, both of the supreme and inferior courts, shall hold their offices during good behaviour, and\nshall, at stated times, receive for their services, a compensation, which shall not be diminished\nduring their continuance in office.\xe2\x80\x9d Under the Constitution, therefore, there are only two\nrequirements to becoming a federal judge: nomination by the president and confirmation by the\nSenate. There are no age, citizenship, or qualification requirements. If the president wanted to, he\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n38\n\n\x0ccould nominate any reader of this book as a federal judge. Additionally, the Constitution guarantees\nthat judges are relatively free from political interference by providing them with lifetime tenure and a\nsalary that cannot be reduced.\nIt is commonly accepted that the three branches of government are coequal, but in reality they are\nvery different. The judiciary is the only unelected branch of government and is therefore the most\nmysterious. Although many Americans know who the president is, and many are familiar with their\nrepresentatives in Congress, very few know the names of the judges who sit on the Supreme Court or\nany lower court. When politicians run for Congress or president, they spend months campaigning,\nbegging voters to look into their eyes and trust them enough to cast their votes. Since judges are not\nelected, the vast majority of Americans cannot associate them with a face. Indeed, many visitors to\nthe Supreme Court building in Washington, DC, routinely come face-to-face with a justice and don\xe2\x80\x99t\nrealize it.\nThe three branches also consume vastly different resources in serving the public, with the entire\nfederal court system consuming less than two-tenths of 1 percent of the federal budget. The political\nbranches capture the public imagination with monuments and landmarks (Air Force One, the White\nHouse, the Capitol), while the federal judiciary works in relative anonymity. (All federal judges, for\nexample, travel commercially and do not have access to government-owned planes.) Finally, the\njudiciary is designed to be the most remote branch from the people. In addition to being unelected,\nfederal judges have life tenure and can be removed from office only through impeachment. They also\ntend to be in public office far longer than politicians. While the United States has had forty-four\npresidents and more than two thousand members of Congress, Chief Justice John Roberts is only the\nseventeenth chief justice. Roberts was only fifty years old when he became chief justice and will likely\nbe chief justice for many decades to come, certainly long after his nominating president, George W.\nBush, has faded from public life.\nWhen we speak of the \xe2\x80\x9cfederal judiciary,\xe2\x80\x9d we are referring to a very small entity compared to other\nfederal bureaucracies. The Supreme Court (the building, justices, and staff) is one part of the federal\njudiciary. The district and appellate courts (described later in this chapter) are another part, and they\nalso comprise judges and staff (although these courts do not own their own buildings; rather, all\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n39\n\n\x0ccourts other than the Supreme Court are rented from other branches of the government).\nThe Administrative Office of the United States Courts runs the day-to-day issues for all the courts,\nsuch as payroll and rent. A second component of the judiciary is the Federal Judicial Center, an\nagency dedicated to conducting research on judicial administration and providing judicial education.\nA third component is the United States Sentencing Commission (USSC), established by Congress to\nmake recommendations on how to establish uniformity in federal criminal sentencing. In addition to\nhis responsibilities in hearing cases and writing opinions, the chief justice oversees the overall\noperation of the federal courts and represents the courts to the other branches of government. When\nit comes to hearing and deciding cases, however, the chief justice is \xe2\x80\x9cfirst among equals\xe2\x80\x9d: he has no\nmore power than any of the other justices, known as associate justices.\nIn that capacity, the chief justice traditionally releases an annual report on the judiciary. Since\nbecoming chief justice in 2005, Chief Justice Roberts (Figure 2.2 "Chief Justice John G. Roberts")\nhas focused his annual reports on judicial pay. Although judicial salaries cannot be reduced, years\nhave passed since Congress approved a cost-of-living increase for judges. District court judges are\ncurrently paid $169,300 (the same salary as members of Congress), while circuit court judges are\npaid $179,500. Supreme Court justices earn $208,100, and the chief justice earns $217,400. While\nthis may seem like a lot of money, it\xe2\x80\x99s important to keep in mind that the integrity of the judicial\nsystem depends on attracting the very best lawyers to join the bench. Lawyers of that caliber are also\nin high demand in private law firms, where they can earn many times more than what judges earn.\nAs a result, high-quality lawyers who otherwise may serve the country by becoming judges never\neven consider joining the bench. As you can see from Note 2.11 "Hyperlink: Excerpt from 2008 YearEnd Report to Congress", there is a risk, the chief justice believes, that the pool of judicial talent may\nbe limited to less-than-the-best lawyers or those who are independently wealthy.\nFigure 2.2 Chief Justice John G. Roberts\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n40\n\n\x0cSource: Photo courtesy of the Supreme Court of the United\nStates,http://en.wikipedia.org/wiki/File:File-Official_roberts_CJ_cropped.jpg.\n\nHyperlink: Excerpt from 2008 Year-End Report to Congress\nhttp://www.supremecourt.gov/publicinfo/year-end/2008year-endreport.pdf\nI suspect many are tired of hearing it, and I know I am tired of saying it, but I must make this plea again\xe2\x80\x94\nCongress must provide judicial compensation that keeps pace with inflation. Judges knew what the pay\nwas when they answered the call of public service. But they did not know that Congress would steadily\nerode that pay in real terms by repeatedly failing over the years to provide even cost-of-living increases.\nLast year, Congress fell just short of enacting legislation, reported out of both House and Senate\nCommittees on the Judiciary, that would have restored cost-of-living salary adjustments that judges have\nbeen denied in past years. One year later, Congress has still failed to complete action on that crucial\nremedial legislation, despite strong bipartisan support and an aggregate cost that is miniscule in relation\nto the national budget and the importance of the Judiciary\xe2\x80\x99s role. To make a bad situation worse,\nCongress failed, once again, to provide federal judges an annual cost-of-living increase this year, even\nthough it provided one to every other federal employee, including every Member of Congress. Congress\xe2\x80\x99s\ninaction this year vividly illustrates why judges\xe2\x80\x99 salaries have declined in real terms over the past twenty\nyears.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n41\n\n\x0cOur Judiciary remains strong, even in the face of Congress\xe2\x80\x99s inaction, because of the willingness of those\nin public service to make sacrifices for the greater good. The Judiciary is resilient and can weather the\noccasional neglect that is often the fate of those who quietly do their work. But the Judiciary\xe2\x80\x99s needs\ncannot be postponed indefinitely without damaging its fabric. Given the Judiciary\xe2\x80\x99s small cost, and its\nabsolutely critical role in protecting the Constitution and rights we enjoy, I must renew the Judiciary\xe2\x80\x99s\nmodest petition: Simply provide cost-of-living increases that have been unfairly denied! We have done our\npart\xe2\x80\x94it is long past time for Congress to do its.\n\nThe Supreme Court is a well-known institution today, but it wasn\xe2\x80\x99t always that way. When the Court\nfirst met, many of the justices (then appointed by George Washington) couldn\xe2\x80\x99t travel in time for the\nCourt\xe2\x80\x99s opening day, so the session was dismissed. For the first three years of its existence, the Court\nheard no cases of any importance. John Jay, the first chief justice, traveled to Europe while he was\nchief justice to negotiate the Jay Treaty with Great Britain. While there, he won election as governor\nof New York. He was reappointed as chief justice by President Washington and confirmed by the\nSenate but declined to return to the Court, citing the Court\xe2\x80\x99s lack of energy, weight, and dignity as\npart of his reasoning. It wasn\xe2\x80\x99t until John Marshall became the fourth chief justice (a position he\nheld for a record thirty-four years) that the Supreme Court firmly established itself as a separate and\ncoequal branch of government. The Supreme Court did not even get its own building until 1932,\nyears after the nation\xe2\x80\x99s capital was established in Washington, DC. Before then, it met in the\nbasement of the old Senate building to hear cases. When William Taft (the only president who also\nserved as a Supreme Court justice) became chief justice, he persuaded Congress to appropriate\nfunds, and the Court finally got its own building in Washington, DC (see Figure 2.3 "U.S. Supreme\nCourt").\n\nHyperlink: Supreme Court Virtual Tour\nhttp://supremecourt.c-span.org/VirtualTour.aspx\nThe Supreme Court building, located at 1 First Street, is an impressive marble building that sits at the\nnorthern border of Washington, DC\xe2\x80\x99s, famous plaza. It is open year-round and is free to visit. If you have\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n42\n\n\x0cnot been there, you can use the link to take a virtual tour of the entire building, inside and out, courtesy of\nC-Span.\n\nThe Supreme Court\xe2\x80\x99s early malaise can partially be attributed to the problem that no one really had a\ngood idea of what the Supreme Court was supposed to do. There were few cases of tremendous\nnational importance in the new republic, and a quirky tradition known as \xe2\x80\x9criding circuit\xe2\x80\x9d meant that\nthe Supreme Court justices also acted as lower appellate court judges, thus making their work at the\nSupreme Court somewhat duplicitous. The Constitution simply states that the judicial power of the\nUnited States is vested in the Supreme Court, without expounding what that means. It wasn\xe2\x80\x99t until\n1803 that the modern role of the Supreme Court began to emerge.\nIn 1800, the presidential election between John Adams and Thomas Jefferson nearly tore the\ncountry apart. The election was bitter, partisan, and divisive. Jefferson won but wasn\xe2\x80\x99t declared the\nwinner until early in 1801. In the meantime, Adams and other Federalists in Congress attempted to\nleave their mark on government by creating a slate of new life-tenured judgeships and appointing\nFederalists to those positions. For the judgeships to become effective, certain paperwork (known as\ncommissions) had to be delivered in person to the new judges. At the time power transitioned from\nAdams to Jefferson, several commissions had not been delivered, and Jefferson ordered his acting\nsecretary of state to stop delivering them. When Jefferson came to power, there was not a single\njudge from his Democratic-Republican Party sitting on the bench, and he wasn\xe2\x80\x99t keen on expanding\nthe Federalist influence on the bench any further. One Federalist judge, William Marbury, sued the\nsecretary of state, James Madison, to deliver his commission. The case was filed in the Supreme\nCourt, led by Chief Justice John Marshall (Figure 2.4 "Chief Justice John Marshall"). Marshall\nhimself was a Federalist and had served as Adams\xe2\x80\x99s secretary of state, so he understood how political\nthe case was and how he stood to be accused of bias if he ruled the wrong way. In a shrewd and\ncalculated move, he ultimately ruled against Marbury but at the same time declared that it was the\nSupreme Court\xe2\x80\x99s role to decide the meaning of the Constitution. This is called judicial review, and it\nmakes the U.S. Supreme Court the most powerful judicial body in the world. The following is from\nMarbury v. Madison: \xe2\x80\x9cIt is emphatically the province and duty of the Judicial Department to say\n\nwhat the law is. Those who apply the rule to particular cases must, of necessity, expound and\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n43\n\n\x0cinterpret that rule. If two laws conflict with each other, the Courts must decide on the operation of\neach.\xe2\x80\x9d [1]\nFigure 2.4 Chief Justice John Marshall\n\nSource: Photo courtesy of the U.S. Department of State, http://www.flickr.com/photos/statephotos/2267272626.\n\nChief Justice Marshall did not invent judicial review; it is a feature of most common-law countries\nand as a concept goes back centuries. He did, however, institutionalize judicial review at the U.S.\nSupreme Court at a time when there was great uncertainty about the Court\xe2\x80\x99s future role in\ngovernment. While all three branches are bound to uphold the Constitution, on all matters relating\nto the meaning of the Constitution, the Supreme Court has the final say.\nAfter Marbury v. Madison, it took the Supreme Court nearly sixty years to again use the power of\njudicial review to strike down legislation. The case was Dred Scott v. Sanford, [2] and it involved a\nslave who traveled with his owner, a doctor in the army, to many states including free states (Figure\n2.5 "Dred Scott"). Dred Scott filed suit for his freedom, and the case ended up before the Supreme\nCourt. In what many commentators call the Supreme Court\xe2\x80\x99s \xe2\x80\x9cself-inflicted injury,\xe2\x80\x9d the Court, in an\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n44\n\n\x0copinion written by Chief Justice Roger Taney, used judicial review to overturn the Missouri\nCompromise and held that Dred Scott was not a person under the Constitution and therefore could\nnot file suit. The decision hastened the country into Civil War, and it took years for the Supreme\nCourt to recover its standing with the public.\nFigure 2.5 Dred Scott\n\nSource: Photo courtesy of the Missouri Historical Society, http://en.wikipedia.org/wiki/File:DredScott.jpg.\n\nJudicial review means that any federal court can hold any act of the president or the Congress to be\nunconstitutional. It is a power that rests with each of the more than eight hundred federal judges,\nfrom the trial courts through the appellate courts. It is an extraordinary power in a democracy, as an\nunelected life-tenured person or group of persons overturns the acts of a popularly elected branch of\ngovernment. Rather than give rise to judicial tyranny, however, our system of checks and balances\nensures that the other two branches also play a critical role in \xe2\x80\x9cchecking\xe2\x80\x9d the judiciary.\nTake, for example, the executive branch. The president can control the judiciary by making careful\njudicial selections. The power of the president to name federal judges is absolute\xe2\x80\x94he is not required\nto consult with any other individual in making his choice. As a matter of custom, presidents have\ntraditionally looked to senators to provide names of judicial candidates for consideration, and some\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n45\n\n\x0cpresidents are more willing than others to defer to the advice of aides and advisors. For much of the\nnation\xe2\x80\x99s history, the Senate routinely confirmed the president\xe2\x80\x99s choices. President Reagan\xe2\x80\x99s\nnomination of Robert Bork in 1987 changed that tradition forever. Alarmed Democrats grilled Bork\nin confirmation hearings and ultimately declined to confirm him, setting the stage for a new breed of\nconfirmation hearings where senators try to ascertain not just the nominee\xe2\x80\x99s character but also how\nhe or she will judge certain issues. Judicial nominees, especially to the Supreme Court, are under so\nmuch scrutiny now that sometimes even the president\xe2\x80\x99s own party will turn against a nominee. This\nhappened to President George W. Bush when he named his close friend Harriet Miers to fill a\nvacancy left by Justice Sandra Day O\xe2\x80\x99Connor\xe2\x80\x99s retirement. Alarmed at her lack of judicial experience\nand record on conservative judicial issues, Republicans urged the president to reconsider his choice,\nand Ms. Miers eventually withdrew as a nominee.\nPresidents hope, and believe, that their selections reflect their own ideologies and beliefs. Federal\njudges are notoriously independent, however, and many demonstrate little hesitance to overrule\ntheir nominating president if they believe it necessary to do so. Several presidents have been\ndisappointed in their nominee as they watched the judge move away from his or her earlier political\nroots. For example, President Eisenhower, a Republican, nominated Earl Warren as chief justice.\nWarren would later transform the civil rights landscape with a series of decisions, leading\nEisenhower to describe nominating Warren as \xe2\x80\x9cthe biggest damned fool mistake I ever\nmade.\xe2\x80\x9d [3] President Nixon, a Republican, placed Harry Blackmun on the Supreme Court, only to see\nBlackmun later move to the left and author Roe v. Wade, [4] the principal decision legalizing access to\nabortion services. More recently, President George H. W. Bush nominated David Souter to the Court\non the belief that Souter would be a reliable conservative. Souter quickly aligned himself with the\nliberal wing of the Court.\nIn addition to nominating judges, the president serves as a check on the judiciary by being the\nprimary means of enforcing judicial decisions. Federal judges do not control any police force and as\nsuch are unable to ensure their decisions are carried out. That responsibility falls on the executive\nbranch. No matter how much a president may disagree with a judicial decision, it is a testament to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n46\n\n\x0cour republican form of government, and the rule of law, that the president nonetheless faithfully\nexecutes a federal court\xe2\x80\x99s decision.\n\nHyperlink: The Little Rock Nine\nhttp://www.npr.org/templates/story/story.php?storyId=14091050\nFigure 2.6Elizabeth Eckford\n\nSource: Photo courtesy of Will Counts,http://en.wikipedia.org/wiki/File:Little_Rock_Desegregation_1957.jpg.\n\nAfter the Supreme Court handed down its seminal decision in Brown v. Board of Education,\n\n[5]\n\nmany\n\nSouthern states continued to resist desegregation. In Little Rock, Arkansas, the local NAACP chapter\nenrolled nine students in Little Rock High School to begin with the fall term in September 1957. Several\nsegregationist groups protested, and Arkansas governor Orval Faubus deployed Arkansas National Guard\ntroops to stop the students from entering the school. President Eisenhower reluctantly ordered the 101st\nAirborne Division of the U.S. Army to Little Rock to ensure the students could enroll and attend class.\nClick the link to listen to a story about one of the students, Elizabeth Eckford (Figure 2.6 "Elizabeth\nEckford"), who tried to enroll in Little Rock High School that day.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n47\n\n\x0cThe Congress can also play an important role in \xe2\x80\x9cchecking\xe2\x80\x9d the judiciary. The most obvious role is in\nconfirming judicial selections. In the last few years, judicial confirmations have become a political\nbattlefield, as activists on both the left and right seek to block judicial nominees they view as being\ntoo radical. It\xe2\x80\x99s not unusual for some judicial candidates to wait years for their confirmation\nhearings. President George W. Bush, for example, initially appointed Chief Justice Roberts to a court\nof appeals judgeship in 2001, but he wasn\xe2\x80\x99t confirmed until 2003, after Republicans regained control\nof Congress in midterm elections. Similarly, the newest member of the Supreme Court, Elena Kagan,\nwas nominated for a federal appellate judgeship in 1999 by President Bill Clinton but was never\nconfirmed due to Republican objections to her nomination.\nIn addition to confirmation, Congress also controls the judiciary through its annual budgetary\nprocess. Although the Constitution protects judicial salaries from any reductions, Congress is not\nobligated to grant any raises. For several years, judges have worked without cost-of-living raises.\nAlthough no one has seriously suggested that Congress is withholding money from the courts in\nretaliation for judicial decisions, some have observed that Congress would like to see the judicial\nbranch yield on some high-profile issues such as televising Supreme Court proceedings in turn for\npay raise consideration.\nFinally, Congress can control the judiciary by determining how the courts are organized and what\nkind of cases the courts can hear. After the 1800 presidential election, for example, the newly elected\nCongress canceled the Supreme Court\xe2\x80\x99s term for the entire year while they reorganized the judiciary.\nMore recently, several conservative members of Congress have suggested splitting up the liberalleaning Ninth Circuit Court of Appeals on the West Coast, to reduce its influence. The Constitution\nalso gives Congress the authority to determine the courts\xe2\x80\x99 jurisdiction. Congress has used this\nauthority in the past to take away controversial cases from judicial consideration. During Civil War\nReconstruction, for example, Congress passed a law taking away the Supreme Court\xe2\x80\x99s jurisdiction to\nhear an appeal from a newspaper publisher jailed for publishing articles opposing\nReconstruction. [6] Recently, Congress did the same thing, removing federal court jurisdiction from\nhearing appeals involving detainees held at the military prison in Guantanamo Bay. In the recent\npast, members of Congress have also introduced legislation prohibiting federal courts from hearing\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n48\n\n\x0ccases about the public display of religion and flag burning or from using any foreign law as support\nfor their decisions.\n\nKEY TAKEAWAYS\nThe third branch (judicial branch) is the only unelected branch of government. As such, it can sometimes\nappear remote or detached from the American public. The judiciary is composed of federal courts, the\nAdministrative Office, the Federal Judicial Center, and the U.S. Sentencing Commission. The chief justice\nhas administrative responsibilities over these agencies in addition to his adjudicatory duties. The judiciary\ncomprises less than two-tenths of 1 percent of the federal budget. In spite of this, judicial pay is very low\ncompared to pay in the private sector and is a source of tension between the judiciary and the other\nbranches of government. Marbury v. Madison established the doctrine of judicial review, which allows\ncourts to determine the final validity of laws as well as the meaning of the Constitution. Judicial review is\nan awesome power, and it is used sparingly. The president can check the judiciary through appointments\nand the enforcement of judicial decisions. The Congress can check the judiciary through funding,\nadministrative control of court calendars and funds, and jurisdiction-stripping legislation.\n\nEXERCISES\n1.\n\nDo you believe that judicial review is a good thing for American democracy? Why or why not?\n\n2.\n\nHow does the Constitution guarantee judicial independence? Do you think judges have enough\nindependence? Too much?\n\n3.\n\nHow much money do you think federal judges should be paid?\n\n4.\n\nDo you believe that Congress should have the ability to remove cases from federal courts? If so, what\ntypes of cases are appropriate for removal?\n\n5.\n\nWhat options does a president have if he disagrees with a federal court\xe2\x80\x99s opinion?\n\n6.\n\nShould a federal court force desegregation on a community that is overwhelmingly against it?\n\n[1] Marbury v. Madison, 5 U.S. 137 (1803).\n[2] Dred Scott v. Sanford, 60 U.S. 393 (1857).\n[3] John Fox, \xe2\x80\x9cBiographies of the Robes: Earl Warren,\xe2\x80\x9d PBS, December\n2006,http://www.pbs.org/wnet/supremecourt/democracy/robes_warren.html (accessed August 22, 2010).\n[4] Roe v. Wade, 410 U.S. 113 (1973).\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n49\n\n\x0c[5] Brown v. Board of Education, 347 U.S. 483 (1954).\n[6] Ex parte McCardle, 74 U.S. 506 (1869).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n50\n\n\x0c2.2 Activists and Strict Constructionists\nLEARNING OBJECTIVES\n1.\n\nExplore the strict constructionist, or originalist, judicial philosophy.\n\n2.\n\nExplore the judicial activist philosophy.\n\n3.\n\nLearn about the modern origin of the divide between these two philosophies.\n\n4.\n\nExamine the evolution of the right to privacy and how it affects judicial philosophy.\n\n5.\n\nExplore the biographies of the current Supreme Court justices.\n\nIn the early years of the republic, judges tended to be much more political than they are today. Many\nwere former statesmen or diplomats and considered being a judge to be a mere extension of their\npolitical activities. Consider, for example, the presidential election of 1800 between John Adams and\nThomas Jefferson. Even by today\xe2\x80\x99s heated standards of presidential politics, the 1800 election was\nbitter and partisan. When Jefferson won, he was in a position of being president at a time when not a\nsingle federal judge in the country came from his political party. Jefferson was extremely wary of\njudges, and when the Supreme Court handed down the Marbury v. Madison decision in 1803\ndeclaring the Supreme Court the ultimate interpreter of the Constitution\xe2\x80\x99s meaning, Jefferson wrote\nthat \xe2\x80\x9cto consider the judges as the ultimate arbiters of all constitutional questions is a very dangerous\ndoctrine indeed, and one which would place us under the despotism of an oligarchy.\xe2\x80\x9d [1] A few years\nlater, the first justice to be impeached, Samuel Chase, was accused of being overly political. His\nimpeachment (and subsequent acquittal) started a trend toward nonpartisanship and political\nimpartiality among judges. Today, judges continue this tradition by exercising impartiality in cases\nbefore them. Nonetheless, charges of political bias continue to be levied against judges at all levels.\nIn truth, the majority of a judge\xe2\x80\x99s work has nothing to do with politics. Even at the Supreme Court\nlevel, most of the cases heard involve conflicts among circuit courts of appeals or statutory\ninterpretation. In a small minority of cases, however, federal judges are called on to interpret a case\ninvolving religion, race, or civil rights. In these cases, judges are guided sometimes by nothing more\nthan their own interpretation of case law and their own conscience. This has led some activists to\nclaim that judges are using their positions to advance their own political agendas.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n51\n\n\x0cIn general terms, judges are thought to fall into one of two ideological camps. On the politically\nconservative right, judges are described as either strict constructionists or originalists. Judges who\nadhere to this philosophy believe that social change is best left to the politically elected branches of\ngovernment. The role of judges is therefore to strictly interpret the Constitution, and nothing more.\nStrict constructionists also believe that the Constitution contains the complete list of rights that\nAmericans enjoy and that any right not listed in the Constitution does not exist and must be earned\nlegislatively or through constitutional amendment. Judges do not have the power to \xe2\x80\x9cinvent\xe2\x80\x9d a new\nright that does not exist in the Constitution. These judges believe in original meaning, which means\ninterpreting the Constitution as it was meant when it was written, as opposed to how society would\ninterpret the Constitution today. Strict constructionists believe that interpreting new rights into the\nConstitution is a dangerous exercise because there is nothing to guide the development of new rights\nother than a judge\xe2\x80\x99s individual conscience. Justice Antonin Scalia, appointed by Ronald Reagan to\nthe Supreme Court in 1984, embodies the modern strict constructionist.\n\nHyperlink: Justice Antonin Scalia\nFigure 2.7Justice Antonin Scalia\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n52\n\n\x0cSource: Photo courtesy of Steve Petteway, Collection of the Supreme Court of the United\nStates,http://en.wikipedia.org/wiki/File:Antonin_Scalia,_SCOTUS_photo_portrait.jpg.\n\nhttp://www.cbsnews.com/stories/2008/04/24/60minutes/main4040290.shtml\nIn 2008, Justice Antonin Scalia (Figure 2.7 "Justice Antonin Scalia") sat down with 60 Minutes to discuss\na new book he wrote and his originalist judicial philosophy. Click the link to watch a portion of this\nfascinating interview with one of the most powerful judges in the country.\n\nOn the politically liberal left are judges who are described as activist. Judicial activists believe that\njudges have a role in shaping a \xe2\x80\x9cmore perfect union\xe2\x80\x9d as described in the Constitution and that\ntherefore judges have the obligation to seek justice whenever possible. They believe that the\nConstitution is a \xe2\x80\x9cliving document\xe2\x80\x9d and should be interpreted in light of society\xe2\x80\x99s needs, rather than\nits historical meaning. Judicial activists believe that sometimes the political process is flawed and\nthat majority rule can lead to the baser instincts of humanity becoming the rule of law. They believe\ntheir role is to safeguard the voice of the minority and the oppressed and to deliver the promise of\nliberty in the Constitution to all Americans. Judicial activists believe in a broad reading of the\nConstitution, preferring to look at the motivation, intent, and implications of the Constitution\xe2\x80\x99s\nsafeguards rather than merely its words. Judicial activism at the Supreme Court was at its peak in\nthe 1960s, when Chief Justice Earl Warren led the Court in breaking new ground on civil rights\nprotections. Although a Republican, and nominated by Republican President Eisenhower, Earl\nWarren became a far more activist judge than anyone anticipated once on the Supreme Court. Chief\nJustice Warren led the Court in the desegregation cases in the 1950s, including the one affecting the\nLittle Rock Nine. The \xe2\x80\x9cMiranda\xe2\x80\x9d [2] warnings\xe2\x80\x94familiar to nearly every American who has ever seen a\npolice show or movie\xe2\x80\x94come from Chief Justice Warren, as does the fact that anyone who cannot\nafford an attorney has the right to publicly funded counsel in most criminal cases.\nFigure 2.8 President Franklin Roosevelt\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n53\n\n\x0cSource: Photo courtesy of the U.S. Library of Congress,http://loc.gov/pictures/resource/cph.3c17121.\n\nThe modern characterization of judges as politically motivated can be traced to the Great Depression.\nAgainst cataclysmic economic upheaval, Americans voted for Franklin D. Roosevelt (Figure 2.8\n"President Franklin Roosevelt") in record numbers, and they delivered commanding majorities in\nboth the Senate and House of Representatives to his Democratic Party. President Roosevelt vowed to\nalter the relationship between the people and their government to prevent the sort of destruction and\ndespair wreaked by the Depression. The centerpiece of his action plan was the New Deal, a legislative\npackage that rewrote the role of government, vastly increasing its size and its role in private\ncommercial activity. The New Deal brought maximum working hours, the minimum wage, mortgage\nassistance, economic stimulus, and social safety nets such as Social Security and insured bank\ndeposits. Although the White House and the Congress were in near-complete agreement on the New\nDeal, the Supreme Court was controlled by a slim majority known as the \xe2\x80\x9cFour Horsemen of the\nApocalypse\xe2\x80\x9d because of their dire warnings of the consequences of economic regulation. Three\njustices known as the \xe2\x80\x9cThree Musketeers\xe2\x80\x9d\xe2\x80\x94Justice Brandeis, Justice Cardozo, and Justice Stone\xe2\x80\x94\nopposed the Four Horsemen. In the middle sat two swing votes. The Four Horsemen initially\nprevailed, and one by one, pieces of President Roosevelt\xe2\x80\x99s New Deal were struck down as\nunconstitutional reaches of power by the federal government. Frustrated, President Roosevelt\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n54\n\n\x0cdevised a plan to alter the makeup of the Supreme Court by increasing the number of judges and\nappointing new justices. The \xe2\x80\x9ccourt-packing plan\xe2\x80\x9d was never implemented due to the public\xe2\x80\x99s\nreaction, but nonetheless, the swing votes on the Supreme Court switched their votes and began\nupholding New Deal legislation, leading some historians to label their move the \xe2\x80\x9cswitch in time that\nsaved Nine.\xe2\x80\x9d During the public debate over the Supreme Court\xe2\x80\x99s decisions on the New Deal, the\njustices came under constant attack for being politically motivated. The loudest criticism came from\nthe White House.\n\nHyperlink: Fireside Chats\nhttp://millercenter.org/scripps/archive/speeches/detail/3309\nOne of the hallmarks of FDR\xe2\x80\x99s presidency was his use of the radio to reach millions of Americans across\nthe country. He regularly broadcast his \xe2\x80\x9cfireside chats\xe2\x80\x9d to inform and lobby the public. In this link,\nPresident Roosevelt complains bitterly about the Supreme Court, claiming that \xe2\x80\x9cthe Court has been acting\nnot as a judicial body, but as a policy-making body.\xe2\x80\x9d Do modern politicians make the same accusation?\n\nThe abortion debate is a good example of the politically charged atmosphere surrounding modern\njudicial politics. Strict constructionists decry Roe v. Wadeas an extremely activist decision and\nbemoan the fact that in a democracy, no one has ever had the chance to vote on one of the most\nsocially controversial and divisive issues of our time. Roe held that a woman has a right to privacy\nand that her right to privacy must be balanced against the government\xe2\x80\x99s interest in preserving\nhuman life. Within the first trimester of her pregnancy, her right to privacy outweighs governmental\nintrusion. Since there is no right to privacy mentioned in the Constitution, strict constructionists\nbelieve that Roe has no constitutional foundations to stand on.\nRoe did not, however, declare that a right to privacy exists in the Constitution. A string of cases\n\nbefore Roe established that right. In 1965 the Supreme Court overturned a Connecticut law\nprohibiting unmarried couples from purchasing any form of birth control or contraceptive. [3] The\nCourt reasoned that the First Amendment has a \xe2\x80\x9cpenumbra of privacy\xe2\x80\x9d that must include the right\nfor couples to choose if and when they want to have children. Two years later, the Supreme Court\nfound a right to privacy in the due process clause when it declared laws prohibiting mixed-race\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n55\n\n\x0cmarriages to be unconstitutional. [4] As a result of these decisions and others like them, the phrase\n\xe2\x80\x9cright to privacy\xe2\x80\x9d today is widely accepted as a form of litmus test for whether a judge (or judicial\ncandidate) is a strict constructionist or activist.\n\nVideo Clip: A Question of Ethics: The Right to Privacy and Confirmation\nHearings\nSince federal judges are appointed for lifetime, the turnover rate for federal judgeships is low.\nRecently, the Supreme Court went through an eleven-year period without any changes in\nmembership. In the last five years, however, four new justices have joined the Court. First, John\nRoberts was nominated by George W. Bush in 2005 to replace retiring Justice Sandra Day O\xe2\x80\x99Connor.\nPresident Bush did not have the opportunity to nominate anyone to the Supreme Court during his\nfirst term as president, and John Roberts\xe2\x80\x99s nomination was viewed widely as a smart move to place\non the Court a young, smart, and popular judge with solid Republican credentials. (Roberts began\nhis legal career as an attorney with the Reagan administration.) Before the Senate could confirm\nRoberts, however, Chief Justice Rehnquist died of thyroid cancer while still in office. President Bush\nwithdrew his nomination and renominated John Roberts as chief justice, which the Senate\nconfirmed. President Bush then began looking for a nominee to replace Justice O\xe2\x80\x99Connor. His first\nnominee was a close personal friend, Harriet Miers. Selecting Miers allowed him to replace a woman\nwith a woman, something important to First Lady Laura Bush. More importantly, the president felt\nthat Miers, a born-again Christian, would comfortably establish herself as a solid judicial\nconservative. Others in the Republican Party, however, were nervous about her nomination given her\nlack of judicial experience. (Miers had never been a judge.) Keen to avoid another situation in which\na conservative president nominated a judge who turned out liberal, as was the case with President\nGeorge H. W. Bush\xe2\x80\x99s nomination of David Souter, key lawmakers put enough pressure on Miers that\nshe withdrew her nomination. For his second nominee, President George W. Bush selected Samuel\nAlito, a safe decision given Alito\xe2\x80\x99s prior judicial record. Although he has been on the Court for only a\nfew years, most legal observers believe Alito\xe2\x80\x99s nomination is critical in moving the Court to the\npolitical right, as Alito has demonstrated himself to be more ideological in his opinions than the\npragmatic O\xe2\x80\x99Connor. In his first term as president, President Barack Obama has had the opportunity\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n56\n\n\x0cto name two justices to the Supreme Court: Sonia Sotomayor in 2009 to replace David Souter and\nElena Kagan in 2010 to replace John Stevens. Both nominations are widely regarded as not moving\nthe Court too much in either direction in terms of activism or originalism. There are now three\nwomen on the Supreme Court, a historical record.\n\nHyperlink: Biographies of the Current Supreme Court Justices\nhttp://www.supremecourt.gov/about/biographiescurrent.pdf\nThe Supreme Court today is more diverse than it ever has been throughout its history. The hardworking\nmen and women of the Court command respect from the legal community both in the United States and\nabroad. Click the link to explore their biographies.\n\nKEY TAKEAWAYS\nJudicial conservatives, also known as originalists or strict constructionists, believe that the Constitution\nshould be interpreted strictly, in light of its original meaning when it was written. They believe that\nsocietal change, especially the creation of new civil rights, should come from the political process rather\nthan the judicial process. Judicial liberals, also known as judicial activists, believe that judges have a role to\nplay in shaping a more perfect union. They believe that the outcome of a case is paramount over other\nconsiderations, including past precedent. Judicial activists are more likely to find new civil rights in the\nConstitution, which they believe should be broadly interpreted in light of modern society\xe2\x80\x99s needs. The\nmodern fight over judicial conservatives and judicial liberals began with FDR\xe2\x80\x99s New Deal and his courtpacking plan and continues to this day. The right to privacy is a good example of the difference between\njudicial conservatives and judicial liberals, and it is seen as a test to determine what philosophy a judge\nsubscribes to. After a long period of stability, membership in the Supreme Court has changed substantially\nin the last three years with three new members. The Court remains closely divided between judicial\nconservatives and judicial liberals, with conservatives poised to control the Court\xe2\x80\x99s direction. Justice\nAnthony Kennedy, a moderate conservative, remains the key swing vote on the Supreme Court.\n\nEXERCISES\n1.\n\nRead Justice Stewart\xe2\x80\x99s dissent in the Griswold case\nhere:http://www4.law.cornell.edu/supct/html/historics/USSC_CR_0381_0479_ZD1.html. Although he\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n57\n\n\x0cbelieves Connecticut\xe2\x80\x99s law is \xe2\x80\x9cuncommonly silly,\xe2\x80\x9d he nonetheless believes that it\xe2\x80\x99s not unconstitutional. Do\nyou think that judges have an obligation to overturn \xe2\x80\x9cuncommonly silly\xe2\x80\x9d laws?\n2.\n\nModern judicial confirmation hearings have been described as an intricate dance between nominees and\nSenators, with the nominees giving broad scripted answers that reveal little about their actual judicial\nphilosophy. Do you agree with this characterization? Do you think any changes should be made to the\nconfirmation process?\n\n3.\n\nIf you were president, what characteristics would you look for in nominating federal judges?\n\n4.\n\nIf an elected legislature refuses to grant citizens a right to privacy, do you believe it is appropriate for the\ncourts to do so? Why or why not?\n\n5.\n\nIf a president believes that the Court has reached the wrong result, should the president be able to change\nthe Court by increasing its numbers or forcing early retirement?\n\n[1] Thomas Jefferson to William C. Jarvis, 1820, in The Writings of Thomas Jefferson, ed. Andrew A. Lipscomb and\nAlbert Ellery Bergh, Memorial Edition (Washington, DC: Thomas Jefferson Memorial Association of the United\nStates, 1903\xe2\x80\x934), 15:277, quoted in Eyler Robert Coates Sr., \xe2\x80\x9c18. Judicial Review,\xe2\x80\x9d Thomas Jefferson on Politics &\nGovernment: Quotations from the Writings of Thomas Jefferson,\n1999,http://etext.virginia.edu/jefferson/quotations/jeff1030.htm (accessed September 24, 2010).\n[2] Miranda v. Arizona, 384 U.S. 436 (1969).\n[3] Griswold v. Connecticut, 381 U.S. 479 (1965).\n[4] Loving v. Virginia, 388 U.S. 1 (1967).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n58\n\n\x0c2.3 Trial and Appellate Courts\nLEARNING OBJECTIVES\n1.\n\nLearn the differences between the state and federal constitutions.\n\n2.\n\nUnderstand subject matter jurisdiction.\n\n3.\n\nExplore the state and federal court systems.\n\n4.\n\nDistinguish the work of trial and appellate courts.\n\nIn many American cities, you can find both a state and a federal courthouse. These courts hear\ndifferent types of cases, involving different laws, different law enforcement agencies, and different\njudicial systems. The rules governing the procedures used in these courts are known\nas civil procedure or criminal procedure and are sometimes so hard to understand they confound\nexperienced attorneys and judges. Nonetheless, as future business professionals, it\xe2\x80\x99s important for\nyou to understand the general boundaries between state and federal courts.\nMost people forget that there are actually fifty-one separate legal systems in the United States: one\nfederal and fifty in the states. Within each legal system is a complex interplay among executive,\nlegislative, and judicial branches of government. The foundation of each of these systems of\ngovernment is a constitution. Some state constitutions are actually older than the federal\nConstitution, while others are relatively new. The Massachusetts Constitution, for example, was\nratified in 1780, seven years before the federal Constitution. The Montana Constitution, on the other\nhand, was adopted in 1972. In some states, state constitutions remain vibrant and provide civil\nprotections beyond the federal Constitution. Several state Supreme Courts, for example, have\ninterpreted their various state constitutions as prohibiting treating gays and lesbians differently\nwhen it comes to marriage under their \xe2\x80\x9cequal protection\xe2\x80\x9d provisions. Other state supreme courts\nhave interpreted their state constitutions to grant citizens the right to choose the time and manner of\ntheir own death. Since these decisions are by state supreme courts interpreting their own state\nconstitutions, they are beyond the reach or review of the federal Congress or federal courts. This\ndynamic power sharing between state and federal governments is known as federalism and is a key\nfeature of our republican form of government.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n59\n\n\x0cTo determine which court a case belongs in, lawyers look first to what the case is about. The rules\nof subject matter jurisdiction dictate whether a case is heard in federal or state court. Lawsuits\ninvolving state laws are generally heard in state courts. Most criminal laws, for example, are state\nlaws. There may be wide differences among the states about what behavior constitutes criminal\nbehavior. Speed limits, for example, are different from state to state. Even serious crimes such as\nmurder or manslaughter, and possible defenses to those crimes, are defined differently by the states.\nDomestic issues such as divorce and family law are also handled at the state level. Some states make\nit very easy to marry (Nevada provides an obvious example), while others define marriage\ndifferently. Some states permit same-sex marriage, but most do not. Child custody and adoption laws\nare state based. Property and probate laws are also based on state law. Laws related to the transfer of\nproperty (including real estate), vehicle or watercraft ownership registration, and the disposition of\nproperty after death are different depending on what state you live in. The laws surrounding\ncontracts are also passed at the state level (although most are based on a common law called\nthe Uniform Commercial Code [UCC]). Finally, the law of torts is state based. Torts are any civil wrong\nother than a breach of contract and can cover a vast array of situations in which people and\nbusinesses suffer legal injury. Some states are far friendlier toward torts than others, and the\nresulting patchwork of tort laws means that companies that do business across the country need to\nbear in mind the different standards they are held to, based on what state their customers live in.\nGiven the wide array of subject areas regulated by state law, it\xe2\x80\x99s not surprising that for most\nindividuals and businesses, their experience with courts is with state courts. Nonetheless, cases do\nsometimes end up in federal court as well. Federal court subject matter jurisdiction is generally\nlimited to cases involving a federal question\xe2\x80\x94either the federal Constitution or a federal law. Cases\ninvolving the interpretation of treaties to which the United States is a party are also subject to federal\ncourt jurisdiction. In fact, any case involving the United States as a party is properly litigated in\nfederal court. Finally, inoriginal jurisdiction cases (so called because the Constitution specifically\ngrants this jurisdiction), lawsuits between states can be filed directly with the U.S. Supreme Court.\nOngoing disputes between Wyoming and Montana over the use of the Tongue and Powder rivers, for\nexample, were litigated in the Supreme Court in 2005.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n60\n\n\x0cSometimes it\xe2\x80\x99s possible for a federal court to hear a case involving a state law. These cases are\ncalled diversity jurisdiction cases, and they arise when all plaintiffs in a civil case are from different\nstates than all defendants and the amount claimed by the plaintiffs exceeds seventy-five thousand\ndollars. Diversity jurisdiction cases allow one party who feels it may not receive a fair trial where its\nopponent has a \xe2\x80\x9chome court\xe2\x80\x9d advantage to seek a more neutral forum to hear its case, a process\ncalled removal.\nWithin both the federal court and the state court system, there is a hierarchy of higher and lower\ncourts. The diagram in Figure 2.9 "State and Federal Court Systems" demonstrates this hierarchy.\nThe U.S. Supreme Court is the highest court in the country, and all courts are bound to follow\nprecedent established by the U.S. Supreme Court through the doctrine of stare decisis. Keep in mind,\nthough, that if an issue is exclusively a state matter (such as a state court interpreting its own state\xe2\x80\x99s\nConstitution), then the U.S. Supreme Court has no jurisdiction on that matter, leaving the state\nsupreme court as the highest court on that particular issue.\nFigure 2.9 State and Federal Court Systems\n\nOn the left-hand side of the diagram is the federal court system. Cases are filed in a U.S. District\nCourt, the trial court in the federal system. Under the court administration system, there are ninetySaylor URL: http://www.saylor.org/books\n\nSaylor.org\n61\n\n\x0cfour judicial districts in the country. Some states with low population have only one judicial district,\nwhile more populous states have multiple judicial districts. The districts are named for their\ngeographical location\xe2\x80\x94the federal court in Manhattan, for example, is the U.S. District Court for the\nSouthern District of New York. The U.S. Department of Justice, which acts as the prosecutor\nrepresenting the federal government in both civil and criminal cases, divides its attorneys among the\nninety-four judicial districts, with each district led by a U.S. attorney appointed by the president\nwithout any Senate confirmation.\nAs a trial court, the U.S. district courts hear civil and criminal trials. The trials may\nbe bench trials (heard only by the judge), or they may be jury trials. At the trial, witnesses are called\nand their testimonies are recorded, word for word, into a trial record (transcript of what was said in\nthe courtroom along with supporting documentation). At the conclusion of the trial, if the losing side\nis unhappy with the outcome, it is entitled as a matter of right to appeal its case to the U.S. Circuit\nCourt of Appeals. There are thirteen circuit courts of appeals in the United States, also spread\ngeographically through the states. A party losing an appeal at the circuit court level can appeal one\nmore time to the U.S. Supreme Court for review, but given the extremely small odds of that appeal\nbeing granted, most federal litigation ends at the U.S. circuit court level.\nOn the right side of the diagram is the state court system. In all fifty states, a trial court\nof general jurisdiction accepts most types of civil and criminal cases. These courts are called various\nnames such as superior court, circuit court, or district court. Confusingly, trial courts in New York\nState are called supreme courts. There may be other courts of limited jurisdiction at the state level,\nsuch as traffic court, juvenile court, family court, or small claims court. Increasingly, states are also\nexperimenting with specialized drug courts to treat drug abuse (not distribution or trafficking) as a\nhealth problem rather than a criminal problem. State judges may be either appointed by the\ngovernor or elected by the public. Like their federal counterparts, state trial courts hold trials, and\nmost preserve a trial record for review by an appellate court. In thirty-nine states, a party that loses\nat trial can file an appeal with an intermediate court of appeals. The remaining states are smaller and\ntherefore don\xe2\x80\x99t maintain this level of appeal, in which case appeals are filed directly with the state\nsupreme court. In states with an intermediate court of appeals, the party losing the appeal can\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n62\n\n\x0ctypically file one more time with the state supreme court, although state supreme court rules vary on\nwhether appeals are a matter of right or discretion. Finally, in certain cases that involve a federal\nconstitutional right, a party that loses at the state supreme court level can appeal to the U.S. Supreme\nCourt for review. These cases are typically criminal and involve the application of the Constitution to\ncriminal procedure, evidence collection, or punishment.\nWhenever an appeal is filed, the trial record is forwarded to the appellate court for review. Appellate\ncourts do not conduct new trials and are unable to recall witnesses or call new witnesses. The trial\ncourt\xe2\x80\x99s duty is to figure out the facts of the case\xe2\x80\x94who did what, when, why, or how. This process of\nfact-finding is an important part of the judicial process, and a great deal of deference is placed on the\njudgment of the fact finder (trier of fact). The trier of fact is typically the jury, or the judge in the case\nof a bench trial. On appeal, the appellate judge cannot substitute his or her interpretation of the facts\nfor that of the trier of fact, even if the appellate judge believes the trier of fact was wrong. The issues\non appeal are therefore limited to questions of law or legal errors. For example, the appellate court\nmay disagree with the trial judge\xe2\x80\x99s interpretation of the meaning of a law, or it may disagree with a\nruling the trial judge made about what evidence should be admitted or excluded to the trier of fact.\nThe deference to the trier of fact (trial court) means that, as a practical matter, appeals are rarely\nwon. Even if a litigant is successful in persuading a court of appeals that legal error has taken place, it\ndoesn\xe2\x80\x99t automatically win the case. In most cases, the best remedy a litigant can hope for is for the\ncourt of appeals to send the case back to a trial court (a process called remand) for reconsideration or\nperhaps a new trial.\n\nKEY TAKEAWAYS\nThere are fifty-one separate legal systems in the United States, each with its own executive, legislative,\nand judicial functions. State constitutions remain a vibrant source of civil rights protections for many\ncitizens because state constitutions are permitted to grant more civil rights (but not less) than the federal\nConstitution. Subject matter jurisdiction is the authority of a court to hear a case based on its subject\nmatter. State law claims are generally heard in state courts, while federal question cases are generally\nheard in federal court. Federal courts sometimes hear state law claims under diversity jurisdiction. Federal\ncases are filed in a U.S. district court and appealed to a U.S. circuit court of appeals. State cases are\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n63\n\n\x0ctypically filed in a trial court and appealed to an intermediate court of appeals. The U.S. Supreme Court is\nthe highest court in the country, and all other courts must follow the precedent in Supreme Court\nopinions. Trial courts are the triers of fact, and their judgment is not questioned by appellate courts.\nAppellate court review is limited to legal errors.\n\nEXERCISES\n1.\n\nDo you think that the \xe2\x80\x9chome court advantage\xe2\x80\x9d that justifies diversity jurisdiction still exists? Why or why\nnot?\n\n2.\n\nShould states retain the ability to grant more civil rights than the federal Constitution? Can you think of\nhistorical examples of this happening? What implications does this have for the future?\n\n3.\n\nStare decisis requires courts to respect and follow established precedent. Why do you think stare decisis is\nimportant in our common-law system? What do you think would happen if courts were not bound to stare\ndecisis?\n\n4.\n\nUnder what circumstances do you think the Supreme Court should feel comfortable abandoning a prior\nprecedent? Do you think the answer differs depending on whether you believe in judicial originalism or\nactivism?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n64\n\n\x0c2.4 The Certiorari Process\nLEARNING OBJECTIVES\n1.\n\nUnderstand the Supreme Court\xe2\x80\x99s jurisdiction, including what kinds of cases are selected for review.\n\n2.\n\nExplore what happens when lower courts of appeal disagree with each other.\n\n3.\n\nLearn about the Supreme Court\xe2\x80\x99s process in hearing and deciding a case.\n\nVideo Clip: The U.S. Supreme Court\nThe Supreme Court\xe2\x80\x99s jurisdiction is discretionary, not mandatory. This means the justices\nthemselves decide which cases they want to hear. For the justices to hear a case, the losing party\nfrom the appeal below must file a petition for a writ of certiorari. During the 2008 term (a term begins\nin October and ends the following June), the Supreme Court received approximately 7,700 petitions.\nOf these, about 6,100 were in forma pauperis, leaving only approximately 1,600 paid petitions. In\nforma pauperis petitions are filed by indigent litigants who cannot afford to hire a lawyer to write\nand file a petition for them. Supreme Court rules permit these petitions to be filed, sometimes\nhandwritten, without any filing fees. These petitions are typically filed by prisoners protesting a\ncondition of their detention or a defect in their conviction and are quickly dismissed by the Supreme\nCourt. Not all in forma pauperis petitions are meritless, however. In the case of Gideon v.\n[1]\n\nWainwright, a poor defendant convicted of burglary without being represented by a lawyer filed a\n\nhandwritten in forma pauperis writ of certiorari with the Supreme Court. The Court granted the writ,\nheard the case, and ruled that Gideon was entitled to have a lawyer represent him and that if he\ncould not afford one, then the government had to pay for one. Gideon was retried with a lawyer\xe2\x80\x99s\nassistance, and he was acquitted and released.\nOf the 7,700 petitions filed in the 2008 term, 87 cases were eventually argued. With such a large\nnumber of petitions filed, and a less than 1 percent acceptance rate, what kind of cases do the justices\ntypically grant? Remember, the Supreme Court is a court of discretionary jurisdiction. It does not\nexist as a court to right every legal wrong, or to correct every social injustice. Typically, the cases fall\ninto one of three categories. The first category is a case of tremendous national importance, such as\nthe Bush v. Gore [2] case to decide the outcome of the 2000 presidential election. These cases are rare,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n65\n\n\x0cbut they dominate headlines on the Supreme Court. Second, the justices typically take on a case\nwhen they believe that a lower court has misapplied or misinterpreted a prior Supreme Court\nprecedent. This category is also fairly infrequent. By far, the majority of cases granted by the\nSupreme Court fall into the third category, the circuit split.\nRecall that there are thirteen circuit courts of appeals in the United States (see Figure 2.10\n"Geography of U.S. Federal Courts"). Eleven are divided geographically among the several states and\nhear cases coming from district courts within their jurisdiction. Thus, for example, someone who\nloses a case in federal district court in Pennsylvania will appeal his or her case to the Third Circuit\nCourt of Appeals, while a litigant who loses in Florida will appeal his or her case to the Eleventh\nCircuit Court of Appeals. In addition to the eleven numbered circuit courts, there are two additional\nspecialized courts of appeals. They are both seated in the District of Columbia. The U.S. Court of\nAppeals for the Federal Circuit is a specialized court that mainly hears appeals involving intellectual\nproperty cases, such as those involving patent law. Decisions by this court on patent law are binding\non all district courts throughout the country, unless overruled by the Supreme Court. The second\nspecialized court is the U.S. Court of Appeals for the District of Columbia Circuit. Although this\nappellate court has the smallest geographical area of any court of appeal, it is a very important court\nas it hears cases against the federal government and the myriad federal agencies in Washington, DC.\nChief Justice Roberts, as well as Justices Scalia, Ginsburg, and Thomas, served on this important\ncourt before being appointed to the Supreme Court.\nA circuit split arises when the circuit courts of appeals disagree with each other on the meaning of\nfederal law. Let\xe2\x80\x99s assume that two similar cases are being decided in federal district court at the same\ntime, one in California and the other in South Carolina. The cases present similar facts and involve\nthe same federal law passed by Congress. Both cases are appealed\xe2\x80\x94the California case to the Ninth\nCircuit and the South Carolina case to the Fourth Circuit. On appeal, it\xe2\x80\x99s possible that the two\nappellate courts may come to opposite conclusions on what the law means, especially if Congress has\nrecently passed the law. Since the circuit court of appeal decision is binding for that circuit, the state\nand meaning of federal law is different based on where a citizen lives. The Supreme Court is\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n66\n\n\x0ctherefore very likely to grant certiorari in this case to resolve the split and decide the meaning of the\nlaw for the entire country.\nFigure 2.10 Geography of U.S. Federal Courts\n\nSource: Photo courtesy of the U.S. Department of\nJustice,http://en.wikipedia.org/wiki/File:US_Court_of_Appeals_and_District_Court_map.svg.\nWhen a petition for writ of certiorari is filed with the Supreme Court, the party that won the case in\nthe appeal below (called the respondent) files an opposition. Together, these two documents are\nconsidered by the justices during one of their weekly conferences to decide whether or not the case\nshould be granted. As previously discussed, cases that fall into one of three categories are generally\ngranted, while others are dismissed. The conference works on the rule of four\xe2\x80\x94only four justices (a\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n67\n\n\x0cminority) need to agree to hear a case for the petition to be granted. The vast majority of cases are\ndismissed, which means the decision of the lower court stands.\nEach Supreme Court justice is permitted to hire up to four law clerks every term to assist with his or\nher work. These law clerks are typically new attorneys from the nation\xe2\x80\x99s best law schools. Being\nselected as a clerk is obviously very prestigious, and the job is reserved for the brightest young legal\nminds. Many justices rely on their clerks to read the thousands of filed petitions and to make\nrecommendations on whether or not to grant the case. This arrangement, called a cert pool (the clerk\nassigned to the case writes a memo that is circulated to all the justices), has been criticized as giving\ntoo much power to inexperienced lawyers. Participation in the cert pool is voluntary and not all the\njustices participate. Justice Alito, for example, does not participate, and his clerks read all the\nincoming petitions independently. Until his retirement, Justice Stevens also did not participate in\nthe cert pool process.\nIf a petition is granted, the parties are then instructed to file written briefs with the Court, laying out\narguments of why their side should win. At this point, the Court also allows nonparties to file briefs\nto inform and persuade the justices. This type of brief, known as an amicus brief, is an important tool\nfor the justices. Many cases before the Supreme Court are of tremendous importance to a broad array\nof citizens and organizations beyond the petitioner and respondent, and the amicus brief procedure\nallows all who are interested to have their voice heard. For example, in the 2003 affirmative action\ncases from the University of Michigan, more than sixty-five amicus briefs were filed in support of the\nuniversity\xe2\x80\x99s policies, from diverse parties such as MTV, General Motors, and retired military leaders.\n\nHyperlink: Amicus Briefs\nhttp://www.vpcomm.umich.edu/admissions/legal/gru_amicus-ussc/um.html\nThe University of Michigan affirmative action cases drew national attention to the practice of colleges and\nuniversities using race as a factor in deciding whether or not to admit a college applicant. The Supreme\nCourt ultimately held that race may be used as a factor but not as a strict numerical quota. The Court was\naided in its decision by numerous amicus briefs urging it to find in favor of the university, including briefs\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n68\n\n\x0cfiled by many corporations. Click the link to read some of these briefs and to understand why these\ncompanies are strong supporters of affirmative action.\n\nAfter the justices have read the briefs in the case, they hear oral arguments from both sides. Oral\narguments are scheduled for one hour, in the main courtroom of the Supreme Court building. They\nare open to the public but not televised. Members of the press are given special access on one side of\nthe courtroom, where they are permitted to take handwritten notes; no other electronic aids are\npermitted. During the oral arguments, the justices are interested not in the attorneys repeating the\nfacts in the briefs but rather in probing the weaknesses of their arguments and the implications\nshould their side win. The justices typically hear two or three cases a day while the Court is in\nsession. Before each day\xe2\x80\x99s session, the marshall of the court begins with the invocation in Note 2.58\n"Hyperlink: Oyez.org".\n\nHyperlink: Oyez.org\nhttp://www.oyez.org/media/oyezoyezoyez\n\nAfter the oral arguments, the justices once again meet in conference to decide the outcome of the\ncase. Unlike the other branches of government, the justices work alone. No aides or clerks are\npermitted into their conferences. Once they decide which side should win, they begin the task of\ndrafting their legal opinions. The opinions are the only way that justices communicate with the\npublic and the legal community, so a great deal of thought and care is given to opinion drafting. If\nthe chief justice is with the winning side, he or she decides which justice writes the majority opinion,\nwhich becomes the opinion of the Court. The chief justice can use this assignment power wisely by\nassigning the opinion to a swing or wavering member of the Court to ensure that justice\xe2\x80\x99s vote\ndoesn\xe2\x80\x99t change. If the chief justice is in the minority, then the most senior of the justices in the\nmajority decides who writes the majority opinion. Dissenting justices are entitled to write their\nown dissenting opinions, which they do in hopes that one day their view will become the law.\nOccasionally, a justice may agree with the outcome of the case but disagree with the majority\xe2\x80\x99s\nreasoning, in which case he or she may write a concurring opinion. After all the opinions are drafted,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n69\n\n\x0cthe Court hands down the decision to the public. Except in very rare instances, all cases heard in a\nterm are decided in the same term, as the Court maintains no backlog.\n\nKEY TAKEAWAYS\nThe Supreme Court has discretionary jurisdiction to hear any case it wishes to hear. Every year, the chance\nof having the Supreme Court hear a particular case is less than 1 percent. The Supreme Court is more likely\nto hear a case if it involves an issue of national importance, if the Court believes a lower court has\nmisinterpreted precedent, or if the case involves a split in the appellate circuits. A circuit split occurs when\ntwo or more federal circuit courts of appeals disagree on the meaning of a federal law, resulting in the law\nbeing different depending on where citizens live. Although it takes a majority of justices to vote together\nto win a case, only a minority decides the Court\xe2\x80\x99s docket under the rule of four. The Supreme Court\ndecides cases every term by reading briefs and amicus briefs and by hearing oral arguments. In any case,\nthe Court may issue a majority opinion, dissenting opinions, and concurring opinions.\n\nEXERCISES\n1.\n\nDo you believe that Supreme Court oral arguments should be televised, as government proceedings are on\nC-Span? Why or why not?\n\n2.\n\nDo you think the Supreme Court should act more as a court of last resort, especially in serious cases such\nas capital crimes, or should the Supreme Court continue to accept only a very small number of cases?\n\n[1] Gideon v. Wainwright, 372 U.S. 335 (1963).\n[2] Bush v. Gore, 531 U.S. 98 (2000).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n70\n\n\x0c2.5 Concluding Thoughts\nAs the smallest branch of government, and with the shortest founding text in the Constitution among\nthe three branches, the U.S. judiciary faced uncertainty and political interference in its early days. In\nrecent decades, however, the judiciary has matured into an independent and transparent institution,\nremarkably resilient to political turbulence and attack. It\xe2\x80\x99s also a relative bargain for taxpayers,\nconsidering its role as the primary interpreter and defender of the Constitution.\nNone of this has prevented political attacks on the judiciary, which continue to this day. You may\nrecall the Florida case involving Terri Schiavo, a patient in a permanent vegetative state, and what\nhappened when her husband won judicial relief to stop medical measures to keep her alive.\nProminent pro-life politicians launched vitriolic attacks on the judges involved. Attacks on the\njudiciary for politically unpopular decisions have become so toxic that former Supreme Court Justice\nSandra Day O\xe2\x80\x99Connor has made it part of her post-Court retirement to stop these attacks and inject\nmore civility into political treatment of judges. While citizen frustration with government is not new,\ndangerous threats against the judiciary are on the rise and represent a worrying trend.\nYou may spend your entire life without ever meeting a single judge. If you do have experiences with a\njudge, you will likely find him or her to be surprisingly human, honest, and above all, fair. The\njudiciary lacks a natural constituency, so the burden of ensuring the continued success of this\nAmerican institution falls on all of us, citizens and corporations alike.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n71\n\n\x0cChapter 3\n\nLitigation\nLEARNING OBJECTIVES\nIn this chapter, you will explore our litigation system in detail. Litigation provides an opportunity for each\nside in a dispute, whether criminal or civil, to lay their side of the story to an impartial jury or judge and\nask that jury or judge to decide who wins and loses, and how much the loser should pay or how much time\nthe defendant should spend in jail. After reading this chapter, you should have a deeper understanding of\nhow litigation is conducted in the United States. Specifically, you should be able to answer the following\nquestions:\n1.\n\nWho are the parties involved in litigation?\n\n2.\n\nWhat is standing and how does it impact litigation?\n\n3.\n\nHow does a court obtain personal jurisdiction over a defendant?\n\n4.\n\nHow does a trial progress from beginning to end?\n\n5.\n\nHow does a losing side appeal a case?\n\nEven if you\xe2\x80\x99ve never stepped foot in a courtroom before, you can probably describe what a courtroom\nlooks like. It\xe2\x80\x99s a large, imposing room with tall ceilings, flags on stands, and wood paneling on the\nwalls. The majority of the floor space is taken up with seating for the public. The front of the\ncourtroom is dominated by the bench, behind which the judge sits, above everyone else in the room.\nNext to the bench is a solitary chair with a microphone in front of it, where a witness sits. Along one\nside of the wall is a separated area with two rows of seats, where the jury sits. Facing the bench, and\nalways closest to the jury, is one table for the party that is carrying the burden of proof in the case:\nthe prosecution in a criminal trial and the plaintiff in a civil trial. Across the aisle, there is another\nimpressive table for the opposite side, the defense. When court is in session, a hush settles into the\nroom so that everyone can hear the judge, commanding in presence, or the witness, captivating in\ndetail.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n72\n\n\x0cMany of us have such clear imagery of a courtroom because our experiences are drawn from popular\nculture. Whether in movies (A Civil Action, To Kill a Mockingbird, Erin Brockovich), on television\nshows (Law & Order, L.A. Law, Boston Legal), or in fictional books (The Firm, Twelve Angry Men),\ncourtroom scenes capture our imagination and fire our sense of righteousness and justice as good\nalways prevails over evil. In our collective courtrooms the truth always comes out, our ideals are\nalways upheld, and the bad guys always lose. Who could forget, for example, the psychological\nbreakdown on the witness stand in the movie A Few Good Men, as Jack Nicholson plays it out?\n\nVideo Clip: You Can\xe2\x80\x99t Handle the Truth\nScenes like these, while providing wonderful imagery, are pure fiction. In a real courtroom, there is\nno back-and-forth argument between counsel and witness as examinations proceed through\nquestioning alone. In a real courtroom, the truth doesn\xe2\x80\x99t always emerge. In a real courtroom, there\nare many shades of gray between good and evil. And finally, in a real courtroom, the bad guys don\xe2\x80\x99t\nalways lose, and the good guys don\xe2\x80\x99t always win.\nAs future business professionals, your responsibility to your company, to your company\xe2\x80\x99s\nstakeholders, and to yourself is to avoid ever seeing the inside of a courtroom. Acting ethically and\nlegally, and identifying the legal pitfalls that you may encounter by mastering the elements of this\ncourse, will help you achieve this goal. Agreeing to arbitration for parties that you have a preexisting\nrelationship with, such as your customers, suppliers, or employees, will also help you stay away from\na courtroom. In spite of this planning, however, many companies still find that litigation is\nsometimes unavoidable. Whether litigation is initiated against parties you don\xe2\x80\x99t have a contract with\n(such as another company that steals your intellectual property rights) or by parties you don\xe2\x80\x99t have a\ncontract with (such as a customer who is injured by your product or an employee harassed by\nanother employee), litigation may be the only dispute-resolution mechanism available.\nIn this chapter we\xe2\x80\x99ll explore the process of litigation from the beginning to the end. You\xe2\x80\x99ll learn about\nthe parties involved and about preliminary matters such as standing and personal jurisdiction and\nthen explore the trial and appeal. We\xe2\x80\x99ll also discuss the role of lawyers and juries in our litigation\nsystem. By the end of the chapter, you\xe2\x80\x99ll have an appreciation that while our litigation system is\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n73\n\n\x0ccherished for its ability to resolve disputes peacefully and establishes a hallmark for public\naccessibility, for businesses it is often a far from satisfactory forum for dispute resolution.\n\nKey Takeaways\nLitigation is an inevitable part of a business\xe2\x80\x99s activities. Lawsuits, trials, and appeals can be ruinously\nexpensive for some companies, especially small- and medium-sized enterprises. Learning about our\nlitigation system will give you the skills and comfort you need should your company find itself in\nlitigation.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n74\n\n\x0c3.1 The Parties Involved\nLEARNING OBJECTIVES\n1.\n\nIdentify the parties involved in litigation.\n\n2.\n\nExplore the role of lawyers in our adversarial system.\n\n3.\n\nUnderstand the roles and obligations of jurors.\n\nThe litigation system relies on parties bringing forth and defending their respective claims. As in the\ngame of chess, each move can take place only if a player makes a decision to move in a particular\ndirection; the game does not play itself. Courts, jurors, and witnesses are similarly moribund: it is up\nto the players, in this case called litigants, to act decisively. Occasionally, a court may act sua sponte,\nwithout a direct request from a party. A judge may decide, for example, to fine a party for bad or\nunethical behavior. These actions are fairly rare. More commonly, judges act on a motion filed by\neither party asking the judge to make a particular decision.\nThe party that begins the lawsuit is called the plaintiff in a civil case. The plaintiff is a victim that has\npresumably suffered some sort of legal wrong that the law recognizes. The plaintiff brings suit\nagainst the defendant\xe2\x80\x94the alleged wrongdoer or perpetrator. Note that in a criminal trial, the party\nthat initiates litigation is the prosecution, representing the people of a state or, in federal cases,\nrepresenting the people of the United States. In a criminal trial the alleged wrongdoer is also called\nthe defendant.\nMany cases involve multiple plaintiffs and multiple defendants. Civil procedure encourages, and\nmakes it easy for, parties to air all their grievances against each other at once. All parties, and every\npossible claim (each claim is a separate violation of law) arising out of a single incident or series of\nrelated incidents, should be identified and named in a lawsuit. For example, if you go to an offcampus party one night and witness a friend being harassed, you might feel the need to step in to\ndefend your friend. The harasser may then turn his attention toward you, perhaps taking a swing at\nyou. Let\xe2\x80\x99s assume that the harasser is drunk and misses, but in return you take a swing and hit him,\nknocking him to the ground. The harasser may file a lawsuit against you, alleging assault and battery.\nThe harasser is the plaintiff, and you are the defendant. The lawsuit filed in court would be\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n75\n\n\x0ccaptioned Harasser v. You. You might decide in return to file a claim against the harasser, alleging\nthat the harasser started the fight and that you acted in self-defense. This is called a counterclaim,\nand you are now the counterplaintiff, making the harasser the counterdefendant. In return, the\nharasser may allege that he wasn\xe2\x80\x99t really harassing your friend but trying to defend himself from\nyour friend\xe2\x80\x99s unwanted advances. The harasser may sue your friend as a third-party defendant\nthrough a process called joinder.\nExcept in some small-claims courts, parties hire attorneys to litigate most cases. Sometimes\nindividuals feel like they have a sufficient grasp on the law to proceed in litigation without a lawyer\nor that they have sufficient legal training (or even a law degree) that hiring a lawyer would be a waste\nof money. Individuals who represent themselves are called pro se litigants and can only proceed pro\nse if the judge overseeing the case allows it. Abraham Lincoln once famously said, \xe2\x80\x9cHe who\nrepresents himself has a fool for a client.\xe2\x80\x9d The complexities of litigation require a cool and detached\nmind to thread a route to success, and if you are representing yourself it is all too easy to allow\npassion to cloud your judgment.\nAttorneys are sometimes called members of the bar. The U.S. legal profession is unique in several\nrespects. In most countries, legal education is an undergraduate program followed by a period of\napprenticeship before an individual is allowed to practice law. Many countries also make a\ndistinction between attorneys who litigate in court and those who do not. In the United Kingdom, for\nexample, solicitors are lawyers who deal with ordinary legal matters outside of court, while Queen\xe2\x80\x99s\nCounsel (QC) are specially trained lawyers who are permitted to argue in court. In the United States,\nlawyers undertake three years of graduate study resulting in the award of the Juris Doctorate degree,\nor JD. Every year, more than thirty thousand students graduate from U.S. law schools with their JD.\nThey then sit for the bar exam in the state where they wish to practice. Since the practice of law in the\nUnited States varies widely by different jurisdictions, lawyers are only permitted to practice in\njurisdictions where they are licensed. Some states permit lawyers from out of state, after a few years\nof being in practice, to apply for bar admission without taking the exam through a process called\nreciprocity. Other states, notably California and Florida, require attorneys to take the bar exam no\nmatter how long they have been in practice. If a lawyer is dealing with an issue or matter that takes\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n76\n\n\x0chim or her out of state to litigate a case, he or she can ask to be admitted temporarily by a court in\nthat foreign state through a motion called pro hac vice. Once the lawyer passes the state\xe2\x80\x99s bar exam or\nis otherwise admitted, he or she is permitted to practice all aspects of law in that state, from drafting\nwills and contracts to arguing a case before the U.S. Supreme Court.\nAttorneys in the United States are broadly divided into civil and criminal attorneys; few lawyers excel\nin both areas. Civil attorneys generally work in two different categories: in law firms, where they may\nrepresent multiple clients, and as in-house counsel, where they represent only one client, their\nemployer. Most large corporations have an in-house legal department to control legal costs but may\nstill hire outside counsel for representation and advice in complex matters.\nWith the possible exception of politicians, no other profession is subject to more morbid jokes than\nlawyering. William Shakespeare famously wrote in Henry VI, through a character speaking of a\nutopian world, \xe2\x80\x9cThe first thing we do, let\xe2\x80\x99s kill all the lawyers.\xe2\x80\x9d In spite of this public animosity\ntoward lawyers, however, if there comes a time when someone needs a lawyer, it\xe2\x80\x99s not uncommon to\nhear them wish they had the most aggressive lawyer money can buy.\nPerhaps part of the reason the public has a low opinion of lawyers can be traced to the ethical and\nlegal obligations of attorneys. Lawyers may be the most regulated of all the professional industries,\nand they are required to comply with complex and sometimes rigid rules of professional conduct.\nUnlike rules for other professions, the rules of professional conduct for lawyers are largely drafted\nand enforced by the bar itself (other lawyers and judges) and almost never involve external\nenforcement mechanisms. These rules govern virtually every aspect of the practice of law, and a\nviolation of these rules can result in disciplinary action from the state bar or supreme court of the\nstate in which the lawyer practices, up to lifetime disbarment. When President Bill Clinton, for\nexample, lied under oath about certain aspects of his extramarital affairs, he was suspended from\npracticing law for five years in Arkansas and ordered to pay a $25,000 fine. These rules of\nprofessional responsibility require attorneys to represent their clients with zealous advocacy.\nOrdinarily, we associate the word \xe2\x80\x9czealot\xe2\x80\x9d with extremists, but that is the standard by which lawyers\nmust represent their clients. This might clarify why some lawyers act the way they do.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n77\n\n\x0cOne of the most sacrosanct rules of professional responsibility is the obligation to keep a client\xe2\x80\x99s\nsecrets. The communications between a client and his or her attorney are absolutely confidential\nunder the attorney-client privilege doctrine. There are many privileges under the law, such as the\nspousal privilege, doctor-patient privilege, and priest-penitent privilege. The attorney-client privilege,\n\nhowever, is arguably the strongest of these privileges. The privilege belongs to the client, and the\nattorney is not permitted to reveal any of these communications without the client\xe2\x80\x99s consent. A\nnarrow exception exists for clients who tell their lawyers they intend to harm others or themselves,\nbut attorneys must tread very carefully to avoid violating the privilege. Many members of the public\nfeel that the privilege may be open to abuse and can\xe2\x80\x99t understand, for example, why an attorney can\xe2\x80\x99t\nreveal a client\xe2\x80\x99s confession to a heinous crime. Ultimately, the privilege exists for the client\xe2\x80\x99s benefit.\nSomeone who cannot communicate with his or her attorney freely is unable to help the attorney\nprepare the best possible case for litigation. You should note that in-house attorneys represent the\ncorporations they work for and not individual employees. If you communicate with an in-house\nattorney for the company where you work, for example, that communication may not be\nautomatically protected by the attorney-client privilege.\n\nHyperlink: The Lynne Stewart Case\nhttp://www.lynnestewart.org\nLynne Stewart, a human rights attorney, was assigned to represent Sheik Omar Abdel-Rahman, the blind\nEgyptian cleric convicted of conspiracy in the 1993 World Trade Center bombing in New York City. As\npart of her representation, she agreed to abide by certain conditions when communicating with her client,\nincluding not speaking to the media. Ms. Stewart broke those promises and inadvertently passed on a\ncommunication from her client to his followers around the world. She was indicted and convicted of\nconspiracy and providing material support to terrorists. She was sentenced to a twenty-eight-month\nprison term. Click the link to read more about her case, including the legal documents involved. A very\ncontroversial aspect of the case involved the use of secret cameras and recorders to listen in on her\nconversations with her client while he was in prison.\nFigure 3.2Lynne Stewart\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n78\n\n\x0cSource: Photo courtesy of Robert B. Livingston,http://en.wikipedia.org/wiki/File:Lynne_Stewart.JPG.\n\nIn spite of an attorney\xe2\x80\x99s professional obligations to his or her client, it\xe2\x80\x99s important to remember that\nultimately a lawyer\xe2\x80\x99s first duty is to the administration of justice. The rules of professional conduct are\nwritten with this goal in mind. The requirements for lawyers on civility, honesty, and fairness are all\nwritten to ensure that lawyers represent the very best aspects of our judicial system. Let\xe2\x80\x99s say, for\nexample, a client admits to his lawyer that he is guilty or liable in a case. The client then wants to\ntestify under oath that he is innocent. Although a lawyer cannot tell anyone what her client has told\nher, the lawyer is also prohibited from knowingly suborning perjury. The attorney must either\nconvince the client to not testify, or withdraw from the case.\nIn the case in Note 3.31 "Hyperlink: A Question of Ethics", an attorney goes a little too far in her\nrepresentation and draws a heavy fine from a judge as a result.\n\nHyperlink: A Question of Ethics\nThe Case of the Birther Attorney\nOrder Hon. Clay D. Land, U.S. District Judge, District Court for the Middle District of Georgia, Case No.\n4:09-CV-106, Rhodes v. MacDonald, athttp://www.scribd.com/doc/20996403/Gov-uscourts-gamd77605-28-0.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n79\n\n\x0cThroughout the presidential election campaign in 2008, persistent rumors swirled around whether\nBarack Obama was born in the United States, a requirement under the Constitution to serve as president.\nAfter the election, California attorney Orly Taitz launched a campaign to prove that the president was not,\nin fact, born in Hawaii. Her bizarre tirades against the media and the courts earned her this unusual\nreprimand from a federal judge. Click the link to read the entire order. Do you believe that in their\n\xe2\x80\x9czealous\xe2\x80\x9d representation of their clients, attorneys have the ethical duty to pursue claims such as these?\nOrder\nIntroduction\nCommenting on the special privilege granted to lawyers and the corresponding duty imposed on them,\nJustice Cardozo once observed, \xe2\x80\x9cMembership in the bar is a privilege burdened with conditions. [A lawyer\nis] received into that ancient fellowship for something more than private gain. He [becomes] an officer of\nthe court, and, like the court itself, an instrument or agency to advance the ends of justice.\xe2\x80\x9d Competent\nand ethical lawyers \xe2\x80\x9care essential to the primary governmental function of administering justice.\xe2\x80\x9d For\njustice to be administered efficiently and justly, lawyers must understand the conditions that govern their\nprivilege to practice law. Lawyers who do not understand those conditions are at best woefully\nunprepared to practice the profession and at worst a menace to it.\nWhen a lawyer files complaints and motions without a reasonable basis for believing that they are\nsupported by existing law or a modification or extension of existing law, that lawyer abuses her privilege\nto practice law. When a lawyer uses the courts as a platform for a political agenda disconnected from any\nlegitimate legal cause of action, that lawyer abuses her privilege to practice law. When a lawyer personally\nattacks opposing parties and disrespects the integrity of the judiciary, that lawyer abuses her privilege to\npractice law. When a lawyer recklessly accuses a judge of violating the Judicial Code of Conduct with no\nsupporting evidence beyond her dissatisfaction with the judge\xe2\x80\x99s rulings, that lawyer abuses her privilege\nto practice law. When a lawyer abuses her privilege to practice law, that lawyer ceases to advance her\ncause or the ends of justice.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n80\n\n\x0cIt is irrefutable that a lawyer owes her client zealous advocacy, but her zeal must be constrained within the\nbounds placed on her as an officer of the Court and under the Court\xe2\x80\x99s rules. Specifically, Rule 11 of the\nFederal Rules of Civil Procedure expressly sets forth the outer boundaries of acceptable attorney conduct.\nThat rule prohibits a lawyer from asserting claims or legal positions that are not well-founded under\nexisting law or through the modification, extension, or expansion of existing law. Rule 11 also prohibits an\nattorney from using the courts for a purpose unrelated to the resolution of a legitimate legal cause of\naction.\nRegrettably, the conduct of counsel Orly Taitz has crossed these lines, and Ms. Taitz must be sanctioned\nfor her misconduct. After a full review of the sanctionable conduct, counsel\xe2\x80\x99s conduct leading up to that\nconduct, and counsel\xe2\x80\x99s response to the Court\xe2\x80\x99s show cause order, the Court finds that a monetary penalty\nof $20,000.00 shall be imposed upon counsel Orly Taitz as punishment for her misconduct, as a deterrent\nto prevent future misconduct, and to protect the integrity of the Court. Payment shall be made to the\nUnited States, through the Middle District of Georgia Clerk\xe2\x80\x99s Office, within thirty days of today\xe2\x80\x99s Order. If\ncounsel fails to pay the sanction due, the U.S. Attorney will be authorized to commence collection\nproceedings. The Court does not take this action lightly, and in fact, cannot recall having previously\nimposed monetary sanctions upon an attorney sua sponte.\n\nAs the Orly Taitz case demonstrates, attorneys must take care to respect a court\xe2\x80\x99s authority at all\ntimes and conduct themselves in a civil manner. Most attorneys have no problem discharging this\nobligation to the judge, but it is to the jury that they focus their attention the most. In our legal\nsystem, the jury has a very special role to play in ensuring citizen participation in the administration\nof justice. As the trier of fact, the jury has the duty of determining the truth in any given situation:\nwho said and did what, why, and when?\nDo you know when someone is lying to you? Have you ever been lied to so well that you didn\xe2\x80\x99t find\nout about the lie until much later? Have your roommates or friends who were involved in a dispute\never asked you to decide who should win? In essence, being a juror relies on those same human\nskills. In every legal proceeding, each of two adversarial sides, absolutely opposed to each other,\nclaims that it is right and the other side is wrong. Our litigation system is a process by which each\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n81\n\n\x0cside gets to present its case to a group of stranger citizens, and then ask them to decide who is lying\nand who is telling the truth.\nThere are two types of juries. A grand jury is a group of citizens convened by the prosecution in\nserious criminal cases to simply determine whether there is probable cause to believe that a crime\nhas occurred and whether it\xe2\x80\x99s more likely than not that the defendant in question committed the\ncrime. The grand jury serves as a procedural step to prevent prosecutors from abusing their powers\nof arrest and indictment, a sort of \xe2\x80\x9csanity check\xe2\x80\x9d on the awesome power of government to accuse\ncitizens of crime. The grand jury requirement exists at the federal level and in some, but not all,\nstates. A grand jury typically meets for an extended period of time and can hear several different\ncases in one day.\nThe grand jury does not determine guilt or innocence. A petit jury does that. This jury is impaneled\nfor a specific trial. During the trial, members of the jury listen to the evidence presented and then\ndeliberate as a group on what they believe the facts of the case are. They then apply the law, as\ninstructed by the judge, to the facts. There are typically twelve members in a petit jury in criminal\ntrials and from six to twelve members in civil trials, and generally speaking they must arrive at a\nunanimous verdict.\nThe jury system is a jewel in our litigation system for it involves ordinary citizens in adjudicating all\nsorts of disputes, from domestic family issues to complex business and insurance litigation to heartwrenching criminal cases. There are problems with administering this system, however.\nBoth grand and petit juries are drawn from citizen voter and driver license rolls. In high-profile\ncases, it may be difficult to find citizens who have not heard about the case or who can be impartial\nabout the case, in spite of their promises to be open minded. When Enron collapsed in 2001, for\nexample, defense attorneys for former CEO Jeff Skilling argued strenuously that the trial should not\nbe held in Houston, where almost every citizen was affected in some way by the energy giant\xe2\x80\x99s\ncollapse or knew someone affected. The question of juror bias was so serious that the U.S. Supreme\nCourt agreed to hear Skilling\xe2\x80\x99s appeal based partially on this argument. Although the Court\neventually found that Skilling\xe2\x80\x99s jury was adequately impartial, Justice Sotomayor noted in a\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n82\n\n\x0cdissenting opinion that the \xe2\x80\x9cdeep seated animosity that pervaded the community at large\xe2\x80\x9d caused her\ngreat concern. [1]\nAnother problem arises from the burdens placed on jurors\xe2\x80\x99 personal lives through their service.\nWhile most states have laws that prevent an employer from firing a worker or taking any negative\nwork action, such as demotion, against the worker for being on jury duty, there is no legal\nrequirement that an employer continue to pay a worker on jury duty. The court system does not pay\njuries for their services either (although some court systems pay a small amount, typically less than\ntwenty dollars per day, to cover food and transportation costs). Some citizens, such as those who are\nself-employed, are therefore at great risk for losing personal income by serving on juries. Imagine\nbeing on the O. J. Simpson criminal trial jury, for example\xe2\x80\x94that trial lasted ten months. The effects\nof jury service on a juror\xe2\x80\x99s personal life can be staggering.\nAnother potential problem arises in the makeup of the jury itself. To provide a fair jury, courts\nattempt to draw from a cross-section of society to reflect the diversity of the surrounding community.\nLocal court rules typically allow judges to excuse potential jurors for hardship or extreme\ninconvenience. If these rules are too generous, then the only citizens left may be those without fulltime employment, such as students or retirees. Such a narrow cross-section of society would tend to\nskew the reliability and trust of the jury system, and judges across the country are becoming\nincreasingly intolerant of attempts to evade jury service. The only professions that automatically\nexempt citizens from jury duty are active-duty soldiers, police officers and firefighters, and public\nofficers.\nIn spite of these administrative problems, our jury system remains a cornerstone of litigation and is\noften openly admired. In South Korea, for example, attempts to create a more open and responsive\ndemocracy resulted in a novel and wholesale revision to the country\xe2\x80\x99s court system: the adoption of\ncitizen juries.\n\nHyperlink: Korea Adopts Jury System\nhttp://www.nytimes.com/2008/07/07/world/asia/07iht-jury.2.14299454.html\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n83\n\n\x0cIn 2007, with little public debate or preparation, South Korea adopted a jury system in certain criminal\nand civil trials. For now, the jury\xe2\x80\x99s decision is only advisory, and the court is free to reject it. The result has\nbeen some confusion about the role of citizens in the legal system, some concern about the methodology\nemployed to implement the jury system, and an increase in transparency and greater citizen participation\nin government affairs.\n\nKEY TAKEAWAYS\nThe federal rules of civil procedure make it easy for parties in a lawsuit to identify and join other relevant\nparties and to make legal claims against each other. The goal of civil litigation is to find the truth. Litigants\ntypically rely on lawyers to assist them in litigation. An attorney\xe2\x80\x99s highest duty is to the administration of\njustice. Lawyers are ethically bound to represent their clients with zealous advocacy. A grand jury acts as a\nbody of citizens to prevent abuse of discretion by prosecutors. A petit jury sits in trials as the trier of fact\nto ascertain the truth through their observations of the presented evidence.\n\nEXERCISES\n1.\n\nCan you think of a situation where an in-house attorney may advise you to retain your own counsel?\n\n2.\n\nMost rules of legal professional conduct are drafted and enforced by the bar itself, but the Sarbanes-Oxley\nAct (passed in reaction to the Enron accounting scandal) imposed a legal duty on lawyers to report acts of\nmisconduct in publicly traded corporations. Do you believe that the bar does an effective job of policing\nitself, or do you think external government agencies should be more involved?\n\n3.\n\nRead the legal documents available for the Lynne Stewart case at Note 3.28 "Hyperlink: The Lynne Stewart\nCase". Do you think that the U.S. government should be able to curb the attorney-client privilege when the\nclient is a convicted terrorist? Or a suspected terrorist?\n\n4.\n\nHow aggressive should a lawyer be in representing his or her client \xe2\x80\x9czealously\xe2\x80\x9d? Read the rest of Judge\nLand\xe2\x80\x99s order in Note 3.31 "Hyperlink: A Question of Ethics". Do you think Orly Taitz\xe2\x80\x99s conduct warranted a\ntwenty-thousand-dollar fine?\n\n5.\n\nDo you think that juries can be trusted to always arrive at the truth? Why or why not?\n\n6.\n\nDo you think the U.S. jury system should be adopted by other countries? What factors do you think should\naffect a country\xe2\x80\x99s decision to adopt a jury system?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n84\n\n\x0c[1] Skilling v. United States, 561 U.S. ___ (2010),http://www.supremecourt.gov/opinions/09pdf/081394.pdf (accessed October 2, 2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n85\n\n\x0c3.2 Standing and Personal Jurisdiction\nLEARNING OBJECTIVES\n1.\n\nExplore the standing requirement.\n\n2.\n\nUnderstand how a court obtains personal jurisdiction over the parties.\n\nBefore a case can be litigated, parties have to demonstrate that they meet two pretrial requirements:\nstanding and personal jurisdiction.\nStanding is a constitutional requirement. Article III of the Constitution grants the judiciary the power\n\nto hear \xe2\x80\x9ccases\xe2\x80\x9d and \xe2\x80\x9ccontroversies.\xe2\x80\x9d This means actual cases and controversies, not merely\nhypothetical ones. Unlike some other jurisdictions, the standing requirement means that courts are\nunable to give advisory opinions. Let\xe2\x80\x99s say, for example, Congress is considering whether or not to\npass a law and would like to know whether the law is constitutional. Standing prevents this question\nfrom being litigated, because it\xe2\x80\x99s not yet an actual case or controversy. Standing, therefore, is a\ndoctrine that limits judicial overreach by circumscribing the types of cases that are litigated in our\ncourts.\nTo demonstrate standing, a party has to prove first that it has an actual case to proceed. This is a\nprocedural matter, and it requires the case to be brought at the right time. If a case is brought too\nearly, it\xe2\x80\x99s not yet ripe. If it\xe2\x80\x99s brought too late, then the case is moot. For example, assume that a state\nis debating whether or not to pass a law that would require thirty hours of financial management\nclasses before anyone is allowed to form his or her own company. If an entrepreneur who wishes to\nform her own company but doesn\xe2\x80\x99t want to take the thirty hours of classes sues the state for an\nunconstitutional law, that lawsuit would be dismissed for being brought too early\xe2\x80\x94it is not ripe since\nthe law hasn\xe2\x80\x99t been passed yet. Now let\xe2\x80\x99s assume that the law has been passed, and the entrepreneur,\nwho has abandoned her plans and is now working for someone else, sues the state anyway. That\nlawsuit would also be dismissed since it is now moot. Even if the entrepreneur won the case and the\nlaw was overturned, the remedy would be meaningless to her since she does not plan to take the class\nanyway.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n86\n\n\x0cIn addition to being brought at the right time, the case has to be brought by the right person. To\nshow standing, a plaintiff has to demonstrate that he has an actual stake in the litigation, or\nsomething of value that would be lost if he loses the case. Of course, if a plaintiff has lost money in a\ncontract dispute or has been injured in a tort case, that is sufficient legal injury. Let\xe2\x80\x99s say, for\nexample, that your roommate is the victim of Internet fraud when she does not receive the goods that\nshe paid for online. She would rather move on and forget the whole episode, but you are outraged\nand decide to sue the perpetrator in court. Even if the perpetrator admitted that it committed fraud,\nyou would still lose the case because you\xe2\x80\x99re not the right plaintiff here; your roommate is.\nCases that don\xe2\x80\x99t involve monetary damages are sometimes more difficult to call. For example, what if\na constitutional right is at stake? What standing does a citizen have to prove to file a lawsuit? Courts\nhave generally held that merely being a taxpayer does not give standing to challenge government\nexpenditures. So, for example, a citizen cannot sue the government to stop the war in Afghanistan\njust because he pays his taxes. If taxpayers don\xe2\x80\x99t have standing to challenge government action, then\nwho does?\nIn 2007 Massachusetts, along with eleven other states, sued the Environmental Protection Agency\n(EPA) to force the agency to regulate carbon dioxide as a pollutant. For years, the EPA had argued\nthat carbon dioxide is not a pollutant and therefore could not be regulated. In response to the suit,\nthe EPA argued that the states lacked standing since they couldn\xe2\x80\x99t prove they had been harmed by\nexcess carbon dioxide in the air. In a major decision, [1] the Supreme Court ruled that the states had\nstanding because they had suffered environmental degradation as a result of global warming brought\nabout by excess carbon dioxide and that therefore the EPA has jurisdiction over carbon dioxide as a\npollutant. This decision, along with the election of President Obama, led to a major policy reversal at\nthe EPA, which is now aggressively pursuing the regulation of carbon pollution to combat global\nwarming.\nAnother high-profile case on standing involves the Pledge of Allegiance. In 2000 a California\nattorney and physician sued the government because his daughter attended a school where the\nPledge of Allegiance was recited every morning. The plaintiff, Michael Newdow, claimed that the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n87\n\n\x0cpledge is unconstitutional under the First Amendment because it contains the words \xe2\x80\x9cunder God.\xe2\x80\x9d In\n2002 the Ninth Circuit Court of Appeals agreed with Newdow, ruling that the pledge is indeed\nunconstitutional. On appeal to the Supreme Court, the Court ducked the question of whether the\npledge is unconstitutional.[2] Instead, the Court held that Newdow lacked standing to bring the\nlawsuit in the first place since he is a noncustodial parent. Only his wife, who had custody of the\ndaughter, could bring the lawsuit.\nIt\xe2\x80\x99s important to note that standing doesn\xe2\x80\x99t have anything to do with the merits of the case. Being\nable to prove standing doesn\xe2\x80\x99t mean that you can win the case at hand. It only means that you\xe2\x80\x99ve\nbeen able to clear a procedural bar toward proceeding with litigation.\nAnother procedural bar before a plaintiff can proceed is personal jurisdiction. Personal jurisdiction is\ndifferent from subject matter jurisdiction, which is the power of a court to hear a case. Personal\njurisdiction is the power of a court over specific litigants, and it requires litigants to have some form\nof minimum contacts with the state where the case is filed. Personal jurisdiction seeks to avoid\ninconvenient litigation, even if the case has actual merit. If you\xe2\x80\x99ve never been to Nebraska, for\nexample, and don\xe2\x80\x99t have any connections to Nebraska, then you might be very surprised to find that\nyou\xe2\x80\x99re being sued in a Nebraska state court. In addition to that, you\xe2\x80\x99d have to go to Nebraska to\nanswer the lawsuit, hire local lawyers to assist you, and spend a lot of time and money in a state you\nhave nothing to do with.\nA court obtains personal jurisdiction over the plaintiff when the plaintiff files its lawsuit. Obtaining\npersonal jurisdiction over the defendant can be a little trickier. Typically, there has to be some sort of\nconnection between the defendant and the state where the court is located. For example, living in the\nstate would create personal jurisdiction. Residency for purposes of personal jurisdiction is different\nfrom residency for other legal requirements such as voting and driving. Even temporary residency,\nsuch as a college student studying out of state, creates residency for personal jurisdiction purposes.\nMoreover, merely being in the state temporarily creates personal jurisdiction. If you\xe2\x80\x99re driving\nthrough Nebraska, for example, and you\xe2\x80\x99re speeding on a local highway, Nebraska courts have\njurisdiction to hear a speeding ticket issued against you. Owning property in a state also creates\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n88\n\n\x0cjurisdiction. For corporations, courts generally hold that personal jurisdiction is proper in the state\nof incorporation as well as in any state the corporation does business.\nPersonal jurisdiction, like standing, is a constitutional requirement. The due process clause of the\nFourteenth Amendment requires government processes to be carried out fairly. In 1980, the\nSupreme Court heard an important case on personal jurisdiction involving a car crash in\nOklahoma. [3] The plaintiff purchased the car in New York and filed a lawsuit against the\nmanufacturer (Volkswagen) and the distributor and retailer (car dealer). The distributor and the\nretailer moved to dismiss the case for lack of personal jurisdiction, arguing that they had no business\nin Oklahoma, had no employees or property there, and did not target citizens of Oklahoma to\npurchase vehicles from them in New York. The Supreme Court held in favor of the distributor and\ncar dealer, finding that neither had \xe2\x80\x9cpurposefully availed\xe2\x80\x9d themselves of the privileges that come\nfrom doing business in Oklahoma. The Court noted that for personal jurisdiction to attach,\n\xe2\x80\x9csubstantial notions of fair play and justice\xe2\x80\x9d cannot be offended.\nToday, most states have written these concepts into laws known as long-arm statutes. These statutes\nset forth the procedure by which out-of-state defendants can be required to appear before a local\ncourt. The statutes provide for how service of process can occur. Service of process is the process by\nwhich any defendant (both local and out-of-state) is notified that it is being sued. Service of process\ntypically requires a copy of the summons (notice to appear before a court) to be personally delivered\nto the defendant or the defendant\xe2\x80\x99s agent. In the case of companies and other nonhuman entities,\nservice of process is usually easy since they are required to have a registered agent as part of the\nprocess of forming an organization. Service can be more challenging with an individual, since some\ndefendants know that litigation can be held up while service is attempted and therefore choose to\navoid being served at all costs. While the best service is personal delivery of the summons, some\nstates prescribe alternative methods such as leaving a copy with a family member while also mailing\na copy.\nThe Internet era has raised some interesting personal jurisdiction issues. Does creating a Web site,\nfor example, subject you to personal jurisdiction in all states where the Web site is accessible? Courts\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n89\n\n\x0chave ruled that the answer depends on what kind of Web site you have created. If it is a general\ninformational Web site that describes a product, then there are insufficient minimum contacts to\ncreate personal jurisdiction. If, on the other hand, the Web site reaches out to specific customers and\nurges them to make a purchase, either through a shopping cart function or by calling the seller, then\nthere are minimum contacts to justify jurisdiction.\n\nKEY TAKEAWAYS\nStanding is a constitutional requirement that requires a plaintiff prove that he or she is the right person to\nbring a lawsuit and that he or she is bringing the lawsuit at the right time. Taxpayers lack standing to sue\nthe government just by being taxpayers. Legal injury does not have to be monetary based; environmental\nharm, for example, may be sufficient to demonstrate standing. Standing has nothing to do with the merits\nof the underlying case. Courts must have personal jurisdiction over a defendant before litigation can\nproceed. Personal jurisdiction, a constitutional requirement, requires minimum contacts with the state\nsuch that substantial notions of fair play and justice are not offended. Once personal jurisdiction is\nestablished, service of process can occur, where a copy of the summons is delivered to the defendant. If\nthe defendant lives out of state, a long-arm statute prescribes the method for service to occur. A Web site\ncreates personal jurisdiction in any state where it reaches out for customers through a shopping cart\nfunction.\n\nEXERCISES\n1.\n\nWhen President Obama nominated Hillary Clinton as secretary of state in 2008, several constitutional\nscholars observed that it may be unconstitutional for her to assume the post due to an often-ignored\nsection of the Constitution. What procedural bar stopped citizens from challenging the nomination?\n\n2.\n\nDo you believe the Supreme Court acted properly by finding that states with environmental damage from\nglobal warming had standing to challenge the federal government?\n\n3.\n\nIn the Volkswagen car crash case, the manufacturer (Volkswagen, a German company) and the importer\ndid not contest personal jurisdiction of Oklahoma state courts. Why do you think they submitted to\njurisdiction so readily?\n\n4.\n\nIf a car dealer in a neighboring state runs advertisements in your state claiming that its deals are better\nthan those of in-state dealers, does that out-of-state car dealer create personal jurisdiction in your state?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n90\n\n\x0c5.\n\nIf you sell something on eBay, do you create personal jurisdiction in the buyer\xe2\x80\x99s state? Why or why not?\n\n6.\n\nIf you commit a tort on the Internet, do you create personal jurisdiction in the victim\xe2\x80\x99s state? For example,\nif you defamed someone who lives out of state on Facebook, have you created jurisdiction in that foreign\nstate?\n\n[1] Massachusetts v. EPA, 549 U.S. 497 (2007).\n[2] Elk Grove Unified School District v. Newdow, 542 U.S. 1 (2004).\n[3] World-Wide Volkswagen v. Woodson, 444 U.S. 286 (1980).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n91\n\n\x0c3.3 Pretrial Procedures\nLEARNING OBJECTIVES\n1.\n\nExplore pretrial procedures such as pleadings, discovery, and motions.\n\n2.\n\nFind out how class-action lawsuits are organized and prosecuted.\n\n3.\n\nLearn about issues and challenges facing parties during discovery.\n\nAfter issues related to subject matter jurisdiction, standing, and personal jurisdiction are sorted out\nand parties have hired counsel to represent them, then a dispute can proceed to the pretrial stage. In\ncivil cases, litigation begins with the filing of a complaint by the plaintiff. The complaint is a simple\ndocument setting forth who the parties are, the facts of the case, and what specific laws the\ndefendant has violated. (Each of these is a claim.) The complaint ends with a prayer for relief. The\nplaintiff may be seeking damages (money), specific performance in certain kinds of contract cases, or a\ntemporary or permanent injunction. It is much easier to get a temporary injunction in the early\nstages of litigation, because courts don\xe2\x80\x99t want to see the defendant take some action that may result\nin irreparable harm. For example, if a real estate development company wants to tear down an old\nshopping mall to build a new skyscraper, and one of the tenants in the old mall claims it still has a\nright to be there, the tenant may be able to obtain a temporary injunction stopping the demolition\nuntil the lease issues are sorted out. If the demolition is allowed to continue and the tenant later\nturns out to be the winner, it will be too late to grant the tenant any meaningful remedy.\nCitizen advocacy groups with an antilitigation public policy agenda often complain\nabout frivolous lawsuits being filed in court. Most court systems have rules to prevent the filing of\nfrivolous suits. In the federal system, the rules state that all claims must be signed by a lawyer\ncertifying that to the \xe2\x80\x9cbest of the person\xe2\x80\x99s knowledge,\xe2\x80\x9d formed after \xe2\x80\x9can inquiry reasonable under the\ncircumstances,\xe2\x80\x9d the claim is not being presented for an unlawful purpose such as harassment and\nthat the claims are either \xe2\x80\x9cwarranted by existing law\xe2\x80\x9d or a nonfrivolous argument for modifying\nexisting law. In practice, this standard is quite easy to meet, and it\xe2\x80\x99s hard to think of a factual\nscenario\xe2\x80\x94other than the most absurd\xe2\x80\x94that would rise to the level of being legally frivolous.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n92\n\n\x0cThe complaint is filed with the clerk of the court where the suit is to be heard. Every court has a\nclerk\xe2\x80\x99s office to handle administrative matters relating to litigation. Even though the court system is\na public service, there is usually a fee associated with filing a complaint to cover some of the court\xe2\x80\x99s\ncosts.\nThe clerk will next issue a summons to the defendant, along with a copy of the complaint. The\nsummons is sent to a process server to effect service on the defendant. When the defendant is served,\nit is very important for the defendant to respond to the complaint in a timely manner. Ignoring the\ncomplaint, even if the defendant believes the complaint is devoid of any merit, is a fatal error. If the\ndefendant does not reply to the complaint, the plaintiff can ask the court to issue\na default judgment against the defendant, including granting all the relief the plaintiff is asking for.\nIn certain types of cases, there may be a large number of plaintiffs injured by a defendant\xe2\x80\x99s actions.\nThis may happen in a product liability lawsuit where a product is purchased by many thousands of\nconsumers, all of whom experience the same product failure. The batteries for Apple\xe2\x80\x99s popular iPod,\nfor example, had a high failure rate, leading to a large number of consumer claims. There also may be\na large number of plaintiffs in financial services cases, where a financial institution or investment\nfirm defrauds a large number of investors. In these cases, several lead plaintiffs may attempt to form\na class in a class-actionlawsuit against the defendants. Under federal civil procedure rules, class\nactions may be granted when there are so many plaintiffs that it is impractical for them to file\nseparate lawsuits, there are questions of law or fact that are common to members of the class, and\nthe lead plaintiffs will fairly and adequately protect the interests of the class.\nThe defendant must file an answer to the complaint within a specified period of time, typically thirty\ndays. The answer is a paragraph-by-paragraph response to the complaint, admitting certain\nparagraphs and denying others. The answer may also contain an affirmative defense (self-defense in\nan assault charge, for example) the defendant wishes to pursue. Taken together, the complaint and\nanswer are known as the pleadings. The answer may admit, for example, noncontroversial claims by\nthe plaintiff such as the defendant\xe2\x80\x99s name, address, and the nature of the defendant\xe2\x80\x99s relationship\nwith the plaintiff. Each time the defendant denies a plaintiff\xe2\x80\x99s claim in the complaint, that sets up a\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n93\n\n\x0ccontroversy or argument that must be litigated. Reducing the number of claims to be resolved before\nan actual trial begins makes the trial shorter. For example, in many civil cases, the plaintiff will make\nclaims about liability and damages. A defendant may be willing to admit that it is liable but may\nargue about the plaintiff\xe2\x80\x99s claims for damages. This can sometimes lead to bifurcated trials, where\nthe issues of liability and damages are litigated separately.\nAt any point in litigation, either party may file motions with the court. The motions are designed to\nshort-circuit the litigation and lead to an early end to the lawsuit. Litigation is so time consuming\nand expensive that either party would be gratified if the judge would simply cut the lawsuit short and\ndeclare a winner. One such motion is the motion to dismiss for failure to state a cause of action. In\nthis motion, the defendant argues that even if it admits everything in the complaint is factually true,\nthat doesn\xe2\x80\x99t lead to any legal liability. In other words, the defendant\xe2\x80\x99s conduct has not broken any\nlaws. A similar motion is the motion for judgment on the pleadings. In this motion, one party asks\nthe judge to decide the case based simply on the answer and complaint.\nIf a long period of time has passed since the incident in question and the filing of the lawsuit, a\ndefendant may file a motion to dismiss based on the statute of limitations. Every civil and criminal\naction has a statute of limitations, which states that any claim or prosecution under the statute must\nbe brought within a specified period of time or it will be dismissed. Only a few crimes are exempt\nfrom the statute of limitations and can be prosecuted at any time: murder (in most states) and rape\n(in many states). The statute of limitations exists to encourage aggrieved parties to file their lawsuits\nquickly, while evidence is still fresh and relevant people have memories of what occurred. As time\npasses, evidence may become stale, witnesses may die or move away, and those that can be located\ncan\xe2\x80\x99t remember what they saw or heard. In other words, the quicker a suit is filed, the more likely\nthat the real truth will be discovered by litigation. For businesses, a statute of limitations also allows\nit to \xe2\x80\x9cclose the books\xe2\x80\x9d on past liabilities, such as accounts payable or tax payments, knowing that too\nmuch time has passed for anyone to come collecting on those monies. It is possible, though, in many\ncases to toll the statute of limitations. If an accountant commits fraud, for example, and a criminal\ncomplaint is filed but the accountant flees overseas for many years, the statute of limitations does not\nrun while the suspect is hiding.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n94\n\n\x0cIn support of any motion, a party may submit an affidavit. Affidavits play an important role in\npretrial procedure because they are an effective way for parties to tell their side of the story to the\njudge. They are limited, however, because even though they are given under oath, they may raise\nmore questions and are not subject to examination by the other side.\nAfter pleadings are filed, the litigation moves into the discovery phase. Discovery is a process in\nwhich each side finds out information about the other\xe2\x80\x99s case. Let\xe2\x80\x99s assume, for example, that you buy\na new car and within a few weeks, a tire falls off suddenly while you\xe2\x80\x99re driving. You would rightly\nconclude that there\xe2\x80\x99s something wrong with the car, so you sue the manufacturer. At this point, you\nhave no idea what\xe2\x80\x99s wrong with the vehicle. Was the design flawed? Was there something wrong with\nthe manufacturing of your specific vehicle? All you know is that new cars should not experience this\nsort of failure. After you file a lawsuit against the manufacturer, discovery allows you to find out\nmore information about the vehicle so that you can effectively proceed with the lawsuit. You could\nfind out what engineers did when they designed the vehicle and review records of similar accidents\nor factory records from the day your vehicle was produced.\nDiscovery is designed to prevent trial by surprise, where either side may suddenly produce a\ndamning piece of evidence that allows it to win the trial. Since trials are based on the discovery of\ntruth, they should be tried on the merits of the case rather than a party\xe2\x80\x99s deceit. In that spirit, the\nrules of discovery are written broadly to cover scope and obligation. In scope, any piece of evidence\nthat may be relevant to the trial is discoverable. Even if evidence may be ruled later to be\ninadmissible for a legal reason, it is discoverable during discovery. In obligation, both parties are\nobligated to turn over material that supports their own case, without demand from the other side. If\nthe material harms their own case, they have to turn it over if the other side asks for it.\nThere are four types of discovery. The simplest (and least expensive) is aninterrogatory. These are\nwritten questions addressed to the other party. The questions tend to be simple and straightforward,\ndealing with uncontroversial matters such as a company\xe2\x80\x99s structure or the names and addresses of\nrelevant witnesses.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n95\n\n\x0cA second type is a request for production. Using this form of deposition, a party can request the other\nparty to produce written communications such as internal company reports, e-mails, product\nmanuals, and engineering specifications. In some cases physical evidence may also be produced. If\nyou sued a vehicle manufacturer because your tire fell off while driving, for example, the\nmanufacturer may ask you to produce your vehicle so that its engineers can inspect it. Failure to\npreserve and produce key evidence in litigation can lead to charges of spoliation, which may result in\nsevere sanctions against the offending party.\nA third form of discovery is a request for admission. Remember that a complaint contains a series of\nclaims the plaintiff is making against the defendant, and the answer is mainly a series of denials of\nthose claims. As each party finds more information about the other\xe2\x80\x99s case in discovery, one party\nmay ask the other to admit that one of the contested claims is true. Doing so narrows the issues for\ntrial because it is one less thing that the jury has to decide. Asking a party to give up a contested\nclaim can be done at any time during litigation. If not done as a formal method of discovery, it may\nbe done as a stipulation instead. For example, in your trial against the vehicle manufacturer, you may\nask the manufacturer to admit that your specific vehicle was manufactured on a specific date at a\nspecific factory.\nFinally, discovery can take the form of a deposition. A deposition is a sworn oral statement, in\nresponse to questions, given by a potential witness in a trial to the attorneys in the case. A deposition\nhearing is attended by the witness being deposed and lawyers from both side, as well as a court\nreporter who keeps a written transcript of the entire deposition. In your product liability suit against\nyour vehicle\xe2\x80\x99s manufacturer, for example, you might want to depose the safety engineer who\ndesigned the car\xe2\x80\x99s tire and braking systems. There is no judge present, so there is great latitude for\nparties to ask questions, even if those questions may result in testimony that is later inadmissible in\ncourt. Depositions serve to allow attorneys to prepare for trial by knowing everything a witness may\nsay in court. They also serve to pin down a witness\xe2\x80\x99s testimony, since a witness who changes\ntestimony between a deposition and trial can be easily impeached. Depositions are easily the most\nexpensive form of discovery, sometimes requiring weeks or months of advance planning, travel, extra\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n96\n\n\x0ccosts, and lost work time from witnesses being deposed. In some cases they can degenerate without\nthe presence of a judge, as Note 3.72 "Video Clip: A Deposition Goes Awry" shows.\n\nVideo Clip: A Deposition Goes Awry\nAlthough the policy behind liberal rules of discovery is to permit both sides to prepare adequately for\ntrial, in effect discovery is an expensive phase of litigation. With most lawyers charging by the hour,\nresponding to discovery requests can quickly rack up daunting legal bills. Discovery can also drag out\nlitigation to many months or years. Most large corporations find they must dedicate entire in-house\nstaffs of attorneys, paralegals, and support staff to respond exclusively to discovery requests. The\njudge assigned to the case is supposed to supervise discovery and ensure that the parties respond in a\ntimely manner, as well as make rulings on specific discovery requests and objections. Theoretically, a\njudge has the power to sanction parties for abusive discovery, up to and including ordering a default\njudgment against the offending party. There are, however, few meaningful sanctions that can be\nlevied against parties that abuse discovery, and plaintiffs in particular have a vested interest in\nmaking discovery last longer than the price of a sought-after settlement. These issues are magnified\nin e-discovery, when mountains of electronic data have to be sifted through to find relevant\ndiscoverable material. Objections to turning over material that may be proprietary, privileged, or the\nresult of thework product doctrine also become more time consuming when parties are engaged in ediscovery.\nDuring or after discovery, parties typically make a motion forsummary judgment. This motion is\ndesigned to cut the trial short by asking the judge to decide based on the information discovered so\nfar in the case. In essence, the party making the motion is saying, \xe2\x80\x9cWhy have a trial?\xe2\x80\x9d since the\nevidence would lead any reasonable jury to the same and inevitable conclusion.\n\nKEY TAKEAWAYS\nLitigation commences with the filing of a complaint by the plaintiff. If the plaintiff wishes to represent\nmany others with the same claim against the same defendants, the plaintiff may try to certify the lawsuit\nas a class-action suit. Frivolous cases are prohibited in litigation, but it is relatively easy to argue that a\ncase is not frivolous. The defendant files an answer to the complaint or risks a default judgment. Most civil\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n97\n\n\x0cand criminal cases must be brought within the prescribed statute of limitations. During the discovery\nphase of litigation, parties share and exchange information about each other\xe2\x80\x99s cases so that neither side is\nsurprised during the trial. There are four methods for conducting discovery: interrogatories, requests for\nproduction, requests for admissions, and depositions.\n\nEXERCISES\n1.\n\nDuring the Catholic priest sex scandal, many potential plaintiffs who were abused as children found that\ntheir lawsuits against the church and individual priests were barred by the statute of limitations because\nthe abuse happened so many years ago. Do you believe that these lawsuits were rightfully barred? Why or\nwhy not? Should the statute be changed in sexual misconduct cases?\n\n2.\n\nDo you think there are too many frivolous cases filed? If you answered yes, how would you revise the\nfederal rules of civil procedure to raise the standard on what constitutes a frivolous case?\n\n3.\n\nLook at a sample interrogatory at http://www.justice.gov/atr/foia/frito-lay/8-16-96.htm. This\ninterrogatory was issued by the U.S. Department of Justice in an antitrust investigation against Frito-Lay\nfor possible violations of the Sherman Antitrust Act. What do you notice about the questions? How long\ndo you think it would take to compile a response to these questions? If you were the defendant, would\nyou object to any of them? If so, on what grounds?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n98\n\n\x0c3.4 The Trial and Appeal\nLEARNING OBJECTIVES\n1.\n\nLearn about jury selection.\n\n2.\n\nFollow a trial from opening statement to closing arguments.\n\n3.\n\nExplore the public policy rationale for the trial system.\n\nAfter discovery is finally completed, and assuming that neither side has been successful in shortcircuiting litigation through motions, the case is finally scheduled for a trial. In civil litigation, this is\na most unusual development, for well over 90 percent of cases filed are resolved or settled before a\ntrial. If a case actually goes to trial, it means there are genuine issues of fact that the parties cannot\nresolve, and both sides are determined to see their side win. Remember that a trial is a fact-finding\nprocess, through which the trier of fact (the jury in most cases or the judge in a bench trial) attempts\nto determine what happened. The trier of fact applies the facts to applicable law as instructed by the\njudge and determines guilt or innocence in a criminal case, or liability or no liability in a civil case.\nThe first step in this process is to seat a jury.\nAt any given day in a courthouse, several citizens may be called by a judge as potential jurors in a\ncase. If a jury needs twelve members, it\xe2\x80\x99s not unusual for a judge to begin with a pool of more than\nfifty or sixty potential jurors to narrow down to a dozen. The process of selecting a petit jury is\ncalled voir dire.\nVoir dire typically begins with the jurors filling out a written questionnaire. The questionnaire asks\nthe jurors to identify their occupation, any work or occupational conflicts, and any potential conflicts\nof interest with the case. The process then continues with attorneys quizzing each potential juror in\nturn. During this questioning, attorneys ask each juror if he or she has any biases against upholding\nthe law and whether he or she can keep an open mind during the trial.\nIf an attorney does not like a juror\xe2\x80\x99s response, that juror may be excused. There are two types of\nchallenges to a potential juror: peremptory or for cause. A party can make a for cause challenge if it\ncan demonstrate to the judge that there is a good reason to excuse the juror, such as the juror\xe2\x80\x99s\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n99\n\n\x0cpersonal relationship with one of the parties, or the juror\xe2\x80\x99s stated unwillingness to be unbiased. Since\nthese excuses are for a good reason, each side is allowed an unlimited number of for cause\nchallenges. A party can also make aperemptory challenge against a juror, without giving any reason\nfor the challenge. Since these challenges are unsupported by rationale or reason, each side is given a\nlimited number of peremptory challenges. A party may make a peremptory challenge based on a\njuror\xe2\x80\x99s perceived bias because of that juror\xe2\x80\x99s occupation or life background but may not make a\nperemptory challenge because of the juror\xe2\x80\x99s race [1] or gender.\nAfter a jury has been selected and sworn in, the trial begins. The plaintiff or prosecution begins by\ndelivering an opening statement. The opening statement is a preview of the trial. In it, the attorneys\nexplain the facts of the case to the jury and indicate what witnesses they will be calling and what the\nwitnesses will say. Attorneys do not make any arguments during the opening statement; they simply\nlay out what jurors can expect from the trial ahead. In a trial against your vehicle\xe2\x80\x99s manufacturer,\nyour attorney may begin by telling the jury to expect testimony from you about your car accident,\nfrom your doctor about the injuries you suffered, and perhaps from an expert witness who has\nexamined your vehicle and believes it was manufactured defectively. Once the plaintiff has delivered\nan opening statement, the defendant will deliver the defense opening statement. In a criminal case,\nthe defense has the right to reserve delivering the opening statement until after the prosecution has\nrested its case (concluded presenting all the witnesses).\nAfter opening statements, the trial moves into the examination phase. Jurors are presented with\nwitnesses, called by each side, to give evidence. The plaintiff begins by calling its witnesses. The\nattorney will guide the witness in delivering testimony by a series of short open-ended questions\nduring thedirect examination. Leading questions (questions that call for a yes or no answer) are not\npermitted during direct examination. As the questioning proceeds, a court reporter maintains a\nrecord of all the words spoken in case there is an appeal. The opposing side may raise objections\nduring the examination, which the judge will rule on. These rulings can also form the basis for a later\nappeal.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n100\n\n\x0cAll the evidence in a trial must be introduced in this manner (questioning a live witness). If one side\nwants to introduce videotape into evidence, for example, it has to call the person who took the\nfootage or was in charge of running the camera to testify about his or her personal knowledge of\nwhere the camera footage came from before the jury can watch the video. In a criminal case, if the\nprosecution wants to introduce the murder weapon into evidence, it must first call the detective or\npolice officer who found the weapon to testify about where he or she found it and where it has been\nsince then.\n\nHyperlink: O. J. Simpson Tries on Gloves\nhttp://video.google.com/videoplay?docid=-7472594685651342793#\nO. J. Simpson\xe2\x80\x99s criminal murder trial was probably the most-watched courtroom proceeding in history.\nDuring the trial, the prosecution sought to introduce a pair of gloves into evidence. The prosecution\nclaimed the gloves contained blood from the victims. In this scene, the defendant, O. J. Simpson, is asked\nto try on the gloves so that the jury can see for themselves whether or not the gloves might belong to him.\nThe fact that the gloves appear too small for his hands later becomes fertile ground for the defense\nattorneys to argue that reasonable doubt exists as to his guilt.\n\nAfter direct examination, the other side has the right to conduct a cross-examination. During the\ncross-examination, the attorney will try to discredit the witness to convince the jury that the witness\nis not credible. The attorney may probe into any potential biases the witness may have or try to prove\nthat the witness\xe2\x80\x99s recollection of events may not be as clear or certain as the witness believes. During\ncross-examination, attorneys frequently engage in asking leading questions, which is permitted.\nOnce the prosecution or plaintiff has called all its witnesses, and the witnesses have undergone direct\nand cross-examination, then the prosecution or plaintiff will rest its case. The defendant may make a\nmotion for a directed verdict, arguing that no reasonable juror could possibly find in favor of the\nprosecution or plaintiff after hearing the evidence presented so far. This motion can be made\nanytime during the trial before the jury returns a verdict. The motion is typically denied, and the trial\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n101\n\n\x0cmoves on to the defense phase. The defense will then present its witnesses, who are led through\ndirect and cross-examination.\nAfter the defense has rested its case, the attorneys once again address the jury in closing arguments.\nHere, the attorneys summarize the case for the jury. They address what witnesses were called and\nwhat the witnesses said. During closing arguments, the attorneys are permitted to be much more\npersuasive and argumentative than during the opening statement. They appeal to the jury\xe2\x80\x99s emotions\nand argue how the jury should interpret the evidence before them.\n\nVideo Clip: Johnnie Cochran Delivers Closing Arguments\nAfter closing arguments are made, the judge in the case charges the jury by giving the jury its\ninstructions. The instructions acquaint the jury with the relevant law. The jury then retires to\ndeliberate. During deliberations, the jury will decide first what facts it believes to be true. Then it will\napply those facts to the law as outlined in the jury instructions. In a trial against your vehicle\xe2\x80\x99s\nmanufacturer, for example, the judge may explain to the jury what is legally required for a product to\nbe considered defective so that the jury can make a determination, based on the evidence presented,\nwhether or not there is any liability.\nCentral to the jury\xe2\x80\x99s deliberations is the burden of proof applicable to the case. In criminal trials, the\nprosecution always carries the burden of proof. That burden is to prove the defendant committed all\nthe elements required in the crime beyond a reasonable doubt. If any member of the jury has any\nreasonable doubts about the defendant\xe2\x80\x99s guilt or innocence, then the only appropriate verdict is not\nguilty. Many people confuse the burden with \xe2\x80\x9cwithout a doubt.\xe2\x80\x9d Jurors may have doubts, but the only\nquestion for the jurors is whether they have any reasonable doubts. This standard is deliberately set\nhigh because of the severe sanctions and penalties that follow a criminal conviction. In a criminal\ntrial, the defense only has to prove reasonable doubt exists and has no burden of proof at all. That is\nwhy in criminal trials, the defense may strategically decide to not call any witnesses and to rest its\ncase strictly on creating doubt by cross-examining the prosecution\xe2\x80\x99s witnesses.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n102\n\n\x0cIn civil cases the burden of proof is preponderance of the evidence. This standard requires the scales\nof justice to tilt ever so slightly toward one party to declare that party the winner. If the jury believes\none side is 51 percent correct and the other is 49 percent correct, that is enough to declare a winner.\nIt is a much easier standard to win, because it only requires a party to prove that its side is more\nlikely than not telling the truth. In a civil liability suit against your vehicle\xe2\x80\x99s manufacturer, your\nburden is to convince the jury that more likely than not, your vehicle was somehow defective.\nSometimes it\xe2\x80\x99s possible for a jury in a criminal trial to find the defendant not guilty, while a separate\njury in a civil case applying a lower burden of proof finds the defendant liable for the same act. This\nis what happened to O. J. Simpson when he was tried for the murder of his wife.\nDuring jury deliberations, the jurors are permitted to ask the judge for clarification about the law and\nto request to see the evidence again. If the jury is unable to come to a verdict, the jury is said to be\ndeadlocked, and a mistrial results. Since trials are expensive and time consuming, the judge will\nusually instruct the jury to try its best before giving up. If the jury does arrive at a decision, it is called\na verdict.\nOnce the jury delivers its verdict, the losing side typically makes a motion\nforjudgment notwithstanding the verdict. In this motion, the party is arguing that the jury arrived at\nthe wrong verdict and that no reasonable jury could have arrived at that verdict. The judge typically\nwill not grant this verdict. Even if the judge believes that the jury arrived at the wrong factual\nconclusion, the judge is not permitted to substitute his or her judgment for that of the jury. If,\nhowever, the jury clearly ignored the law in arriving at its verdict in a criminal case, the judge may\noverrule the jury. This phenomenon is known as jury nullification.\nIf the judge denies the motion for judgment notwithstanding the verdict, then the judge enters the\njury\xe2\x80\x99s verdict as a judgment. After that, the losing party has the right to file an appeal. Remember that\non appeal, the appellate court is only reviewing the record for legal error and cannot call new\nwitnesses or substitute its judgment on the facts for the jury\xe2\x80\x99s. In the following excerpt, Supreme\nCourt Justice Ruth Bader Ginsburg uses the trial record to make a point in her dissenting opinion in\nan important employment discrimination case involving gender discrimination. Although hers was a\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n103\n\n\x0cdissenting opinion and the plaintiff lost her case, Congress reacted to the decision by passing the Lily\nLedbetter Fair Pay Act, the first law signed by President Obama after he assumed office.\n\nHyperlink: Justice Ginsburg Reviews an Employment Discrimination Case\nhttp://www.law.cornell.edu/supct/html/05-1074.ZD.html\nFrom 1979 to 1998, Lilly Ledbetter worked as a supervisor at Goodyear\xe2\x80\x99s plant in Gadsden, Alabama. Over\nthe course of her career, her pay slipped when compared to the pay of men of equal experience and\nseniority. She sued the company, alleging pay discrimination on the basis of her gender under Title VII of\nthe 1964 Civil Rights Act. The law states that any lawsuit must be initiated within 180 days of the unlawful\ndiscriminatory act occurring. Ledbetter argued that each paycheck she received was an unlawful\ndiscriminatory act, so the fact that she filed her lawsuit within 180 days of her last paycheck means her\nlawsuit is within the time limit. Goodyear argued that the discriminatory act was the decision to pay her\nless, which took place many years ago and that therefore her lawsuit is too late. In a 5\xe2\x80\x934 decision, the\nSupreme Court ruled in Goodyear\xe2\x80\x99s favor. In her dissent, Justice Ginsburg returns to the trial record to\nmake her point that Ledbetter is the victim of unlawful discrimination. The following is from the\ndissenting opinion:\nSpecifically, Ledbetter\xe2\x80\x99s evidence demonstrated that her current pay was discriminatorily low\ndue to a long series of decisions reflecting Goodyear\xe2\x80\x99s pervasive discrimination against women\nmanagers in general and Ledbetter in particular. Ledbetter\xe2\x80\x99s former supervisor, for example,\nadmitted to the jury that Ledbetter\xe2\x80\x99s pay, during a particular one-year period, fell below\nGoodyear\xe2\x80\x99s minimum threshold for her position. Although Goodyear claimed the pay disparity\nwas due to poor performance, the supervisor acknowledged that Ledbetter received a \xe2\x80\x9cTop\nPerformance Award\xe2\x80\x9d in 1996. The jury also heard testimony that another supervisor\xe2\x80\x94who\nevaluated Ledbetter in 1997 and whose evaluation led to her most recent raise denial\xe2\x80\x94was\nopenly biased against women. And two women who had previously worked as managers at the\nplant told the jury they had been subject to pervasive discrimination and were paid less than their\nmale counterparts. One was paid less than the men she supervised. Ledbetter herself testified\nabout the discriminatory animus conveyed to her by plant officials. Toward the end of her career,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n104\n\n\x0cfor instance, the plant manager told Ledbetter that the \xe2\x80\x9cplant did not need women, that [women]\ndidn\xe2\x80\x99t help it, [and] caused problems.\xe2\x80\x9d After weighing all the evidence, the jury found for\nLedbetter, concluding that the pay disparity was due to intentional discrimination.\n\nOnce all appeals are exhausted, the winner in litigation can finally collect whatever damages it is\nentitled to. This process is called execution. If the loser is unable or unwilling to pay the judgment,\nthe winner can petition the court to use its full legal resources, including asking the sheriff to seize\nthe loser\xe2\x80\x99s assets for sale, to satisfy the judgment. The winner can also ask that the loser\xe2\x80\x99s wages\nbe garnished until the judgment is satisfied. The loser in litigation cannot refile a civil lawsuit once it\nhas been decided under the doctrine of res judicata. Just like criminal cases cannot be retried after\nacquittal under the double jeopardy clause of the Constitution, res judicata operates as a bar to\nrelitigation.\n\nKEY TAKEAWAYS\nThe process of selecting a jury is called voir dire. Each side is permitted to question a potential juror and\nexcuse that juror for any reason through a peremptory challenge or for a good reason through a for cause\nchallenge. A trial begins with opening statements where the parties lay out the essential facts of their\ncase. Next, witnesses are called to provide testimonial evidence. The side calling the witness conducts a\ndirect examination, while the opposing side conducts a cross-examination. After all witnesses are called,\nthe parties make closing arguments to the jury, which then deliberates and applies the law as outlined in\nthe jury instructions. The burden of proof in a criminal case is \xe2\x80\x9cbeyond a reasonable doubt,\xe2\x80\x9d while the\nburden of proof in a civil case is \xe2\x80\x9cpreponderance of evidence.\xe2\x80\x9d A jury\xe2\x80\x99s verdict must be converted into a\nlegal judgment by the trial judge. Once all appeals are settled, res judicata prevents the case from being\ntried again.\n\nEXERCISES\n1.\n\nWhy would a jury engage in jury nullification? If a jury cannot engage in nullification, what are its\nalternatives to express a similar view?\n\n2.\n\nOne of President Obama\xe2\x80\x99s first acts as president was to sign into law a statute aimed at overturning the\nLedbetter decision. How can Congress overturn the Supreme Court in this instance?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n105\n\n\x0c3.\n\nAlthough litigation is rightfully criticized as slow and expensive, res judicata means the parties have only\none chance to \xe2\x80\x9cget it right.\xe2\x80\x9d Do you think relaxing the rules of res judicata would help with the expense\nand time involved in litigating cases?\n\n[1] Batson v. Kentucky, 476 U.S. 79 (1986).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n106\n\n\x0c3.5 Concluding Thoughts\nThe litigation system, publicly financed, is an important dispute-resolution mechanism that\nprocesses millions of cases in both state and federal courts every year. The system permits parties to\nair their grievances against each other in an open and transparent manner and is typically very\neffective at finding the truth. The jury system, in particular, is largely admired for its ability to\ninvolve ordinary citizens in an important form of civil service. For many businesses, however,\nlitigation can be a vexing and distracting problem. The extraordinarily high costs associated with\ncomplex litigation, along with pressure from stakeholders to settle cases rather than litigate them\nfully, means that most businesses would prefer to avoid litigation whenever possible. These problems\nhave led many courts to experiment with various levels of reform, from mandatory pretrial\nsettlement attempts to mandatory mediation to jury selection and management reforms. These\nreforms are aimed at maintaining the vitality and usefulness of the litigation system, which can be a\ntrusted and valuable resource for all citizens and corporations.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n107\n\n\x0cChapter 4\n\nAlternative Dispute Resolution\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand alternative dispute resolution (ADR) options, including\nthe benefits and drawbacks to different methods of dispute resolution. You will know the legal basis for\nmandatory arbitration, as well as why parties enter into voluntary ADR methods. You will understand\ncurrent debates regarding the fairness of ADR. Additionally, you should be able to answer the following\nquestions:\n1.\n\nWhat are the benefits and drawbacks of ADR as compared to litigation?\n\n2.\n\nWhat legal basis supports the use of ADR rather than litigation?\n\n3.\n\nWhat unique challenges exist in ADR efforts among B2B (business to business), B2C (business to\nconsumer), and B2E (business to employees)?\n\n4.\n\nWhat are the ethical implications of ADR between parties that are unequal in power?\n\nImagine that you\xe2\x80\x99ve been wronged by a supplier, by your employer, or by a business where you are a\ncustomer. You\xe2\x80\x99ve correctly determined that you have an actionable legal claim. What are you going to\ndo? You probably won\xe2\x80\x99t run to the courthouse to file a formal complaint to initiate litigation. This is\nbecause litigation is very expensive and time consuming. Besides, you may wish to continue doing\nbusiness with the supplier, employer, or business. Perhaps the matter is of a private nature, and you\ndo not want to engage in a public process to determine the outcome. You would like the dispute to be\nresolved, but you do not want to engage in public, time-consuming, expensive litigation to do it.\nA common method of dispute resolution that avoids many of the challenges associated with litigation\nis alternative dispute resolution. Alternative dispute resolution (ADR) is a term that encompasses\nmany different methods of dispute resolution other than litigation. ADR involves resolving disputes\noutside of the judicial process, though the judiciary can require parties to participate in specific types\nof ADR, such as arbitration, for some types of conflicts. Moreover, some ADR methods vest power to\nresolve the dispute in a neutral party, while other strategies vest that power in the parties\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n108\n\n\x0cthemselves. See Figure 4.1 "A Continuum of Different ADR Methods" for a continuum of different\nADR methods based on where power to solve the dispute is vested.\nFigure 4.1 A Continuum of Different ADR Methods\n\nSource: Adapted from New York State Unified Court System\n,http://www.nycourts.gov/ip/adr/images/continuum2.jpg.\nCommon methods of ADR include negotiation, mediation, and arbitration. Lesser used methods of\nADR include minitrials, hybrid forms of mediation-arbitration (with elements of both), and\ncollaborative goal-oriented processes. ADR is often used to resolve disputes among businesses,\nemployers and employees, and businesses and consumers. ADR can also be used in many other types\nof conflicts. For instance, ADR strategies can be used in domestic law cases, such as divorce, or in\ninternational legal issues, such as issues relating to transboundary pollution. This chapter limits its\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n109\n\n\x0cfocus to the use of ADR methods in business. Particularly, we will examine the common methods of\nADR, including the benefits and drawbacks to each. We will also examine potential consequences to\nparties that have unequal bargaining power. Additionally, we will examine the use of ADR methods\nin situations where ADR may not be the most appropriate method of dispute resolution, such as civil\nrights violations.\nADR methods are used outside of the courtroom, but that does not mean that they are outside of the\ninterests of our legal system. Participation in ADR has important legal consequences. For instance,\nparties that have agreed by contract to be subject to binding arbitration give up their constitutional\nright to bring their complaint to court. The Federal Arbitration Act (FAA) is a federal statute under\nwhich parties are required to participate in arbitration when they have agreed by contract to do so,\neven in state court matters. Indeed, the FAA is a national policy favoring\narbitration. [1] The Southland Corp. Court said that \xe2\x80\x9cin enacting\xe2\x80\xa6[the FAA], Congress declared a\nnational policy favoring arbitration and withdrew the power of the states to require a judicial forum\nfor the resolution of claims which the contracting parties agreed to resolve by arbitration.\xe2\x80\x9d This is an\nexample of federal preemption exercised through the Supremacy Clause in the U.S. Constitution.\nThere is a very good chance that you will\xe2\x80\x94or already have\xe2\x80\x94signed a contract that contains a\nmandatory arbitration clause. This means that if a dispute arises under that contract, then you will\nbe required to arbitrate your claim rather than going straight to court. Under a binding arbitration\nclause, you will have waived your constitutional rights to go to court. Even if you have never signed\nsuch a contract and never will, there is still a good likelihood that you will be involved in a\ncommercial dispute at some point in your life. Because of this, it\xe2\x80\x99s important to understand the ADR\nprocess, situations in which litigation is a better choice than ADR, and special issues that arise when\nparties have unequal bargaining power.\n\nKey Takeaways\nAlternative dispute resolution (ADR) is a body of dispute-resolution methods outside of the litigation\nprocess. ADR is often faster, less expensive, and more private than litigation. For this reason, ADR can be\nthe preferred dispute-resolution method, particularly when an ongoing relationship between disputants is\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n110\n\n\x0cdesired. However, some types of disputes might be best resolved through litigation, such as in cases where\nparties have unequal power or resources or in civil rights violations. Common methods of dispute\nresolution are negotiation, mediation, and arbitration. Mandatory arbitration clauses are common in\ncontracts, and such clauses are enforceable against the parties even if they wish to litigate their claims.\n\n[1] Southland Corp. v. Keating, 465 U.S. 1 (1984).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n111\n\n\x0c4.1 Negotiation\nLEARNING OBJECTIVES\n1.\n\nUnderstand the role of negotiation in avoiding and settling disputes.\n\n2.\n\nExplore negotiation as it is commonly employed in business.\n\n3.\n\nUnderstand the implications of bargaining power during negotiation.\n\n4.\n\nBecome familiar with the benefits and drawbacks of negotiation as a form of alternative dispute\nresolution (ADR).\n\nImagine that you are a tent manufacturer. Your supplier of tent fabric routinely supplies you with\nappropriate water-resistant fabric to construct your tents, so that you can produce your products and\nbring them to market. After many years of a good working relationship, your fabric supplier\ndelivered nonconforming goods. Specifically, the fabric delivered was not water-resistant, despite\nyour need for water-resistant fabric to produce your tents. However, on your notifying the supplier of\nthe problem, the supplier denied that the fabric was nonconforming to your order. You refused to\npay for the goods. The fabric supplier insisted on payment before future delivery of any additional\nfabric. Without water-resistant fabric, you cannot continue to produce your tents.\nThis is an example of a business to business (B2B) dispute. Despite the problem, you will likely wish\nto continue working with this supplier, since you have a good, long-standing relationship with it.\nThis problem seems to be a \xe2\x80\x9chiccup\xe2\x80\x9d in your regular business relationship. Accordingly, you will\nprobably want to resolve this dispute quickly and without hard feelings. It is very unlikely that you\nwill immediately hire an attorney to file a formal complaint against your supplier. However, that\ndoes not change the fact that there is a dispute that needs to be resolved.\nOne of the first strategies that you and your supplier are likely to employ is negotiation. Negotiation is\na method of alternative dispute resolution (ADR) that retains power to resolve the dispute to the\nparties involved. No outside party is vested with authoritative decision-making power concerning the\nresolution of the dispute. Negotiation requires the parties to define the conflicts and agree to an\noutcome to resolve those conflicts. Often, this can take the form of a compromise. Note that a\ncompromise does not mean that anyone \xe2\x80\x9closes.\xe2\x80\x9d Indeed, if both parties are satisfied with the result of\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n112\n\n\x0cthe negotiation and the business relationship can continue moving forward, then both parties will be\nvery likely to consider this as a \xe2\x80\x9cwinning\xe2\x80\x9d situation.\nBenefits to negotiation as a method of ADR include its potential for a speedy resolution, the\ninexpensive nature of participation, and the fact that parties participate voluntarily. Drawbacks\ninclude the fact that there are no set rules, and either party may bargain badly or even unethically, if\nthey choose to do so. In a negotiation, there is no neutral party charged with ensuring that rules are\nfollowed, that the negotiation strategy is fair, or that the overall outcome is sound. Moreover, any\nparty can walk away whenever it wishes. There is no guarantee of resolution through this method.\nThe result may not be \xe2\x80\x9cwin-win\xe2\x80\x9d or \xe2\x80\x9cwin-lose,\xe2\x80\x9d but no resolution at all. Also, generally speaking,\nattorneys are not involved in many negotiations. This last point may be seen as a drawback or a\nbenefit, depending on the circumstances of the negotiation.\nThough our example involves B2B, the parties may or may not have equalbargaining power. If your\nbusiness and your supplier are both dependent on each other for roughly equal portions of the\nrespective businesses, then they are most likely relatively equal with respect to bargaining power.\nHowever, in our example, if your business is a very small business but your supplier is a very large\nbusiness\xe2\x80\x94perhaps with a patent protecting the rights to the specialty fabric that you need\xe2\x80\x94then we\nmight say that the B2B negotiation is potentially unbalanced, since one party has a much more\npowerful bargaining position than the other. Specifically, your business needs that particular type of\nfabric, which is only available from one supplier. But your supplier does not need your business\nbecause it has a legal monopoly in the form of a patent for its product, and it probably sells to many\nmanufacturers. This would be an example ofunequal bargaining power.\nWhen the negotiation occurs as a result of a dispute, but not a legal dispute per se, then the party\nwith the weakest bargaining position may be in a very vulnerable spot. This is illustrated in Note 4.13\n"Hyperlink: Rubbermaid\xe2\x80\x99s Unequal Bargaining Power". When Rubbermaid\xe2\x80\x99s raw materials price for\nresin increased, it needed to raise its prices. However, Wal-Mart refused to accept the necessary\nprice increase for Rubbermaid products. This refusal had a substantial negative impact on\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n113\n\n\x0cRubbermaid\xe2\x80\x99s business, since Wal-Mart was its main customer. In short, Rubbermaid needed WalMart, but Wal-Mart did not need Rubbermaid.\n\nHyperlink: Rubbermaid\xe2\x80\x99s Unequal Bargaining Power\nA Question of Ethics\nhttp://www.pbs.org/wgbh/pages/frontline/video/flv/generic.html?s=frol02s48aq71&continuous=1\nWatch \xe2\x80\x9cMuscling Manufacturers,\xe2\x80\x9d a clip from Is Wal-Mart Good for America? to see how unequal\nbargaining power can affect the least powerful party in a negotiation.\nAs economist Brink Lindsey from the Cato Institute commented, \xe2\x80\x9cWe\xe2\x80\x99ve definitely seen a shift in the\nbalance of bargaining power between manufacturers and retailers\xe2\x80\xa6Back in the old days, manufacturing\nwas a high-productivity endeavor; retailing and distribution was fairly low-productivity\xe2\x80\xa6And so\nmanufacturers called the shots.\xe2\x80\x9d\n\n[1]\n\nThat doesn\xe2\x80\x99t appear to be the case anymore.\n\nNegotiation is a skill often developed by people who are charged with settling existing disputes or\nwith creating new agreements. Since we are focusing on dispute resolution in this chapter, we will\nlimit our discussion to the resolution of disputes rather than the negotiation of new contract terms,\nbut keep in mind that these activities essentially draw on the same skills.\nIn Getting to Yes, written by members of the Harvard Program on Negotiation, the goal of negotiation\nis viewed as \xe2\x80\x9cwin-win.\xe2\x80\x9d [2] Note that this is a substantially different goal from litigation. Our\nadversarial legal system requires one party to \xe2\x80\x9cwin\xe2\x80\x9d and the other party to \xe2\x80\x9close.\xe2\x80\x9d Getting to\nYes focuses on principled negotiation, and it sets forth specific steps and discusses strategies to allow\n\nparticipants to achieve the \xe2\x80\x9cwin-win\xe2\x80\x9d goal. This book\xe2\x80\x99s popularity perhaps suggests that people have\na real interest in learning about ADR, avoiding litigation, and ensuring that all parties leave the\nresolution process as \xe2\x80\x9cwinners.\xe2\x80\x9d Some concepts common in negotiation include the BATNA,\nWATNA, and the bargaining zone. For example, the authors of Getting to Yes encourage negotiators\nto know their best alternative to a negotiated agreement (BATNA). This ensures that unfavorable\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n114\n\n\x0cterms will not be accepted and terms consistent with a negotiator\xe2\x80\x99s interests won\xe2\x80\x99t be\nrejected. [3] Likewise, the worst alternative to a negotiated agreement (WATNA) is a concept used by\nsome negotiators prior to entering negotiations. The bargaining zone is the area in which parties to a\nnegotiation are willing to trade, barter, or negotiate their positions, within which parties can find an\nacceptable agreement. If you think of a Venn diagram, the bargaining zone would be where the two\novals overlap. Thereservation point is essentially a party\xe2\x80\x99s \xe2\x80\x9cbottom line,\xe2\x80\x9d beyond which it will not\nagree to terms.\nLet\xe2\x80\x99s go back to our example. Imagine that after negotiating with your fabric supplier, the following\nfacts emerged: The fabric supplier believed that it sent the correct fabric to you, because one of your\nnew employees inadvertently ordered the wrong fabric. You reviewed your business records and\ndetermined that this allegation was true. This sounds like a misunderstanding that would be easy to\nclear up in negotiation, doesn\xe2\x80\x99t it? Imagine the embarrassment and hard feelings that would have\nbeen caused by immediately filing a formal complaint in court, not to mention the great expense that\nboth parties would have incurred. Through negotiation, chances are very good that this\nmisunderstanding will be resolved in a win-win outcome and that you will be able to continue your\nworking relationship with your supplier.\n\nKEY TAKEAWAYS\nNegotiation is a method of alternative dispute resolution (ADR) in which the parties retain power to decide\non a resolution of the issue themselves, without relying on a neutral decision maker. Negotiation is also\nused between parties entering into agreements, when there is no legal dispute. Negotiation is often the\nfirst method of dispute resolution attempted, because it is inexpensive and relatively fast. Additionally,\nparties that wish to continue working together in the future often employ negotiation as a friendly\nmethod to resolve disputes. Negotiation between parties with unequal bargaining power can result in the\nstronger party being heavy-handed at the negotiation table, which can result in unfair outcomes for the\nweaker party. Since negotiation does not follow an externally imposed set of rules, parties may negotiate\nas their conscience dictates. However, negotiation is often considered a dispute-resolution option that can\nresult in a win-win situation for all parties, as illustrated by the popular book Getting to Yes, in which\nnegotiation strategies are set forth in detail.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n115\n\n\x0cEXERCISES\n1.\n\nVisit http://www.sfhgroup.com/ca/training/online-training/test-your-skills.php and click \xe2\x80\x9cNegotiate with\nBill\xe2\x80\x9d under \xe2\x80\x9cOnline Negotiation Course.\xe2\x80\x9d This is a free interactive negotiation exercise. After completing\nthe negotiation, answer the following questions: How far did you get? (If you did not get to level three, go\nback and try it again. See if you can get all the way through to level three.) What negotiation strategies did\nyou learn? In other words, what works? What doesn\xe2\x80\x99t work?\n\n2.\n\nWhat are the benefits of negotiation as a dispute-resolution method? What are the drawbacks?\n\n3.\n\nHow can parties that have unequal bargaining power negotiate meaningfully, without one party taking\nadvantage of the other? Have you ever negotiated with someone who had more bargaining power than\nyou? What were your strategies during the negotiation? Did you obtain your goal by the conclusion of the\nnegotiation?\n\n4.\n\nWatch the video in Note 4.13 "Hyperlink: Rubbermaid\xe2\x80\x99s Unequal Bargaining Power". If you were a\nmanufacturer and you had to raise prices due to an increase in price for your raw materials, and if WalMart was your most important customer, what strategies would you employ so that both parties would\nhave a chance to have a \xe2\x80\x9cwin-win\xe2\x80\x9d outcome?\n\n[1] Hedrick Smith, \xe2\x80\x9cWho Calls the Shots in the Global Economy?\xe2\x80\x9d PBS, November 16,\n2004,http://www.pbs.org/wgbh/pages/frontline/shows/walmart/secrets/shots.html (accessed on August 23,\n2010).\n[2] Roger Fisher, William Ury, and Bruce Patton, Getting to Yes (New York: Penguin Books, 1991).\n[3] Roger Fisher, William Ury, and Bruce Patton, Getting to Yes (New York: Penguin Books, 1991), 100.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n116\n\n\x0c4.2 Mediation\nLEARNING OBJECTIVES\n1.\n\nLearn what mediation is.\n\n2.\n\nExplore the process of mediation as an alternative dispute resolution (ADR) strategy.\n\n3.\n\nIdentify disputes suitable to mediation as a form of ADR.\n\n4.\n\nBecome familiar with the benefits and drawbacks of mediation as a form of ADR.\n\nMediation is a method of ADR in which parties work to form a mutually acceptable agreement. Like\n\nnegotiation, parties in mediation do not vest authority to decide the dispute in a neutral third party.\nInstead, this authority remains with the parties themselves, who are free to terminate mediation if\nthey believe it is not working. Often, when parties terminate mediation, they pursue another form of\nADR, such as arbitration, or they choose to litigate their claims in court. Mediation is appropriate\nonly for parties who are willing to participate in the process. Like negotiation, mediation seeks a\n\xe2\x80\x9cwin-win\xe2\x80\x9d outcome for the parties involved. Additionally, mediation is confidential, which can be an\nattractive attribute for people who wish to avoid the public nature of litigation. The mediation\nprocess is usually much faster than litigation, and the associated costs can be substantially less\nexpensive than litigation.\nUnlike in many negotiations, a third party is involved in mediation. Indeed, a neutral mediator is\ncrucial to the mediation process. Mediators act as a go-between for the parties, seeking to facilitate\nthe agreement. Requirements to be a mediator vary by state. See Note 4.23 "Hyperlink:\nMediators" to compare the requirements between states. There are no uniform licensing\nrequirements, but some states require specific training or qualifications for a person to be certified as\na mediator. Mediators do not provide advice on the subject matter of the dispute. In fact, the\nmediators may not possess any subject-matter expertise concerning the nature of the dispute.\nHowever, many mediators are trained in conflict resolution, and this allows them to employ methods\nto discover common goals or objectives, set aside issues that are not relevant, and facilitate an\nagreement into which the parties will voluntarily enter. Mediators try to find common ground by\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n117\n\n\x0cidentifying common goals or objectives and by asking parties to set aside the sometimes emotionally\nladen obstacles that are not relevant to the sought-after agreement itself.\n\nHyperlink: Mediators\nhttp://www.mediationworks.com/medcert3/staterequirements.htm\nVisit this site to see the various requirements and qualifications to become a mediator in the different\nstates.\n\nDisputants choose their mediator. This choice is often made based on the mediator\xe2\x80\x99s reputation as a\nskilled conflict resolution expert, professional background, training, experience, cost, and\navailability. After a mediator is chosen, the parties prepare for mediation. For instance, prior to the\nmediation process, the mediator typically asks the parties to sign a mediation agreement. This\nagreement may embody the parties\xe2\x80\x99 commitments to proceed in good faith, understanding of the\nvoluntary nature of the process, commitments to confidentiality, and recognition of the mediator\xe2\x80\x99s\nrole of neutrality rather than one of legal counsel. At the outset, the mediator typically explains the\nprocess that the mediation will observe. The parties then proceed according to that plan, which may\ninclude opening statements, face-to-face communication, or indirect communication through the\nmediator. The mediator may suggest options for resolution and, depending on his or her skill, may\nbe able to suggest alternatives not previously considered by the disputants.\nMediation is often an option for parties who cannot negotiate with each other but who could reach a\nmutually beneficial or mutually acceptable resolution with the assistance of a neutral party to help\nsort out the issues to find a resolution that achieves the parties\xe2\x80\x99 objectives. Sometimes parties in\nmediation retain attorneys, but this is not required. If parties do retain counsel, their costs for\nparticipating in the mediation will obviously increase.\nIn business, mediation is often the method of ADR used in disputes between employers and\nemployees about topics such as workplace conditions, wrongful discharge, or advancement\ngrievances. Mediation is used in disputes between businesses, such as in contract disputes.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n118\n\n\x0cMediation is also used for disputes arising between businesses and consumers, such as in medical\nmalpractice cases or health care disputes.\nLike other forms of dispute resolution, mediation has benefits and drawbacks. Benefits are many.\nThey include the relative expediency of reaching a resolution, the reduced costs as compared to\nlitigation, the ability for parties that are unable to communicate with each other to resolve their\ndispute using a nonadversarial process, the imposition of rules on the process by the mediator to\nkeep parties \xe2\x80\x9cwithin bounds\xe2\x80\x9d of the process, confidentiality, and the voluntary nature of\nparticipation. Of course, the potential for a \xe2\x80\x9cwin-win\xe2\x80\x9d outcome is a benefit. Attorneys may or may not\nbe involved, and this can be viewed as either a benefit or a drawback, depending on the\ncircumstances.\nDrawbacks to mediation also exist. For example, if disputants are not willing to participate in the\nmediation process, the mediation will not work. This is because mediation requires voluntary\nparticipation between willing parties to reach a mutually agreeable resolution. Additionally, even\nafter considerable effort by the parties in dispute, the mediation may fail. This means that the\nresolution of the problem may have to be postponed until another form of ADR is used, or until the\nparties litigate their case in court. Since mediators are individuals, they have different levels of\nexpertise in conflict resolution, and they possess different backgrounds and worldviews that might\ninfluence the manner in which they conduct mediation. Parties may be satisfied with one mediator\nbut not satisfied in subsequent mediations with a different mediator. Even if an agreement is\nreached, the mediation itself is usually not binding. Parties can later become dissatisfied with the\nagreement reached during mediation and choose to pursue the dispute through other ADR methods\nor through litigation. For this reason, parties often enter into a legally binding contract that\nembodies the terms of the resolution of the mediation immediately on conclusion of the successful\nmediation. Therefore, the terms of the mediation can become binding if they are reduced to such a\ncontract, and some parties may find this to be disadvantageous to their interests. Of course, any\nparty that signs such an agreement would do so voluntarily. However, in some cases, if legal counsel\nis not involved, parties may not fully understand the implications of the agreement that they are\nsigning.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n119\n\n\x0cKEY TAKEAWAYS\nMediation is a method of ADR in which the parties retain power to decide the issue themselves without\nvesting that power in an outside decision maker. However, mediation relies on neutral mediators who\nfacilitate the mediation process to assist the parties in achieving an acceptable, voluntary agreement.\nMediation is more formal than negotiation but less formal than arbitration or litigation. Mediation is\nrelatively inexpensive, fast, and confidential, unlike litigation. Though nonbinding mediation resolutions\nare not binding on the parties, these resolution agreements may be incorporated into a legally binding\ncontract, which is binding on the parties who execute the contract. Mediation does not follow a uniform\nset of rules, though mediators typically set forth rules that the mediation will observe at the outset of the\nprocess. Successful mediation often reflects not only the parties\xe2\x80\x99 willingness to participate but also the\nmediator\xe2\x80\x99s skill. There is no uniform set of rules for mediators to become licensed, and rules vary by state\nregarding requirements for mediator certification.\n\nEXERCISES\n1.\n\nVisit the link in Note 4.23 "Hyperlink: Mediators" and find your state\xe2\x80\x99s requirements and qualifications for\nmediators. What would it take for you to become a mediator in your state? Do you think that your state\nrequirements ensure that only qualified mediators practice? Why or why not?\n\n2.\n\nIdentify a situation in which you would choose mediation as your preferred method of dispute resolution.\nWhy is mediation the best method in this situation? What are the potential benefits and drawbacks of\nmediation in this situation?\n\n3.\n\nShould mediators be required to be licensed, like attorneys or physicians, before practicing? Why or why\nnot?\n\n4.\n\nVisit http://www.sfhgroup.com/ca/training/online-training/test-your-skills.php and scroll down to\nMediation game. Click on \xe2\x80\x9cplay game\xe2\x80\x9d under \xe2\x80\x9cThe Angry Neighbours.\xe2\x80\x9d This is a free interactive mediation\nexercise. After completing the mediation, answer the following questions: Were you able to successfully\nmediate this dispute? If you did not reach a successful resolution, go back and try it again. See if you can\nreach a successful resolution. What mediation strategies did you learn? What works? What doesn\xe2\x80\x99t work?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n120\n\n\x0c4.3 Arbitration\nLEARNING OBJECTIVES\n1.\n\nExplore the option of arbitration as an alternative dispute resolution (ADR) strategy.\n\n2.\n\nExplore contemporary issues of fairness in arbitration.\n\n3.\n\nDetermine when arbitration is a viable option for dispute resolution.\n\n4.\n\nExamine the benefits and drawbacks of arbitration as a form of ADR.\n\nArbitration is a method of ADR in which parties vest authority in a third-party neutral decision\n\nmaker who will hear their case and issue a decision, which is called an arbitration award.\nAn arbitrator presides over arbitration proceedings. Arbitrators are neutral decision makers who are\noften experts in the law and subject matter at issue in the dispute. Their decisions do not form\nbinding precedent. Arbitrators may be members of the judiciary, but in arbitrations they are not\njudges. Arbitrators act in an analogous capacity to judges in trials. For instance, they determine\nwhich evidence can be introduced, hear the parties\xe2\x80\x99 cases, and issue decisions. They may be certified\nby the state in which they arbitrate, and they may arbitrate only certain types of claims. For instance,\nthe Better Business Bureau trains its own arbitrators to hear common complaints between\nbusinesses and consumers (B2C).\nParticipation in the arbitration proceeding is sometimes mandatory. Mandatory arbitration results\nwhen disputes arise out of a legally binding contract involving commerce in which the parties agreed\nto submit to mandatory arbitration. Arbitration is also mandatory when state law requires parties to\nenter into mandatory arbitration.\nAlthough perhaps not obvious, federal law lies at the heart of mandatory arbitration clauses in\ncontracts. Specifically, Congress enacted the Federal Arbitration Act (FAA) [1] through\nits Commerce Clause powers. This act requires parties to engage in arbitration when those parties\nhave entered into legally binding contracts with a mandatory arbitration clause, providing the subject\nof those contracts involves commerce. [2] In Southland Park v. Keating, the U.S. Supreme Court\ninterpreted this federal statute to apply to matters of both federal and state court jurisdiction.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n121\n\n\x0cIndeed, the Court held that the FAA created a national policy in favor of arbitration. It also held that\nthe FAA preempts state power to create a judicial forum for disputes arising under contracts with\nmandatory arbitration clauses. [3] In a later decision, the Court held that the FAA encompasses\ntransactions within the broadest permissible exercise of congressional power under the Commerce\nClause. [4]This means that the FAA requires mandatory arbitration clauses to be enforceable for\nvirtually any transaction involving interstate commerce, very broadly construed.\nSome states require mandatory arbitration for certain types of disputes. For instance, in Oregon, the\nstate courts require mandatory arbitration for civil suits where the prayer for damages is less than\n$50,000, excluding attorney fees and costs. [5] Many parties accept the arbitration award without\nappeal. However, when state law requires mandatory arbitration of certain types of disputes, parties\nare permitted to appeal because the arbitration is nonbinding. In nonbinding arbitration, the parties\nmay choose to resolve their dispute through litigation if the arbitration award is rejected by a party.\nHowever, some states have statutory requirements that, in practice, create a chilling effect on\nappealing an arbitration award. For example, in the state of Washington, if the appealing party from\na nonbinding mandatory arbitration does not do better at trial than the original award issued by the\narbitrator, then that party will incur liability not only for its own expenses but also for those of the\nopposing side. [6]In nonbinding arbitration, this is a powerful incentive for parties to accept the\narbitration award without appealing to the judicial system.\nVoluntary arbitration also exists, and it is frequently used in business disputes. Sometimes parties\nsimply agree that they do not want to litigate a dispute because they believe that the benefits of\narbitration outweigh the costs of litigation, so they choose voluntary arbitration in hopes of a speedy\nand relatively inexpensive outcome. Other times, parties are not certain how strong their case is. In\nsuch cases, arbitration can seem much more attractive than litigation.\nArbitration awards can be binding or nonbinding. Some states, like Washington State, have codified\nthe rule that arbitration decisions are binding when parties voluntary submit to the arbitration\nprocedure. [7] In binding arbitration, the arbitration award is final; therefore, appealing an arbitration\naward to the judicial system is not available. In many states, an arbitration awards is converted to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n122\n\n\x0ca judgment by the court, thereby creating the legal mechanism through which the judgment holder\ncan pursue collection activities. This process, called confirmation, is contemplated by the FAA and\noften included in arbitration agreements. But even if the FAA does not apply, most states have\nenacted versions of either the Uniform Arbitration Act or the Revised Uniform Arbitration Act. These\nstate laws allow confirmation of arbitration awards into judgments as well.\nLike any other form of dispute resolution, arbitration has certain benefits and drawbacks. Arbitration\nis an adversarial process like a trial, and it will produce a \xe2\x80\x9cwinner\xe2\x80\x9d and a \xe2\x80\x9closer.\xe2\x80\x9d Arbitration is more\nformal than negotiation and mediation and, in many ways, it resembles a trial. Parties present their\ncases to the arbitrator by introducing evidence. After both sides have presented their cases, the\narbitrator issues an arbitration award.\nRules related to arbitration differ by state. The rules of procedure that apply to litigation in a trial do\nnot typically apply to arbitration. Specifically, the rules are often less formal or less restrictive on the\npresentation of evidence and the arbitration procedure. Arbitrators decide which evidence to allow,\nand they are not required to follow precedents or to provide their reasoning in the final award. In\nshort, arbitrations adhere to rules, but those rules are not the same as rules of procedure for\nlitigation. Regardless of which rules are followed, arbitrations proceed under a set of external rules\nknown to all parties involved in any given arbitration.\nArbitration can be more expensive than negotiation or mediation, but it is often less expensive than\nlitigation. In Circuit City Stores Inc. v. Adams, the U.S. Supreme Court noted that avoiding the cost of\nlitigation was a real benefit of arbitration. [8] The costly discovery phase of a trial is nonexistent or\nsharply reduced in arbitration. However, arbitration is not necessarily inexpensive. Parties must bear\nthe costs of the arbitrator, and they typically retain counsel to represent them. Additionally, in\nmandatory arbitration clause cases, the arbitration may be required to take place in a distant city\nfrom one of the disputants. This means that the party will have to pay travel costs and associated\nexpenses during the arbitration proceeding. The Circuit City Court also noted that mandatory\narbitration clauses avoid difficult choice-of-law problems that litigants often face, particularly in\nemployment law cases.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n123\n\n\x0cArbitration is faster than litigation, but it is not as private as negotiation or mediation. Unlike\nmediators, arbitrators are often subject-matter experts in the legal area of dispute. However, as is\ntrue for mediators, much depends on the arbitrator\xe2\x80\x99s skill and judgment.\nA common issue that arises is whether mandatory arbitration is fair in certain circumstances. It\xe2\x80\x99s\neasy to imagine that arbitration is fair when both parties are equally situated. For example, business\nto business (B2B) arbitrations are often perceived as fair, especially if businesses are roughly the\nsame size or have roughly equal bargaining power. This is because they will be able to devote\napproximately the same amount of resources to a dispute resolution, and they both understand the\nsubject under dispute, whatever the commercial issue may be. Moreover, in B2B disputes, the\nsubjects of disputes are commercial issues, which may not implicate deeper social and ethical\nquestions. For example, contract disputes between businesses might involve whether goods are\nconforming goods or nonconforming goods under the Uniform Commercial Code (UCC). No powerful\n\nsocial or ethical questions arise in such disputes. Indeed, resolving such disputes might be seen as\n\xe2\x80\x9cbusiness as usual\xe2\x80\x9d to many commercial enterprises.\nHowever, issues of fairness often arise in business to employee (B2E) and business to consumer\n(B2C) situations, particularly where parties with unequal bargaining power have entered into a\ncontract that contains a mandatory arbitration clause. In such cases, the weaker party has no real\nnegotiating power to modify or to delete the mandatory arbitration clause, so that party is required\nto agree to such a clause if it wants to engage in certain types of transactions. For example, almost all\ncredit card contracts contain mandatory arbitration clauses. This means that if a consumer wishes to\nhave a credit card account, he will agree to waive his constitutional rights to a trial by signing the\ncredit card contract. As we know, the FAA will require parties to adhere to the mandatory arbitration\nagreed to in such a contract, in the event that a dispute arises under that contract. In such cases,\nquestions regarding whether consent was actually given may legitimately be raised. However, the\nU.S. Supreme Court has held that in B2E contexts, unequal bargaining power alone is not a sufficient\nreason to hold that arbitration agreements are unenforceable, [9] and it is not sufficient to preclude\narbitration. [10]\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n124\n\n\x0cAdditionally, concerns about fairness do not end at contract formation. If a dispute arises and\nmandatory arbitration is commenced, the unequal power between parties will continue to be an\nimportant issue. In the case between a credit card company and an average consumer debtor, the\ncredit card company would clearly be in a more powerful position vis-\xc3\xa0-vis the debtor by virtue of the\ncompany\xe2\x80\x99s financial strength and all that comes with it, such as experienced attorneys on staff,\ndispute-resolution experience, and contractual terms that favor it, rather than the consumer debtor.\nIn such cases, if the consumer debtor is the aggrieved party, he may very well decide to drop the\nmatter, especially if the arbitration clause requires arbitration proceedings to occur in a distant city.\nThe credit card company will have vast financial resources as compared to the consumer debtor.\nMoreover, in this example the credit card company\xe2\x80\x99s legal counsel will know how to navigate the\narbitration process and will have experience in dispute resolution, processes that often confound\npeople who are not trained in law. Additionally, the list of arbitrators may include people who are\ndependent on repeat business from the credit card company for their own livelihoods, thereby\ncreating\xe2\x80\x94or at least suggesting\xe2\x80\x94an inherent conflict of interest. Many mandatory arbitration clauses\ncreate binding awards on one party while reserving the right to bring a claim in court to the other\nparty. That is, a mandatory arbitration clause may allow the credit card company to appeal an\narbitrator\xe2\x80\x99s award but to render an award binding on the consumer debtor. Obviously, this would\nallow the credit card company to appeal an unfavorable ruling, while requiring the consumer debtor\nto abide by an arbitrator\xe2\x80\x99s unfavorable ruling. To a consumer debtor, the arbitration experience can\nseem like a game played on the credit card company\xe2\x80\x99s home court\xe2\x80\x94daunting, feckless, and\nintimidating.\nAdditionally, some types of disputes that have been subjected to mandatory arbitration raise serious\nquestions about the appropriateness of ADR, due to the nature of the underlying dispute. For\nexample, in some recent B2E disputes, claims relating to sexual assault have been subjected to\nmandatory arbitration when the employee signed an employment contract with a mandatory\narbitration clause. Tracy Barker, for example, was reportedly sexually assaulted by a State\nDepartment employee in Iraq while she was employed as a civilian contractor by KBR Inc., a former\nHalliburton subsidiary. When she tried to bring her claim in court, the judge dismissed the claim,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n125\n\n\x0cciting the mandatory arbitration clause in her employment contract. After arbitration, she won a\nthree-million-dollar arbitration award. As KBR Inc. noted, this \xe2\x80\x9cdecision validates what KBR has\nmaintained all along; that the arbitration process is truly neutral and works in the best interest of the\nparties involved.\xe2\x80\x9d Despite this statement, KBR Inc. has filed a motion to modify the award. [11]\nIn a similar case, employee Jamie Leigh Jones worked for KBR Inc. in Iraq when she was drugged\nand gang raped. She was initially prohibited from suing KBR Inc. in court because her employment\ncontract contained a mandatory arbitration clause. However, when considering this case, the Fifth\nCircuit Court of Appeals ruled that sexual assault cases may, in fact, be brought in court rather than\nbeing subjected to mandatory arbitration, despite the contract language requiring mandatory\narbitration. [12] Jones\xe2\x80\x99s claims were beyond the scope of the arbitration clause, because sexual assault\nis not within the scope of employment. Moreover, under Senator Al Franken\xe2\x80\x99s lead, the Senate took\naction to prohibit the Department of Defense from contracting with defense contractors that require\nmandatory arbitration for sexual assault claims. If such action is passed, it would essentially allow\nthe Fifth Circuit\xe2\x80\x99s holding to apply in all federal jurisdictions rather than just in the Fifth Circuit.\nCheck out Note 4.44 "Video Clip: Al Franken" to hear the details of Senator Franken\xe2\x80\x99s work on this\nmatter. One might think that passing such a law would be a \xe2\x80\x9cno brainer\xe2\x80\x9d to lawmakers. However,\nsome Senators voted against the measure, arguing that the federal government should not insert\nitself into rewriting contracts. Instead, some argued that the use of arbitration and mediation should\nbe expanded for such cases.\n\nVideo Clip: Al Franken\nWatch Senator Al Franken discuss the facts of the Jamie Leigh Jones case here:\n\nIn B2C cases, different issues of fairness exist. As noted previously, when the disputants possess\nunequal power, these issues can be magnified. Public Citizen, a nonprofit organization that\nrepresents consumer interests in Congress, released a report concerning arbitration in B2C disputes.\nSpecifically, the report argued that arbitration is unfair to consumers in B2C disputes and that\nconsumers fare better in litigation than in arbitration. According to the report, incentives exist to\nfavor businesses over consumers in the arbitration process. It pointed to the lack of appeal rights,\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n126\n\n\x0clack of requirement to follow precedents or established law, limits on consumers\xe2\x80\x99 remedies,\nprohibitions against class-action suits, limitations on access to jury trials, limitations on abilities to\ncollect evidence, and greater expense as additional factors speaking to the unfairness of arbitration\nover litigation in B2C disputes. Check out Note 4.45 "Hyperlink: Arbitration" for the full report.\n\nHyperlink: Arbitration\nhttp://www.citizen.org/documents/ArbitrationDebateTrap(Final).pdf\nCheck out this Public Citizen report, The Arbitration Debate Trap: How Opponents of Corporate\nAccountability Distort the Debate on Arbitration, which argues arbitration is bad for consumers in B2C\ndisputes.\n\nImportantly, and despite the FAA\xe2\x80\x99s broad interpretation, not all binding arbitration clauses have\nbeen upheld by courts in B2C cases. In 2007, the Ninth Circuit Court of Appeals ruled that AT&T\xe2\x80\x99s\nbinding arbitration clause for wireless customers is unenforceable under California state law. [13] The\ncourt further noted that the relevant state law is not preempted by the FAA, because the FAA does\nnot prevent the courts from applying state law. In this case, that law involved unconscionability of\ncontract terms. As noted previously, the FAA requires parties to submit to mandatory arbitration\nwhen they agree to do so in a legally binding contract, and it preempts state powers to provide a\njudicial forum in those matters. However, the Ninth Circuit\xe2\x80\x99s holding in this case underscores the\nfact that state contract law is not circumvented by the federal statute.\nArbitration is a widely used form of ADR, but important questions have been raised about its\nappropriateness in certain types of disputes. Before signing a mandatory arbitration agreement, it\xe2\x80\x99s\nimportant to realize that under current law, your opportunity to bring your claim in court will be\nseverely restricted or entirely precluded. Moreover, if you sign such an agreement with a party who\nholds inherently greater power than you, such as your employer, then you may find yourself at an\nextreme disadvantage in an arbitration proceeding.\n\nKEY TAKEAWAYS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n127\n\n\x0cArbitration is a form of ADR in which parties vest authority to decide a dispute with a third-party\narbitrator, who hears the evidence and issues an arbitration award. Arbitration may be binding or\nnonbinding, and it may be mandatory or voluntary. Arbitration awards issued by arbitrators can be\nconfirmed to judgments by judges. Issues of fairness arise in arbitration when disputants possess unequal\npower, such as arbitration in employment or consumer disputes. Questions concerning the\nappropriateness of mandatory arbitration arise in cases involving issues of civil rights violations. The\nFederal Arbitration Act requires enforcement of mandatory arbitration clauses in contract disputes\ninvolving commerce where mandatory arbitration clauses exist. The Arbitration Fairness Act of 2009 would\nresolve several issues of unfairness, but this act has not yet been passed in to law.\n\nEXERCISES\n1.\n\nCheck out Jon Stewart\xe2\x80\x99s perspective on Senator Franken\xe2\x80\x99s proposed measure to prevent the Department\nof Defense from contracting with defense contractors that require mandatory arbitration for disputes\narising from sexual assaults at http://www.thedailyshow.com/watch/wed-october-14-2009/rape-nuts.\nDoes the comedian accurately portray this issue? What role does popular culture have in shaping our\nopinions and conceptions of our legal system?\n\n2.\n\nIn the Barker v. Halliburton Inc. case, does the three-million-dollar arbitration award in favor of the sexual\nassault victim prove that arbitration works, even in violations of civil rights disputes? Why or why not?\n\n3.\n\nChoose one argument in The Arbitration Debate Trap: How Opponents of Corporate Accountability Distort\nthe Debate on Arbitration in Note 4.45 "Hyperlink: Arbitration" and develop a counterargument to support\nthe contention that arbitration is good in B2C disputes. Compare your argument with the argument in the\nreport. Which side is the most persuasive? After completing this exercise, do you believe that arbitration is\ngood or bad for consumers in B2C disputes? Why?\n\n4.\n\nBank of America announced that it would no longer require mandatory arbitration in disputes arising\nbetween it and consumer credit card account holders. Review the story\nhere:http://www.reuters.com/article/idUSTRE57D03E20090814. What are the benefits and drawbacks to\nBank of America\xe2\x80\x99s credit card account customers with respect to this change?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n128\n\n\x0c5.\n\nIn what contexts have you entered into an arbitration agreement (e.g., home purchase, credit card\nagreement, cell phone agreement)? Write a short essay discussing the implications of entering into that\nagreement.\n\n[1] 9 U.S.C. \xc2\xa71 et seq.\n[2] 9 U.S.C. \xc2\xa72.\n[3] Southland Corp. v. Keating, 465 U.S. 1 (1984).\n[4] Citizens Bank v. Alafabco, Inc., 539 U.S. 52 (2003).\n[5] ORS 36.405.\n[6] Washington State Court Rules of Procedure, Superior Court Mandatory Arbitration Rules 7.3.\n[7] Uniform Arbitration Act, RCW 7.04.\n[8] Circuit City Stores, Inc., v. Adams, 532 U.S. 105 (2001).\n[9] Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20 (1991).\n[10] Lozano v. AT & T Wireless, 504 F.3d 718 (9th Cir. 2007).\n[11] Juan A. Lozano, \xe2\x80\x9cWoman Awarded $3M in Assault Claim against KBR,\xe2\x80\x9d AP News, November 19,\n2009, http://www.thefreelibrary.com/Woman+awarded+%243M+in+ assault+claim+against+KBRa01612064743 (accessed September 24, 2010).\n[12] Jones v. Halliburton Co., 583 F.3d 228 (5th Cir. 2009).\n[13] Lozano v. AT & T Wireless, 504 F.3d 718 (9th Cir. 2007).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n129\n\n\x0c4.4 Other Methods of Alternative Dispute Resolution\nLEARNING OBJECTIVES\n1.\n\nLearn about in-house dispute-resolution methods, med-arb, private judging, minitrials, and summary jury\ntrials.\n\n2.\n\nExplore the benefits and drawbacks to forms of alternative dispute resolution (ADR) discussed in this\nsection.\n\nRemember that ADR is a broad term used to denote methods to resolve disputes outside of litigation.\nThis can really be any method, whether or not it bears a specific label or adheres to a particular\nprocedure. For instance, negotiation might be a quick meeting in the hallway between disputants, or\nit might involve a formal round of negotiations where all parties are represented by legal counsel.\nHowever, when parties are attempting to resolve a dispute, it makes sense for them to agree to a\nspecific procedure for doing so beforehand, so that each party understands how to proceed.\nNegotiation, mediation, and arbitration are the most common forms of ADR. However, these\nmethods might not be appropriate for every dispute. Other forms of ADR exist, ranging from inhouse programs to very formal external processes. This section briefly discusses commonly used\nalternatives to resolving disputes besides negotiation, mediation, arbitration, or litigation.\nSome ADR processes or programs are available only to certain groups of people, such as members of\na particular organization. For instance, some organizations, like Boeing, have an\ninternal ethics hotline. This hotline is available for employees to report perceived ethics violation that\nthey have observed. Ethics advisors answer employees\xe2\x80\x99 questions and follow up on reports that need\nfurther investigation. One major benefit is that reporting parties generally (but not always) remain\nanonymous. Another benefit is that the company has time to redress problems that could give rise to\ndisputes of much greater magnitude if left unaddressed.\nAn open-door policy is an in-house program that allows company employees to go directly to any level\nof management to file a complaint or grievance, without threat of retaliation for their reporting. In\ntheory, this policy creates an open atmosphere of trust, and it breaks down class barriers between\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n130\n\n\x0cgroups of employees. However, many employees may not feel comfortable in making a complaint\nabout a manager\xe2\x80\x99s decision. Moreover, supervisors may not be comfortable with their employees\nbypassing them to file complaints. Open-door policies sound very good in theory, but they may not\nwork as well in practice.\nAnother type of in-house program is an ombudsmen\xe2\x80\x99s office. These stations generally hear\ncomplaints from stakeholders, such as employees or customers.Ombudsmen try to troubleshoot these\ncomplaints by investigating and attempting to resolve the issues before they escalate into more\nformal complaints.\nMore formal methods of ADR include mediation-arbitration (med-arb), which is essentially a\nmediation followed by an arbitration. If the mediation does not produce a satisfactory outcome, then\nthe parties submit to arbitration. The neutral party mediating the dispute also serves as the\narbitrator if the dispute-resolution process goes that far. Med-arb has the same benefits and\ndrawbacks as mediation and arbitration alone, with some important differences. For instance,\nparties in a med-arb know that their dispute will be resolved. This is unlike mediation alone, where\nparties may walk away if they do not think that the mediation is serving their interests. Moreover, the\nparties in med-arb have an opportunity to reach a win-win outcome as in mediation. However, if\nthey do not reach a satisfactory outcome, then one party will \xe2\x80\x9cwin\xe2\x80\x9d and one party will \xe2\x80\x9close\xe2\x80\x9d during\nthe arbitration phase. The knowledge that an arbitration will definitely follow a failed mediation can\nbe a strong incentive to ensure that the mediation phase of a med-arb works.\nPrivate judging, contemplated by many state statutes, is a process in which active or retired judges\n\nmay be hired for private trials. Private judging is essentially private litigation. The hired judge can\npreside over a private trial that is not truncated by limits on discovery or abbreviated rules of\nprocedure, as would be the case in arbitration. Additionally, the judge who oversees the process is\nhighly experienced in such matters as evidence and decision rendering. Moreover, the parties who\ncan afford to pay for this service have a substantial benefit in not having to wait to have their cases\nheard in the public court. The private trial is also private rather than public, which may be important\nto parties who require confidentiality. In states where statutes permit hiring a judge for such matters,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n131\n\n\x0cthe parties\xe2\x80\x99 ability to appeal is often preserved. Drawbacks include the sometimes questionable\nnature of enforceability of judgments rendered, though some state statutes allow enforceability of\nthose judgments as if they were issued in public court. Moreover, this system may benefit those who\ncan afford to pay for this service, while others must wait for their case to appear on the docket in\npublic court. This raises questions of fairness. See Note 4.54 "Hyperlink: Private Judges" for one\nstate\xe2\x80\x99s frequently asked questions (FAQ) regarding private judges.\n\nHyperlink: Private Judges\nhttp://www.in.gov/judiciary/admin/private-judges/faq.html\nCheck out Indiana Courts\xe2\x80\x99 Web page with frequently asked questions about private judges.\nDoes your state permit private judging?\n\nA minitrial is a procedure that allows the parties to present their case to decision makers on both\nsides of the dispute, following discovery. This is a private affair. After the cases are presented, the\nparties enter into mediation or negotiation to resolve their dispute.\nA summary jury trial is a mock trial presented to a jury whose verdict is nonbinding. The presentation\nis brief and succinct, and it follows a discovery period. The jury does not know that its verdict will be\nadvisory only. This process allows parties to measure the strengths and weaknesses of their cases\nprior to engaging in litigation, which presumably saves both time and money. After the minitrial,\nparties are in a better position to negotiate or mediate an outcome that fairly represents their\npositions.\n\nKEY TAKEAWAYS\nMethods of ADR other than negotiation, mediation, and arbitration are available to disputants. For\nexample, minitrials, med-arb, private judging, and summary jury trials are common alternatives, as are inhouse programs like ombudsmen, anonymous ethics hotlines, and open-door policies. Benefits and\ndrawbacks to these methods exist relative to other methods of ADR and to litigation.\n\nEXERCISES\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n132\n\n\x0c1.\n\nVisit Boeing\xe2\x80\x99s Ethics Line Web page:http://www.boeing.com/companyoffices/aboutus/ethics/hotline.html.\nDo you think this program can address all disputes before they get out of hand? Why or why not? What\ntype of dispute might not be appropriate to bring to an ethics hotline program?\n\n2.\n\nLocate two \xe2\x80\x9cethics hotline\xe2\x80\x9d programs from an online search. Compare these programs. What are the\nbenefits and drawbacks to each?\n\n3.\n\nCheck out Note 4.54 "Hyperlink: Private Judges". Do you think that people should be permitted to hire\njudges to preside over private trials if they can afford to do so? What benefits to litigants in a private trial\nhave over litigants in a public trial? What ethical issues exist with respect to private judges?\n\n4.\n\nWhy would a party choose med-arb over mediation or arbitration alone?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n133\n\n\x0c4.5 Public Policy, Legislation, and Alternative Dispute\nResolution\nLEARNING OBJECTIVES\n1.\n\nExplore potential restrictions upon ADR.\n\n2.\n\nReview points of access to government to change public policy.\n\n3.\n\nExamine the Arbitration Fairness Act Bill.\n\nAlternative dispute resolution can be a very useful alternative to litigation. There are many\nadvantages to disputants, such as expediency, cost savings, and greater privacy than litigation. In\nbusiness to business (B2B) disputes, alternative dispute resolution (ADR) often makes sense.\nThe Federal Arbitration Act (FAA) is a federal statute that the U.S. Supreme Court interpreted as a\nnational policy favoring arbitration in Southland Corp. v. Keating. [1] According to the Southland\nCorp Court, state power to create judicial forums to resolve claims when contracting parties enter\n\ninto a mandatory arbitration agreement has been preempted by the FAA. However, not all disputes\nare well suited for ADR. This is an area in which Congress could make substantial changes in public\npolicy through the creation of new law, to ensure fairness between unequal parties and to ensure the\nprotection of civil rights. Congress could do this by making ADR optional, rather than mandatory, for\nsome types of disputes. It could exclude certain types of disputes from being bound to arbitration\nthrough mandatory arbitration clauses.\nFor example, the proposed Arbitration Fairness Act of 2009 (AFA) would invalidate mandatory\narbitration clauses in employment and consumer disputes, as well as in disputes arising from civil\nrights violations. See Note 4.63 "Hyperlink: Arbitration Fairness Act Bill". The AFA is a proposed bill\nto amend the FAA. Under the Commerce Clause, Congress has the power to limit the use of\nmandatory arbitration, just as it has the power to enforce mandatory arbitration clauses under the\nCommerce Clause through the existing FAA. By passing a new law that excludes certain types of\ndisputes from being subjected to mandatory arbitration, Congress could set new policy regarding\nfairness in dispute resolution. Likewise, if it fails to act, Congress is also acceding to the U.S.\nSupreme Court\xe2\x80\x99s broad interpretation of the FAA as a national policy favoring arbitration. Either\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n134\n\n\x0cway, policy regarding mandatory arbitration exists, and Congress has a central role in defining that\npolicy.\n\nHyperlink: Arbitration Fairness Act Bill\nhttp://thomas.loc.gov/cgi-bin/query/z?c111:H.R.1020\nReview the Arbitration Fairness Act Bill, which would amend the Federal Arbitration Act.\n\nIn 1925, when the FAA was originally passed, records indicate that Congress intended that\nmandatory arbitration clauses be enforced in contracts between merchants, rather than between\nbusinesses and consumers or between employers and employees. In the latter relationships, the\nparties have vastly unequal power. Moreover, despite the existence of mandatory arbitration clauses\nin contracts, the FAA was not contemplated as a means to preempt state power to provide judicial\nforums for certain types of disputes. [2] However, the U.S. Supreme Court has greatly expanded the\nFAA\xe2\x80\x99s applicability since then.\nIf Congress passed the AFA, this would be an example of one branch of government \xe2\x80\x9cchecking\xe2\x80\x9d\nanother branch\xe2\x80\x99s power as contemplated by the U.S. Constitution. Specifically, the legislative branch\nwould be checking the judicial branch\xe2\x80\x99s power by passing a law to counteract the U.S. Supreme\nCourt\xe2\x80\x99s broad interpretation of the FAA in Southland Corp. v. Keating.\nThis is how our government is supposed to work. One branch checks another branch\xe2\x80\x99s power. This\n\xe2\x80\x9cchecking\xe2\x80\x9d of power maintains relative balance among the branches. Because people have different\npoints of entry into the lawmaking process, this system ultimately balances the many special\ninterests of the American people. For example, some businesses and employers that do not wish the\nAFA to pass may wonder what recourse they have. After all, the U.S. Supreme Court\xe2\x80\x99s interpretation\nof the FAA currently favors their interests. Since the AFA has not yet passed, they could lobby\nlawmakers against its passage. Note too that if the AFA becomes law, these interest groups are not\nsimply shut out of the government\xe2\x80\x99s lawmaking process. They continue to have access to lawmaking.\nOne point of entry is through the legislative branch. For instance, they could return to Congress and\nask it to pass a new law to counteract the AFA, or to repeal the AFA altogether. They also have a\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n135\n\n\x0cpoint of entry to the lawmaking process through the judicial branch. Specifically, once a case or\ncontroversy arose under the AFA in which they had standing, they could ask the courts to interpret\nthe statute narrowly, or they could ask the courts to strike down the statute altogether.\nOn the other side of the issue, consumers and employees who do not like the FAA\xe2\x80\x99s current broad\ninterpretation can work within our government system to change the law. For instance, they can ask\nCongress to pass a new law, such as the AFA. They could ask Congress to repeal the FAA. They could\nalso wait for another case to arise under the FAA to try to get the relevant holding in theSouthland\nCorp. case overturned. This is perhaps more difficult than the first two options, because any U.S.\n\nSupreme Court case produces many progeny at the circuit court level. Each decision at the circuit\ncourt level also produces binding precedent within that jurisdiction. It is very difficult to get a case\nbefore the U.S. Supreme Court. Even if that happened, there would be no guarantee that the Court\nwould overturn a prior opinion. In fact, the opposite is usually true. Precedent is most often followed\nrather than overturned.\nIn the United States, the policy process is open for participation, though changes often take much\nwork and time. People with special interests tend to coalesce and press for changes in the law to\nreflect those positions. This appears to be what is happening in the world of ADR now. After many\nyears of mandatory arbitration requirements that have yielded perhaps unfair processes or results,\ngroups that believe they should not be forced into ADR by mandatory arbitration clauses are building\nmomentum for their position in Congress. If the AFA passes, that will not be the end of the story,\nhowever. New interest groups may form to support the previous law, or a new law altogether.\n\nKEY TAKEAWAYS\nPublic policy regarding arbitration has been codified in the FAA and expanded by the U.S. Supreme Court.\nTo change public policy, interest groups can access the government lawmaking power through several\npoints, including through the legislative branch and through the judicial branch. To change public policy\nregarding mandatory arbitration clauses, for instance, Congress could amend or repeal the FAA.\nAdditionally, given another dispute arising under the FAA concerning its scope, the U.S. Supreme Court\ncould overturn prior decisions that broadly interpret the FAA\xe2\x80\x99s reach. Our government\xe2\x80\x99s structure allows\nseveral points of access for those who would protect the status quo of public policy and for those who\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n136\n\n\x0cseek to change it. The U.S. government is a dynamic system that provides opportunities for special\ninterests to coalesce and change the law and public policy.\n\nEXERCISES\n1.\n\nHow many points of entry are there into lawmaking processes? Which point would be the easiest to access\nif you wanted to change the law? Why?\n\n2.\n\nCheck out Note 4.63 "Hyperlink: Arbitration Fairness Act Bill". Do you think that the AFA will solve the\nissue of perceived unfairness in dispute resolution? Why or why not? Are there any additions that you can\nmake to this bill to make it more likely to achieve the goal of greater fairness in dispute resolution, if\npassed?\n\n[1] Southland Corp. v. Keating, 465 U.S. 1 (1984).\n[2] Margaret L. Moses, Statutory Misconstruction: How the Supreme Court Created a Federal Arbitration Law Never\nEnacted by Congress, 34 Fla. St. U.L. Rev. 99 (2006).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n137\n\n\x0c4.6 Concluding Thoughts\nAlternative dispute resolution (ADR) is a popular and common group of methods to resolve disputes\nin many different contexts. In business, ADR is commonly used in business to business (B2B),\nbusiness to consumer (B2C), and business to employee (B2E) disputes. Several methods of ADR\nexist. The most commonly employed methods include negotiation, mediation, and arbitration. Under\nfederal law, national policy favors arbitration. Sometimes ADR is perceived as unfair, because parties\nhave unequal power relative to each other or because the subject matter of the dispute is not\nconsidered suitable for ADR. Like other areas of law and public policy, ADR is dynamic and subject\nto change, particularly when special interest groups coalesce successfully and create momentum for\nchange within our legal system. Currently, there is a nascent movement to exclude certain types of\ndisputes from ADR by amending the federal law that requires mandatory arbitration when parties\nhave contractually consented to it.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n138\n\n\x0cChapter 5\n\nThe Constitution\nLEARNING OBJECTIVES\nIn this chapter, we will discuss the federal U.S. Constitution and how it affects businesses. Specifically, you\nshould be able to answer the following questions:\n1.\n\nWhat are the main purposes of the U.S. Constitution?\n\n2.\n\nHow does the Constitution grant authority to the government to regulate business?\n\n3.\n\nHow does the Bill of Rights provide basic civil liberties to all persons in the United States?\n\n4.\n\nHow do due process and equal protection operate to constrain governments from acting unfairly?\n\nVideo Clip: Schoolhouse Rock, the Preamble\nThe Constitution is not the first constitution adopted by the original thirteen colonies. During the\ntime of the Revolutionary War against Great Britain, the states were governed by\nthe Articles of Confederation. The articles granted limited authority to a federal government,\nincluding the power to wage wars, conduct foreign policy, and resolve issues regarding claims by the\nstates on western lands. Many leading scholars and statesmen at the time, known as Federalists,\nthought that the articles created a federal government that was too weak to survive. The lack of\npower to tax, for example, meant that the federal government was frequently near bankruptcy in\nspite of its repeated requests to the states to put forth more money to the federal government. Larger\nstates resented the structure under the articles, which gave small states an equal vote to larger states.\nFinally, the articles reserved the power to regulate commerce to the states, meaning each pursued its\nown trade and tariff policy with other states and with foreign nations. In 1786, work began in a series\nof conventions to rewrite the articles, resulting in the adoption of the U.S. Constitution in\nPhiladelphia in 1787.\nIn this chapter we explore the Constitution in depth. We\xe2\x80\x99ll examine how the Constitution sought to\nrectify the weaknesses in the articles, especially in commerce. We go beyond the meaning of the\nwords and explain how judicial interpretation of the Constitution, while still evolving, has forever\nchanged its original place in U.S. political economy. We\xe2\x80\x99ll explore the first ten amendments to the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n139\n\n\x0cConstitution, the Bill of Rights, and look at how many of the key civil liberties contained in the Bill of\nRights also affect businesses. By the end of the chapter, you should have a solid grasp on why the\nConstitution remains an enduring document and why it\xe2\x80\x99s important for business professionals to be\nable to speak on it with authority.\n\nKey Takeaways\nThe Articles of Confederation established the United States of America. It provided a central federal\ngovernment with limited powers, including the power to wage war. The articles ultimately failed because\nthe federal government lacked the power to raise its own taxes or to regulate commerce. In 1787, the\nPhiladelphia Convention adopted a new Constitution to replace the articles.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n140\n\n\x0c5.1 Federalism and Preemption\nLEARNING OBJECTIVES\n1.\n\nExplore how the Constitution creates a limited government through the separation of powers and\nthrough checks and balances among the three branches of government.\n\n2.\n\nLearn how the Constitution resolves conflicts between state and federal laws.\n\n3.\n\nUnderstand the rules surrounding preemption.\n\nHave you ever read the Constitution from beginning to end? Look at the text of the Constitution. It\xe2\x80\x99s\nremarkably short\xe2\x80\x94shorter than many people realize. Historically, it is the shortest and oldest written\nconstitution still in force. Ironically, the Constitution\xe2\x80\x99s brevity may be one of the reasons that it\nendures to this day, as judicial interpretation has kept its meaning relevant for modern times.\nMuch of its content deals with the allocation of power among three separate and coequal branches of\ngovernment. Substantively, much more attention is paid to the limitations on the power given to\neach of the three branches than to any positive grant of rights. Indeed, while many Americans believe\nthat it is their \xe2\x80\x9cconstitutional right\xe2\x80\x9d to be free, many of those freedoms are actually contained in the\nBill of Rights, which are amendments to the Constitution. In contrast, the main body of the\nConstitution is concerned primarily with structure. In other words, the Constitution is a document of\nprohibition, outlining what government cannot do as opposed to what government must do.\nAs a result of this structure, the Constitution is rarely the right place to deal with contemporary\npolitical issues, no matter how important. At the state level, many states permit frequent\namendments to their constitutions to reflect contemporary public policy, from school funding to\ngambling to gay marriage. There is often support among many people for constitutional amendments\nto ban flag burning, permit prayer in school, ban gay marriage, or ban abortion. At the federal level,\nhowever, these issues are rarely resolved at the constitutional level. There is a practical bar, of\ncourse, given how difficult it is to amend the Constitution. Even if it were easier to amend, however,\nthe Constitution remains very much a document of structure rather than substantive law.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n141\n\n\x0cDuring his confirmation hearings, Chief Justice John Roberts spoke of his role as an umpire calling\nthe balls and strikes and not pitching or batting. If judges are umpires, then the Constitution sets\nforth the rules of the game. The biggest rule laid down in the Constitution is the separation of powers.\nFundamentally, the separation of powers requires that each branch of government play its own role\nin governing the people. The judicial branch plays a critical role in interpreting the Constitution and\noutlining the powers of the legislature and executive branches. The interplay between Article I\n(legislative) and Article II (executive) is no less important. Although more than two centuries have\npassed since the first Congress and the first president served, the limits of power between these two\nbranches continue to be redefined, especially in the wake of the September 11 terrorist attacks.\nArticle I of the Constitution establishes the legislative branch through abicameral legislature. The\nlower House of Representatives, with frequent elections (every even-numbered year), has 435\nmembers, with representation spread proportionately to a state\xe2\x80\x99s population as determined by a\ncensus every decade. The most populous state, California, has fifty-three members, while several\nstates are so small that they have only one representative (Alaska, Delaware, Montana, North\nDakota, South Dakota, Vermont, and Wyoming). The House is led by the Speaker of the House,\ntypically from the party that holds the majority in the House. The House is generally thought to\nrepresent the most contemporary views of the American public, with its large body of members and\nfrequent elections.\nAs a check on the majority will, and on the power of larger states, the Senate is a smaller body with\none hundred members (two from each state) and with less frequent elections (every six years). The\nSenate is meant to be a more deliberative body and to ensure a wider level of debate before\nimpassioned legislation is hastily rushed into law. The makeup of the Senate means that citizens\nfrom smaller states, representing much fewer people, can often frustrate the will of the majority of\nAmericans. The Constitution places the power to legislate with both chambers, but the House retains\nthe exclusive right to originate bills raising revenue (taxation), while the Senate maintains the\nexclusive right to provide advice and consent to the president, where advice and consent are\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n142\n\n\x0crequired. Additionally, while the House retains the right toimpeach officials for \xe2\x80\x9chigh crimes and\nmisdemeanors,\xe2\x80\x9d the Senate tries such impeached officials.\nArticle II of the Constitution establishes the executive branch of government. While the Constitution\nwas being drafted, the delegates knew that they wanted George Washington to be president.\nWashington was in retirement in Mount Vernon at the time, after successfully leading the colonies in\nthe Revolutionary War. Since the delegates knew Washington would be president, they spent\nremarkably little time in writing Article II, which is very short. Washington was elected to both his\nfirst and second terms with 100 percent of the Electoral College vote, something no other president\nhas since done. While Article II sets forth some of the mechanisms for becoming president\xe2\x80\x94and is\nthe only place in the Constitution that prescribes a specific oath of office\xe2\x80\x94when the Constitution was\ndrafted, little was known about what the president\xe2\x80\x99s role would be.\nArticle II grants the president an almost total power over foreign affairs, including the power to make\ntreaties and appoint ambassadors. He is commander-in-chief of the armed forces. The president is\nalso responsible for executing, or enforcing, the laws of the country. While Congress can pass any\nlegislation it wants to, ultimately legislation is meaningless unless there are sanctions for violating\nthe law. Through the prosecutorial and police functions, the president ensures that the will of the\npeople, as expressed through Congress, is carried out.\nThe Constitution\xe2\x80\x99s deliberate ambiguity on the powers of the president left much room for debate on\nhow strong the executive branch should be. After the September 11 attacks, many in the George W.\nBush administration argued for a strong unitary executive theory. Bush administration lawyers\nreasoned that only a strong executive could effectively wage war with Al-Qaeda. Under a\ncongressional authorization, the administration embarked on a program to capture and kill terrorists\naround the world and to gather as much information about terrorist activities as possible. Many in\nCongress believed, however, that the executive branch overstepped its authority in pursuing these\ngoals, leaving Congress behind.\nFor example, to collect intelligence on suspected terrorists in the United States, Congress passed a\nlaw, the Foreign Intelligence Surveillance Act, in 1978. FISA, as the law is known, requires federal\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n143\n\n\x0claw enforcement officials to seek a search warrant from a secret court before carrying out\nsurveillance or wiretapping. The Bush administration routinely carried out surveillance on persons\nin the United States without this judicial oversight, arguing that it was part of the unitary executive\ntheory to do so. In another program, the Bush administration allegedly captured suspected terrorists\nabroad and moved them to secret prisons outside the jurisdiction of the United States for\ninterrogation, a practice known as extraordinary rendition. In late 2009, an Italian court convicted\ntwenty-three American officials, including members of the Central Intelligence Agency (CIA), of\nextraordinary rendition in the case of a Muslim cleric kidnapped from Milan. The officials were\nconvicted in their absence and have not been extradited to Italy. Extraordinary rendition is likely\nillegal under U.S. and international law, but lawsuits attempting to find out more information about\nthe program have been thwarted by the executive branch\xe2\x80\x99s claim of thestate secrets doctrine.\nCongress and the president have also clashed over the treatment of suspected terrorists. Article I,\nSection 9 of the Constitution states that \xe2\x80\x9cThe Privilege of the Writ of Habeas Corpus shall not be\nsuspended, unless when in Cases of Rebellion or Invasion the public Safety may require it.\xe2\x80\x9d The right\nof habeas corpus is a fundamentally important right, appearing first in the Magna Carta and\nconsidered so important by Constitutional delegates that it was inserted into the text of the\nConstitution itself, not in the Bill of Rights. When the Bush administration began imprisoning\nsuspected terrorists at the military base in Guantanamo Bay, Cuba, the administration took a series\nof unprecedented positions on the legal status of those detainees, including the position that the\ndetainees did not have the right to seek habeas relief. Federal courts, including the Supreme Court,\ngradually overturned most of these positions, and the detainees are now being tried by either\nmilitary tribunals or civilian courts.\nAnother controversial position adopted by the administration was on the use of enhanced, or\naggressive, interrogation methods. Critics claimed these techniques amounted to torture (which is\nbanned by U.S. law as passed by Congress) and may be unconstitutional under the Eighth\nAmendment, which prohibits cruel or unusual punishment.\n\nVideo Clip: \xe2\x80\x9cMancow\xe2\x80\x9d Waterboarded\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n144\n\n\x0cAnother aspect of the separation of powers that is less obvious is the separation of power between\nthe federal and state governments, known as federalism. You already know that state and federal\ngovernments sometimes share power and that the rules of subject matter jurisdiction determine\nwhich legal system has jurisdiction over a particular matter or controversy. In some areas, such as\nfamily or property law, the states have near exclusive jurisdiction. In other areas, such as negotiating\ntreaties with foreign countries or operating airports and licensing airlines, the federal government\nhas near exclusive authority. In the middle, however, is a large area of subject matter where both\nstate and federal governments may potentially have jurisdiction. What happens if state and federal\nlaws exist on the same subject matter, or worse, what happens if they directly contradict each other?\nLegal rules of preemption seek to provide an answer to these questions. Under the Constitution\xe2\x80\x99s\nSupremacy Clause (Article VI, Section 2), the Constitution and federal laws and treaties are the\n\xe2\x80\x9csupreme law of the land\xe2\x80\x9d and judges in every state \xe2\x80\x9cshall be bound\xe2\x80\x9d by those laws. Let\xe2\x80\x99s say, for\nexample, that Congress sets the minimum wage at $7.25 an hour. A state that passes a law making\nthe minimum wage lower than that would immediately see the law challenged in federal court as\nunconstitutional under preemption and Supremacy Clause principles, and the state law would be\noverturned.\n\nHyperlink: Medical Marijuana in the States\nhttp://www.npr.org/templates/story/story.php?storyId=113924395\nUnder the federal Food and Drug Act, marijuana is classified as a Schedule I drug under the Controlled\nSubstances Act, meaning it is restricted just like cocaine or heroin. Fourteen states have passed laws that\npermit marijuana to be grown, sold, and used for medicinal purposes, such as treating nausea and\nstimulating hunger in cancer patients. The federal government aggressively prosecuted medicinal use of\nmarijuana, and in 2005 the Supreme Court ruled that the federal law trumps state laws,\n\n[1]\n\nmeaning that\n\nlocal growers could be arrested and prosecuted under federal law even if what they were doing was\nperfectly legal and authorized under state law. In 2009 the Obama administration announced a change in\npolicy. Listen to this National Public Radio story about what this change means for the medicinal use of\nmarijuana in the states.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n145\n\n\x0cWhen there is no direct conflict between state and federal law, then the rules of preemption state\nthat courts must look to whether or not Congress intended to preempt the state law when it passed\nthe federal statute. If there is no clear statement by Congress that it wishes to preempt state law, or if\nit is unclear what Congress meant to do, then the state law will survive if possible (i.e., there is a\npresumption against preemption). Even if there is no statement by Congress on preemption,\nhowever, if Congress so completely regulates a particular subject area that there is \xe2\x80\x9cno room\xe2\x80\x9d left for\nstates to regulate, then preemption exists. For example, after September 11, Michigan passed a law\nrequiring student pilots in Michigan to pass a Federal Bureau of Investigation (FBI) background\ncheck. The Federal Aviation Administration, which sets forth pilot qualifications and licensing, has\nno such requirement, and since the federal government regulates the aviation industry completely\n(from airports to pilots to airlines to training standards), Michigan\xe2\x80\x99s law is preempted.\n\nHyperlink: Can States Regulate Car Safety Standards?\nhttp://www.nhtsa.dot.gov/cars/rules/import/fmvss/index.html\nSometimes it\xe2\x80\x99s not clear whether or not a state law is preempted, and the courts must undertake a\nsearching inquiry to determine congressional intent. In Geier v. Honda,\n\n[2]\n\nfor example, a teenager filed a\n\ntort lawsuit against Honda for injuries she suffered during a car accident. Her lawsuit claimed that her\n1987 Honda Accord was defective because it didn\xe2\x80\x99t have any airbags. Airbag technology, which existed at\nthe time but was used primarily in expensive luxury cars, would have minimized her injuries. If she had\nwon her state lawsuit in the District of Columbia, then in effect all 1987 Honda Accords sold in the District\nof Columbia would have to be equipped with airbags to avoid tort liability. Honda\xe2\x80\x99s defense was\npreemption. Under a federal regulatory scheme known as the Federal Motor Vehicle Safety Standards\n(FMVSS), the federal government sets forth safety standards that cars must meet to be sold in the United\nStates. FMVSS 208 sets the standard for seat belts, and in 1987 manufacturers were required to install\neither airbags or passive (motorized) seat belts. A rule that required manufacturers to install airbags\nexclusively would directly contradict FMVSS 208, so the Supreme Court ruled that FMVSS preempted any\nstate attempts to regulate motor vehicle safety standards.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n146\n\n\x0cWhen the Supreme Court found preemption in the Honda case, many in the business community\nwondered if a new era of preemption might have arrived. Federal regulation would in effect provide a\nshield against liability lawsuits. These hopes were short lived, as the Supreme Court continues to\nhold a presumption against preemption. The drug industry, in particular, would like preemption to\nend tort litigation.\n\nHyperlink: If the FDA Approves a Drug Label, Can Patients Still Sue Drug\nManufacturers?\nhttp://www.npr.org/templates/story/story.php?storyId=101465350\nWyeth Pharmaceuticals manufacturers an antinausea drug called Phenergan, which was approved by the\nU.S. Food and Drug Administration (FDA) in 1955. Under federal law, the FDA must approve the wording\non labels and documentation accompanying regulated drugs. The FDA-approved label contained\nwarnings against \xe2\x80\x9cintra-arterial\xe2\x80\x9d injection, which carried the risk of irreversible gangrene. The plaintiff in\nthe case, Vermont musician Diana Levine, went to a clinic for treatment and ended up losing her arm\nwhen Phenergan was incorrectly administered to her. She sued Wyeth, arguing that the warning label on\nthe drug didn\xe2\x80\x99t prohibit the type of injection that led to her injuries. A jury awarded her more than six\nmillion dollars in damages. On appeal to the Supreme Court, Wyeth argued that since the FDA approved\nthe label, lawsuits arguing that the label was inadequate were preempted. The Supreme Court examined\nthe history of the Food and Drug Act and ruled for Diana Levine, holding that when Congress wrote the\nlaw, it never meant to preempt state laws. In fact, the Supreme Court found that Congress meant for state\nlawsuits to work alongside the Food and Drug Act to ensure drug safety for consumers.\n\nKEY TAKEAWAYS\nThe Constitution is mainly a structural document, setting forth the allocation of power among the three\nbranches of government and the limitations on that power. It is concerned mainly with what the\ngovernment cannot do, as opposed to what the government must do. At the federal level, constitutional\namendments are rarely used to carry out social policy. Article I of the Constitution establishes a bicameral\nlegislature, with a House of Representatives and a smaller, more deliberative Senate. Both chambers must\nagree before legislation can be passed. Article II of the Constitution establishes the executive power in the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n147\n\n\x0cpresident, who must execute the laws passed by Congress. The balance of power between Congress and\nthe president is subject to much interpretation and change throughout history, including the post\xe2\x80\x93\nSeptember 11 era. Power is also divided between state and federal governments under federalism. The\nSupremacy Clause states that when there is a conflict between state and federal law, federal law wins. If\nthere is no direct conflict, the state law survives unless Congress expressly preempts state law.\n\nEXERCISES\n1.\n\nOne of the attempts to use the Constitution to achieve a social policy was Prohibition. Review the twentyseven amendments to the Constitution. Other than the Bill of Rights, can you identify other amendments\nused to achieve social policy?\n\n2.\n\nCan you name your representatives in the House of Representatives and the Senate? Who is the current\nSpeaker of the House and the Senate Majority Leader?\n\n3.\n\nCan you think of current examples where legislation that is popular with the majority of Americans is held\nup in the Senate, especially by Senators from smaller states?\n\n4.\n\nDo you believe that the United States is better served by a strong or weak unitary executive? Explain your\nanswer.\n\n5.\n\nWhere should the balance of power lie between Congress and the president in prosecuting the war on\nterror? If the president believes enhanced interrogation such as waterboarding is necessary to obtain\nnecessary intelligence, should Congress attempt to intervene?\n\n6.\n\nIn 2007 five victims of extraordinary rendition filed suit against Jeppesen Dataplan Inc. (a Boeing\nsubsidiary), claiming that Jeppesen provided logistical support to the CIA\xe2\x80\x99s extraordinary rendition\nprogram. The government has so far successfully kept the case from going to trial, arguing that doing so\nwould endanger government secrets. Do you believe that someone who has been subject to extraordinary\nrendition should be able to sue the government, or private companies, for what happened to them? Why\nor why not?\n\n7.\n\nIn the Geier case, the Supreme Court held that states may not regulate motor vehicle safety standards.\nHow do you think states like California and Massachusetts can impose stricter emission controls on motor\nvehicles than the federal standard?\n\n[1] Gonzalez v. Raich, 545 U.S. 1 (2005).\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n148\n\n\x0c[2] Geier v. American Honda Motor Company, 529 U.S. 861 (2000).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n149\n\n\x0c5.2 The Commerce, Taxing, and Spending Clauses\nLEARNING OBJECTIVES\n1.\n\nExplore how the Constitution grants the power to regulate commerce to the federal government.\n\n2.\n\nUnderstand how the meaning of the Commerce Clause has expanded greatly.\n\n3.\n\nLearn about state police powers and the limitations on those powers.\n\n4.\n\nLearn about the power given to Congress to tax and spend money.\n\nHyperlink: The Powers of Congress\nhttp://topics.law.cornell.edu/constitution/articlei#section8\n\nMembers of the Constitutional Convention were divided about how powerful the new central\ngovernment should be. To avoid the rise of tyrannical government, the Constitution carefully grants\ncertain powers to Congress, reserving all other powers to the states. These powers are listed in Article\nI, Section 8. Look at this section in Note 5.25 "Hyperlink: The Powers of Congress"and notice how\ndetailed these powers are.\nThe list begins with monetary matters, an issue of great concern at the time because the prior\ngovernment was bankrupt and states regulated their own money supply. The Congress therefore has\nthe power to borrow money, lay and collect taxes, regulate commerce (the Commerce Clause),\nestablish a uniform law on bankruptcy and naturalization, make money (currency) and establish its\nvalue, punish the counterfeiting of U.S. money, and establish a uniform system of weights and\nmeasures. The list then moves on to aspirational ideals for the young new country to strive toward.\nCongress has the power to establish post offices and post roads and to protect intellectual property in\ncopyrights and patents. Next, the list turns to Congress\xe2\x80\x99s adjudicative powers: to create lower courts\nunder the Supreme Court created in Article III and to define crimes committed on the \xe2\x80\x9chigh seas\xe2\x80\x9d\nand against the \xe2\x80\x9claw of nations.\xe2\x80\x9d Congress is also given fiscal responsibility over the armed forces\nand navy (note there is, of course, no mention of an air force) and the power to provide oversight to\nthe militia. Then, to help Congress with carrying out these powers, Article I, Section 8 provides that\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n150\n\n\x0cthe states may cede to Congress a district, not to exceed ten square miles, that will become the seat of\ngovernment, and to exercise exclusive legislative authority over this district.\nThe scope of power granted under Article I, Section 8 is the subject of much debate among legal\nscholars. The clause granting Congress the power to regulate commerce is particularly troublesome.\nThere is very little debate about the power of Congress to regulate foreign trade. This power is\nexplicit, total, and exclusive. If Congress wanted to ban all imports and exports into and out of the\nUnited States, for example, it could legitimately do so. Indeed, Congress routinely uses economic\ntrade sanctions against \xe2\x80\x9crogue\xe2\x80\x9d nations such as Cuba and North Korea as a means of economic\nwarfare to try to bring about regime change. Even in the case of friendly allies such as Canada,\nMexico, and the European Union, Congress routinely engages in trade regulations that restrict or\ndistort foreign trade. Since this power is exclusive to Congress, state attempts to regulate foreign\ncommerce are invalid. Oregon, for example, cannot ban Oregon companies from exporting to Mexico\nor establish a free trade zone with duty-free imports with China.\nThere is more disagreement about Congress\xe2\x80\x99s power to regulate domestic commerce. Notice how\nArticle I, Section 8 is structured. Many scholars believe that this list is complete and exhaustive,\nsince it lists all the powers the Founding Fathers wanted to give Congress at the time. The idea, they\nargue, was to create powerful and limited government, leaving the states room to govern in all other\nareas. As evidence, these scholars point to the structure of the list and the high level of detail\nprovided (such as specific crimes to be made punishable and the square mile limitation for the seat\nof government). Other scholars believe that the list should be interpreted more broadly and that the\nlanguage granting Congress the power to \xe2\x80\x9cmake all laws necessary and proper\xe2\x80\x9d to carry out the\nenumerated powers demonstrates the Founding Fathers\xe2\x80\x99 desire for a more flexible interpretation, to\nallow Congress the power to react to needs and challenges not foreseeable at the time the clause was\ndrafted.\nIn the early part of the country\xe2\x80\x99s history, the first view held firm sway, and together courts and\nCongress carefully observed the constitutional limits to the growth of federal government power. If\nyou consider our modern federal government, however, it\xe2\x80\x99s obvious that the second view is now\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n151\n\n\x0cmore prevalent. Today, the federal government does a lot more than what is enumerated on the list\nin Article I, Section 8. From regulating educational standards, to defining clean air and water, to\noutlawing workplace discrimination, to licensing portions of the electromagnetic spectrum for cell\nphone and digital television providers to use, it\xe2\x80\x99s clear that if a member of the Constitutional\nConvention were to travel forward in time, he would be shocked at both the pace of progress and the\nsize and power of the federal government. How did our country\xe2\x80\x99s view of congressional power evolve\nover time?\nThe answer can be traced to the Great Depression. In response to unprecedented economic distress,\nPresident Roosevelt sought to redefine the very nature of the employer/employee relationship. He,\nalong with Congress, enacted legislation that established a minimum hourly wage, set maximum\nweekly working hours, established workplace safety rules, outlawed child labor, and provided for a\nsafety net to protect older and disabled workers. These laws initially ran into stiff opposition at the\nSupreme Court. The justices at the time clung to a more formalistic reading of Article I, Section 8\nand saw the employer/employee relationship as one governed by freedom of contract. In this view, if\na worker wanted to work and an employer was willing to provide that work, then the government\nshould not interfere with that contract. Thus, early portions of the New Deal were struck down as\nunconstitutional under the Commerce Clause.\nAfter President Roosevelt proposed his court-packing plan, leading one of the swing votes on the\nSupreme Court to change his vote to begin upholding the New Deal, the barriers surrounding the\ninterpretation of the Commerce Clause came crashing down. Courts have now adopted a very flexible\nreading of the Commerce Clause. As long as Congress makes reasonable findings that a certain\nactivity has some sort of effect on interstate commerce, Congress can regulate that activity.\nThis broad interpretation of the Commerce Clause has been challenged repeatedly. In 1964, for\nexample, Congress passed a broad and sweeping Civil Rights Act, prohibiting discrimination against\ncitizens on the basis of race, color, national origin, and sex. Congress relied on its power under the\nCommerce Clause to pass this legislation. That same year, the Heart of Atlanta Motel in Georgia\n(Figure 5.3 "Heart of Atlanta Motel") filed a federal lawsuit seeking to overturn the Civil Rights Act\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n152\n\n\x0cas unconstitutional, arguing that Congress lacked the authority under the Commerce Clause to pass\nthe law. The Supreme Court held the law to be constitutional, finding that since 75 percent of the\nmotel\xe2\x80\x99s clients came from out of state and since the motel was located near Interstates 75 and 85, the\nbusiness had an \xe2\x80\x9ceffect\xe2\x80\x9d on interstate commerce. [1]Subsequent civil rights legislation, including the\nimportant Americans with Disabilities Act, is also grounded in congressional authority to regulate\ninterstate commerce.\nFigure 5.3 Heart of Atlanta Motel\n\nSource: Photo courtesy of Georgia State University, Special Collections of the University Library,\nhttp://tarlton.law.utexas.edu/clark/heart_long.html.\n\nIn the late 1990s, several curious decisions by the conservative wing of the Supreme Court led some\nobservers to wonder if the days of virtually unfettered authority by Congress to regulate under the\nCommerce Clause were coming to an end. Judicial conservatives, especially the late Chief Justice\nRehnquist, have always been somewhat uncomfortable with the broad reading of the Commerce\nClause, worried that it has led to a runaway federal government many times bigger than what the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n153\n\n\x0cFounding Fathers intended. In a 1995 case, the Supreme Court held that the 1990 Gun-Free School\nZones Act was unconstitutional. The law prohibited the possession of weapons in schools and was\nbased on a congressional finding that possession of firearms in educational settings would lead to\nviolent crime, which in turn affects general economic conditions by causing damage and raising\ninsurance costs and by limiting travel to and through unsafe areas. Students intimidated by a violent\neducational setting would also be affected, learning less and leading to a weaker educational system\nand economy. By a 5\xe2\x80\x934 margin, the Supreme Court found these arguments unpersuasive and\noverturned the law, holding that Congress lacked authority under the Commerce Clause to regulate\nthe carrying of handguns into schools. [2] Then, five years later, the Supreme Court overturned a\nportion of the 1994 Violence Against Women Act, which gave a woman the right to sue her attacker\nin federal court for civil damages, holding that the effects of violence against women were too\n\xe2\x80\x9cattenuated\xe2\x80\x9d to be valid under the Commerce Clause. [3] Any expected revolution in the scope of\nCongress\xe2\x80\x99s authority failed to materialize, however, and these two cases are probably aberrations\nrather than predictors of where the Court is heading on this topic.\nWhile the Constitution limits the federal government\xe2\x80\x99s powers to those enumerated in Article I,\nSection 8, the states also have broad lawmaking authority. These powers stem from the\nstates\xe2\x80\x99 police power, which permits states to regulate broadly to protect and promote the public order,\nhealth, safety, morals, and general welfare. You\xe2\x80\x99ve probably experienced this yourself. Different\nstates have different speed limits, for example. Some states permit the sale of alcohol on Sundays,\nwhile others prohibit it. Some states permit casino gambling, while others do not. A few states permit\nsame-sex marriage, while many do not. Some states prohibit smoking in bars and restaurants,\nincluding North Carolina, home to the nation\xe2\x80\x99s tobacco industry. In California, an attempt to rein in\nobesity resulted in a state law to require calorie counts on restaurant menus and a ban on the use of\ntrans fats. In Texas, teenagers must have parental permission to use tanning beds at a salon.\nMassachusetts bans dog racing. Many states are implementing bans on texting while driving.\n\nHyperlink: How Assisted Suicide Ruling Affects Doctors\xe2\x80\x99 Work\nhttp://www.npr.org/templates/story/story.php?storyId=5160904\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n154\n\n\x0cIn 1994 Oregon voters approved the country\xe2\x80\x99s first physician-assisted suicide law, the Oregon Death with\nDignity Act. The law permits certain patients to voluntarily hasten death by taking a lethal dose of\nprescription medication. To meet the law\xe2\x80\x99s requirements, the patient must be terminally ill with less than\nsix months to live, must be informed and voluntarily request the medication, must be able to consume the\nmedication by himself or herself, must be referred to counseling, and must have the terminal diagnosis\nconfirmed by a second doctor. Many patients, fearing a painful or torturous natural death, obtain the\nmedication and never take it, but some do. In 2001 Attorney General John Ashcroft issued a rule\ninterpreting the federal Controlled Substances Act as prohibiting any physician from prescribing\nmedication under the Death with Dignity Act, subjecting any doctor who did so to federal prosecution. In\na 6\xe2\x80\x933 decision, the Supreme Court decided that the Controlled Substances Act did not grant the attorney\ngeneral the authority to override a state standard for regulating medicine.\n\n[4]\n\nIn doing so, the Court held\n\nthat the state police power is entitled to greater deference, in this case, than Congress\xe2\x80\x99s powers under the\nCommerce Clause. Listen to the National Public Radio story for one physician\xe2\x80\x99s account of how the Death\nwith Dignity Act has affected his practice.\n\nThe Oregon Death with Dignity Act case illustrates how a state, in exercising its police power, can\nactually grant more civil rights to its citizens than the federal government does or wishes to.\nSimilarly, states that have legalized same-sex marriage have done so under their police powers,\nwhich is permissible as long as the exercise of police power does not violate the federal Constitution.\nGenerally, this means the state legislation must be reasonable and applied fairly rather than\narbitrarily. Additionally, a critical limitation on the state police power is that it cannot interfere with\nCongress\xe2\x80\x99s power to regulate interstate commerce. This concept is known as\nthe dormant commerce clause because it restricts the states\xe2\x80\x99 abilities to regulate commerce, rather\nthan the federal government\xe2\x80\x99s.\nA state law that discriminates against out-of-state commerce, or places an undue burden on interstate\ncommerce, would violate the dormant commerce clause. For example, if a state required out-of-state\ncorporations to pay a higher tax or fee than an in-state corporation, that would be unconstitutional.\nA state that required health and safety inspections of out-of-state, but not in-state, produce or goods\nwould be unconstitutional. In 2005 the Supreme Court held that state restrictions prohibiting out-ofSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n155\n\n\x0cstate wineries from selling directly to consumers in-state was unconstitutional. [5] Federal courts have\nrepeatedly held that state attempts to regulate Internet content (typically to prevent pornography)\nare unduly burdensome on interstate commerce and therefore unconstitutional. Note, however, that\nthis prohibition against out-of-state discrimination does not prevent a state from exercising its police\npower to protect state citizens, as long as the power is exercised evenly and equally. If a state wanted\nto weigh trucks on highways to ensure they did not exceed maximum weight rules, for example, that\naction would be permissible even if the trucks came from out of state, as long as the requirement\napplied equally to all trucks on that state\xe2\x80\x99s highways.\nIn addition to the power to regulate commerce, the Constitution places two critical powers with\nCongress: the taxing power and the power to spend the taxes it collects. The taxing power is a broad\none, and the Supreme Court has not overturned a tax passed by Congress in nearly a century. As long\nas the tax bears some reasonable relationship to generating revenue, the tax is valid.\nStates are also permitted to tax, but only if the activity taxed has a nexus to the state. A transaction\n(such as a sale) that takes place inside the state would create a nexus for sales tax to attach. Working\ntypically creates a nexus for state or local income tax to apply, and owning real property creates a\nnexus for real estate tax to apply. What happens, however, if a state\xe2\x80\x99s citizen purchases goods from a\nseller out of state? Traditionally, buyers do not pay sales tax to the government directly\xe2\x80\x94rather, they\npay the sales tax to the seller, who collects the tax on behalf of the government and turns it over to\nthe government at regular intervals. In the past, mail-order catalog sellers from out of state would\nnot collect sales tax in states where they don\xe2\x80\x99t have a physical presence. As the popularity of ecommerce has skyrocketed, more and more states are reexamining how to tax transactions from outof-state sellers by compelling those sellers to collect the applicable sales tax. Some states are so\ndesperate they are starting to look for a nexus anywhere they can. In New York, for example, the\nlegislature passed a law requiring Amazon.com to collect sales tax from New York residents based on\nthe presence of New York citizens who link to Amazon\xe2\x80\x99s Web site in turn for a commission generated\nby those links.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n156\n\n\x0cCongress also has the power to \xe2\x80\x9cpay the debts and provide for the common defense and general\nwelfare.\xe2\x80\x9d This spending power is considered very broad. Courts have interpreted this power to mean\nthat Congress can spend money not only to carry out its powers under Article I, Section 8 but also to\npromote any other objective, as long as it does not violate the Constitution or Bill of Rights. For\nexample, in 1984 Congress passed the National Minimum Drinking Age Act, which required states to\nadopt a minimum age of twenty-one for the purchase and possession of alcohol. If a state did not\nadopt the age-twenty-one requirement, Congress would withhold federal highway funds from that\nstate to repair and build new roads. One by one, states began adopting age twenty-one as the\nminimum drinking age, even though the age requirement would typically be a matter of state police\npower. In a challenge by South Dakota, which wanted to keep nineteen as the minimum drinking\nage, the Supreme Court upheld Congress\xe2\x80\x99s use of withholding funds to force the states to raise the\nminimum drinking age. [6] Congress has used the spending power to coerce states to adopt a fiftyfive-mile-per-hour speed limit (rescinded by the Clinton administration) and to lower the driving\nunder the influence (DUI) blood alcohol level limit from 0.10 in most states to 0.08.\n\nKEY TAKEAWAYS\nArticle I, Section 8 of the Constitution grants certain specific powers to Congress. The power to regulate\ncommerce is one of these powers, and the power of foreign commerce is explicit, total, and exclusive.\nDuring the Great Depression, the Supreme Court greatly expanded the interpretation of Congress\xe2\x80\x99s ability\nto regulate domestic interstate commerce, and this expansion led to congressional authority to regulate\nvirtually all human activity within the United States, with very few limited exceptions. This authority\nextends to civil rights, where Congress has passed several key pieces of legislation, including the Civil\nRights Act of 1964 and the Americans with Disabilities Act, under the Commerce Clause. Attempts by\njudicial conservatives to circumscribe the power of the Commerce Clause appear to have failed for now.\nUnlike the federal government, states have broad police powers to regulate for the health, safety, and\nmoral well-being of their citizens. The exercise of these police powers cannot violate the federal\nConstitution and, importantly, cannot violate the dormant commerce clause by discriminating against or\nplacing an undue burden on interstate commerce. The power to tax is broad, and as long as a tax bears a\nreasonable relationship to raising revenue, the tax is upheld as constitutional. The power to spend is\nsimilarly broad, and Congress can spend funds to achieve broad objectives beyond its enumerated powers.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n157\n\n\x0cEXERCISES\n1.\n\nArticle I, Section 8 of the Constitution establishes the seat of government, which today is Washington, DC.\nResidents of Washington, DC, have no representation in Congress other than a nonvoting delegate. Should\nWashington, DC, residents be granted more representation? What are the legal impediments toward such\na move? What would be the political repercussions?\n\n2.\n\nToday the United States is one of the few remaining countries to refuse the adoption of the metric system\nfor weights and measures. Would the decision to \xe2\x80\x9cgo metric\xe2\x80\x9d be within the powers of Congress? For more\ninformation on this topic, explore the National Institute of Standards and Technology\nathttp://www.nist.gov.\n\n3.\n\nCongressional authority to regulate foreign trade extends to the use of economic sanctions against rogue\nforeign nations. How effective have these sanctions been in the past? Do you believe it is more effective\nfor Congress to ban trade with a foreign nation to encourage its citizens to overthrow hostile governments\nor for Congress to encourage trade so that those citizens may prosper economically?\n\n4.\n\nIf states are prohibited by the dormant commerce clause from discriminating against out-of-state\ncommerce, how can state universities charge a lower tuition rate to in-state residents? Can you distinguish\nthe role the state is playing when it does so, between that of a spender and that of a collector of monies?\n\n5.\n\nRead the New York Times article on Amazon.com and its efforts to avoid a nexus to collect sales tax,\nathttp://www.nytimes.com/2009/12/27/business/27digi.html. Amazon.com generates more than twenty\nbillion dollars in sales annually but only collects sales taxes in five states, where it is headquartered and\nwhere it has facilities. Through a process called \xe2\x80\x9centity isolation,\xe2\x80\x9d the company has created methods that\nallow it to avoid creating a nexus even in states where it has employees and facilities. What are the\nimplications of this behavior?\n\n6.\n\nIn 2005, in an effort to coerce states to tighten up standards for issuing identity cards and driver licenses in\nthe fight against terrorism, Congress passed the REAL ID Act stipulating certain requirements for stateissued identification. States that failed to comply would be punished by its citizens being denied access to\nfederally run facilities including airports. How is this an exercise of the spending power? Do you believe\nCongress should have the ability to stipulate who can use federally funded airports?\n\n[1] Heart of Atlanta Motel v. United States, 379 U.S. 241 (1964).\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n158\n\n\x0c[2] United States v. Lopez, 514 U.S. 549 (1995).\n[3] United States v. Morris, 529 U.S. 598 (2000).\n[4] Gonzalez v. Oregon, 546 U.S. 243 (2006).\n[5] Granholm v. Heald, 544 U.S. 460 (2005).\n[6] South Dakota v. Dole, 483 U.S. 203 (1987).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n159\n\n\x0c5.3 Business and the Bill of Rights\nLEARNING OBJECTIVES\n1.\n\nLearn how the Constitution protects the civil liberties of business entities.\n\n2.\n\nExplore how the First Amendment protects a company\xe2\x80\x99s right to speak.\n\n3.\n\nDiscuss how the due process clause protects companies from arbitrary government action.\n\n4.\n\nLearn how the equal protection clause protects companies from government discrimination.\n\nThe ink on the Constitution was barely dry when the first Congress began turning its attention to\namending it. During the debate surrounding the Constitution, there was much discussion about\nwhether or not an explicit protection of civil liberty was necessary. Some believed that the British\ncommon-law system implicitly protected civil liberties, so a written declaration of rights wasn\xe2\x80\x99t\nnecessary. Others believed that the Constitution created a strong federal government and that a\nwritten declaration of rights was therefore critically necessary. In 1789, the same year the\nConstitution went into effect, Congress proposed ten amendments to the Constitution, a package that\nbecame known as the Bill of Rights. Within two years, the Bill of Rights had garnered the necessary\nvotes to become law.\nWhen we speak of civil liberties protected in the Constitution, we often think of how these liberties\napply to people. Although the Constitution does not contain the word \xe2\x80\x9ccorporation,\xe2\x80\x9d corporations\nhave some characteristics of being a \xe2\x80\x9cperson,\xe2\x80\x9d so various courts have held that several of these civil\nrights also apply to business entities. In this section we\xe2\x80\x99ll take a closer look at how these rights apply\nto businesses. In particular, we\xe2\x80\x99ll examine the First, Fifth, and Fourteenth amendments.\nBefore we begin, it\xe2\x80\x99s worth making some observations about civil liberties generally. First, there are\nno absolute rights, in spite of the wording of any specific amendment. For example, the First\nAmendment states that \xe2\x80\x9cCongress shall make no law abridging the freedom of speech.\xe2\x80\x9d In fact, there\nare many laws that limit the freedom of speech. You aren\xe2\x80\x99t allowed to libel or slander someone, for\nexample, or incite a crowd into a riot. Instead of absolute rights, courts have to constantly balance\ncompeting interests in deciding where the limits of our rights lie. The right of the public to know\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n160\n\n\x0cinformation about the lives of politicians and other high-profile figures, for example, must often be\nbalanced by the right those citizens have to their own privacy.\nSecond, it\xe2\x80\x99s fair to say that while the Constitution sets up a system of government based on principles\nof representative democracy, the Bill of Rights exists to protect the minority, not the majority. The\nvast majority of Americans will go through life without ever having their constitutional rights\ntrampled on. It is for the very small minority of Americans that find themselves victims of\nconstitutional violations that we find the greatest strength of the Bill of Rights. For this reason, many\nissues raised by civil liberties generally rise above the political process, where the majority generally\nprevails. For example, public opinion polls show that well over 95 percent of Americans feel that\nburning the American flag should be illegal. When such an overwhelming majority agrees on\nsomething, in a democracy the majority should prevail. In our democracy, however, the Supreme\nCourt has stepped in and decided that the First Amendment will protect the very tiny percentage of\nthe American population that wishes to burn the flag as a display of political opposition.\nAdditionally, it\xe2\x80\x99s important to note that the only reason those of us in the majority know where the\nboundaries of our civil liberties lie is because of that tiny minority. If Americans weren\xe2\x80\x99t willing to\ntest the boundaries by burning the flag or joining the Communist Party or refusing to take loyalty\noaths or refusing to send their Amish children to public schools, then our civil liberties would remain\ntheoretical ideals rather than concrete rights. Finally, note that other than the right to vote, the civil\nliberties protected by the Constitution extend to all persons physically on U.S. soil, not just citizens\nor legal immigrants. Persons visiting the United States temporarily, such as tourists and students, as\nwell as undocumented aliens, are all entitled to the full protections of the U.S. Constitution while\nsubject to U.S. law.\nThird, the extent of our civil liberties protections vary from time to time. Society evolves with\nprogress and challenges, and with that evolution, different needs arise in the realm of civil liberties.\nThe Founding Fathers could not contemplate a digital world where an act of defamation on Facebook\ncan spread to millions of people in a matter of hours, or imagine a society as pluralistic and diverse\nas ours has become. One constitutional amendment, the Eighth, illustrates how time shifts the\nmeaning and application of civil liberty. The Eighth Amendment prohibits \xe2\x80\x9ccruel and unusual\xe2\x80\x9d\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n161\n\n\x0cpunishment. The Supreme Court, in defining what \xe2\x80\x9ccruel and unusual\xe2\x80\x9d is, looks to \xe2\x80\x9cevolving\nstandards of decency\xe2\x80\x9d in making the determination\xe2\x80\x94in other words, what is cruel and unusual today\nmay have been normal in years past.\nFinally, major portions of the Bill of Rights apply equally to the states as they do the federal\ngovernment. When adopted, the amendments were meant to restrict the federal government only\n(for example, \xe2\x80\x9cCongress shall make no law respecting an establishment of religion.\xe2\x80\x9d). States were not\nsimilarly restricted, and many states did in fact establish official state churches in the early days of\nthe United States. After the Civil War, the Constitution was amended to include the Fourteenth\nAmendment, which prevents any state from depriving citizens of their rights without \xe2\x80\x9cdue process of\nlaw.\xe2\x80\x9d Gradually, throughout the twentieth century, the Supreme Court developed a doctrine called\nincorporation, by which the limitations on government behavior in the Bill of Rights were extended to\n\napply to the states as well. While many portions of the Bill of Rights apply to the states, not all of it\ndoes. There is no requirement, for example, that states use a grand jury system to indict criminals.\nThere is also no requirement that states provide juries in civil trials.\n\nHyperlink: Does the Second Amendment Apply to the States?\nhttp://www.npr.org/templates/story/story.php?storyId=128182208\nIn 2008 the Supreme Court handed down a major victory for gun owners and gun rights advocates by\ndeclaring that a ban on handguns in the District of Columbia was unconstitutional under the Second\nAmendment, which the Court held protected an individual\xe2\x80\x99s right to possess a firearm in private homes in\nWashington, DC, and other federal territories.\n\n[1]\n\nSoon after the case was decided, several lawsuits were\n\nfiled across the nation, challenging similar bans on handguns in various states. In 2010 the Supreme\nCourt decided that the Second Amendment is indeed incorporated against the states, meaning that state\nlaws banning the possession of handguns in private homes are unconstitutional.\n\n[2]\n\nWe turn our attention first to the First Amendment. The First Amendment contains several\nimportant clauses pertaining to speech and religion. The two different clauses on religion are\ndesigned to be almost always in conflict with each other. On the one hand, the First Amendment\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n162\n\n\x0cprohibits the government from establishing any religion\xe2\x80\x94this is called the Establishment Clause. On\nthe other hand, the First Amendment prohibits the government from restricting the free exercise of\nreligion\xe2\x80\x94this is called the Free Exercise Clause. The conflict arises when some segments of society\nbelieve that the Free Exercise Clause means that they can practice their religion freely and openly,\nsuch as in a public school or city hall. Those who believe in what Thomas Jefferson called a\n\xe2\x80\x9cwall of separation\xe2\x80\x9d between church and state, on the other hand, believe that the Free Exercise\nClause must be subservient to the Establishment Clause, which would strictly prohibit such public\ndisplays of religious life.\nAs is often true in Bill of Rights cases, courts have had to fashion a test to draw the lines between\nthese two competing visions of the Establishment and Free Exercise clauses. Generally speaking, the\nuse of public funds for religious purposes and the public display of religious life are generally\nacceptable as long as the primary motivation is not to advance a specific religion. A city that wishes\nto display a Christmas tree or nativity scene, for example, would be permitted to do so as part of a\ngeneral holiday-themed cultural display that also included a menorah and Rudolph, while a public\nhigh school that wished to have a public prayer before a football game would be prohibited. Several\nevangelical Christian groups have campaigned hard to de-emphasize teaching evolution in public\nhigh schools, replacing it with an alternative theory called intelligent design, which states that the\nuniverse is so complex that it is impossible to be explained by random nature and, therefore, an\nintelligent entity designed it. In one high-profile trial involving a lawsuit against a school board for\nadopting intelligent design, a Republican-appointed federal judge found intelligent design to be a\nthin disguise for the teaching of Bible-based creationism, a violation of the Establishment\nClause. [3] On the other hand, the Supreme Court has found that the use of public funds to display the\nTen Commandments on public lands such as parks is not automatically an Establishment Clause\nviolation, depending on the context in which the monument or statue was erected. [4]\nThe First Amendment also protects the right to freedom of speech. While many nations believe in the\nright of citizens to think and speak freely, the United States is fairly unique in enshrining those\nprinciples into constitutional law. As is true in most Bill of Rights cases, the cases that test the limits\nof the First Amendment tend to be ones that involve the most unpopular, even heinous, speech. For\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n163\n\n\x0cexample, after World War II many European nations outlawed the Nazi Party along with any Nazi\npropaganda material, as well as neofascist ideology. As a result, many pro-Nazi and white\nsupremacist Web sites, books, catalogs, and music are hosted in the United States, where the First\nAmendment protects even hateful speech.\nNot all speech is protected by the First Amendment; the type of speech very much drives the level of\nprotection afforded it under the First Amendment. Courts generally recognize political speech as\nspeech most deserving of protection. Political dissent, displeasure with the government, forced\nloyalty oaths, restrictions on party membership, and even speech advocating the overthrow of\ngovernment, all deserve extraordinary protection under the First Amendment. Political speech isn\xe2\x80\x99t\nalways written or uttered\xe2\x80\x94it can sometimes take place through symbolic speech. The Supreme Court\nhas held, for example, that burning the U.S. flag as a form of protest against U.S. government policy\nis symbolic speech, and therefore attempts to criminalize flag burning are unconstitutional\nrestrictions on political speech. [5]\nOn the other end of the spectrum is speech that deserves no protection under the First Amendment\nat all, such as speech that incites a panic (yelling \xe2\x80\x9cFire\xe2\x80\x9d in a crowded theater when there is no fire, for\nexample). Defamation is another type of speech that falls into this category, and\nboth libel and slander are actionable torts. Obscene speech is also not subject to any protection under\nthe First Amendment. Defining what is obscene has always vexed courts. The best test courts have\ndeveloped is called the Miller test. [6] Under the Miller test, material is considered obscene if when\napplying contemporary community standards, the work, taken as a whole, appeals to a prurient\ninterest in sex; portrays sexual conduct as specifically defined by applicable state law; and lacks\nserious literary, artistic, political, or scientific value. It\xe2\x80\x99s important to keep in mind, however, that\neven obscene and defamatory speech is subject to the doctrine of prior restraint. Attempts to shut\ndown the speech before it is uttered are considered unconstitutional.\n\nHyperlink: Fleeting Expletives\nhttp://www.npr.org/templates/story/story.php?storyId=10741235\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n164\n\n\x0cAlthough the First Amendment generally prevents the U.S. government from engaging in censorship, an\nexception exists for broadcast radio and television. Unlike cable and satellite programming, which\nrequires viewers and listeners to \xe2\x80\x9copt in\xe2\x80\x9d with a paid subscription to access content, broadcast radio and\ntelevision use the public airwaves to carry transmissions that are readily accessible for free by anyone with\na television or a radio. In 1973, in a case involving comedian George Carlin\xe2\x80\x99s \xe2\x80\x9cDirty Words\xe2\x80\x9d monologue,\nthe Supreme Court held that although the monologue wasn\xe2\x80\x99t obscene, the government (through the\nFederal Communications Commission, or FCC) could nonetheless regulate indecent material when\n[7]\n\nvulnerable listeners, such as children, may be listening. Under this authority, the FCC enforces the\n\xe2\x80\x9cfleeting expletives\xe2\x80\x9d rule, which fines broadcasters for airing even momentary exclamations of profanity\nduring live broadcasts. In 2010, after several rounds of litigation, the Second Circuit Court of Appeals held\nthe FCC\xe2\x80\x99s policy was unconstitutionally vague.\n\nOne area of First Amendment law that remains unsettled is what rights corporations have to speak,\nalso known as commercial speech. In the early part of the twentieth century, the Supreme Court\nfound that corporations had virtually no protection under the First Amendment. This view gradually\nevolved as the role and influence of companies grew. Today, corporations engage not just in purely\ncommercial speech such as product advertising but also in matters of public policy, from\nglobalization to human rights to environmental protection and global warming. In 2002 it looked\nlike the Supreme Court would finally issue some guidance on this issue. [8] In California, Nike Inc.\nwas under fire from labor activists for allegedly engaging in sweatshop conditions in its foreign\nfactories, including hiring child labor. In response to these allegations, Nike issued a series of press\nreleases and denials, the \xe2\x80\x9cspeech\xe2\x80\x9d in this case. Several activists filed lawsuits against Nike, claiming\nthat these press releases and denials constituted false advertising by a company, which is against\nCalifornia law. Nike\xe2\x80\x99s defense was that the press releases were more like political speech and were\ntherefore protected by the First Amendment. Nike lost the argument in California state courts, and\nwhen the U.S. Supreme Court agreed to hear the case, the parties settled before the case could\nproceed any further.\nIn early 2010, however, the Supreme Court handed down another important decision on the rights of\ncorporations to speak. [9] In striking down federal and twenty-two state restrictions on corporate\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n165\n\n\x0cspending on political campaigns, the Supreme Court held that corporations are persons and\ntherefore entitled to engage in political speech. Since corporations are unable to literally \xe2\x80\x9cspeak,\xe2\x80\x9d\nthey speak through spending money, and thus restrictions on how corporations may spend money\nduring political campaigns are unconstitutional. The four dissenting justices worried about the\nimplications of this ruling. If corporations aren\xe2\x80\x99t allowed to vote, then why should corporations be\nallowed to spend freely to drown out the voices of real voters, who have no hopes of matching\ncorporate spending on issue advertisements? Similarly, foreign persons have the same rights as U.S.\ncitizens in making speeches on U.S. soil. If corporations are persons for purposes of speech, then it\nstands to reason that foreign corporations operating in the United States are entitled to the same\nprotections and can also spend freely to influence U.S. elections. The implications of this ruling will\nlikely be felt for many years to come.\nNot all protected speech is protected all the time in all places. The government is permitted to place\nreasonable time, place, and manner restrictions on speech to maintain important governmental\nfunctions. These restrictions are generally upheld if they further an important or substantial\ngovernmental interest, they are unrelated to the suppression of free expression (in other words, are\ncontent neutral), and any restriction on First Amendment freedoms is no greater than that necessary\nto further governmental interests (the restriction is not overbreadth). Thus, for example, courts have\nupheld restrictions on posting signs on city-owned utility poles and picketing or protest permit\nrequirements. On the other hand, when Congress tried to make it illegal for commercial Web sites to\nallow minors to access \xe2\x80\x9charmful\xe2\x80\x9d content on the Internet in the Child Online Protection Act (COPA),\nthe Supreme Court held the Act unconstitutional because of the overbreadth doctrine. [10] The Court\nfound there were less restrictive alternatives than the Act, such as blocking and filtering software,\nand therefore the burdens placed by COPA on the First Amendment, by sweeping both legal as well\nas illegal behavior, were too heavy to be constitutional.\nFigure 5.4 Joseph Frederick and Bong Hits 4 Jesus\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n166\n\n\x0cSource: Photo courtesy of Clay Good / Zuma Press,http://en.wikipedia.org/wiki/File:Bh4j.jpg.\n\nDoes this doctrine permit school officials to curb the free speech rights of high school students, who\notherwise have rights outside of school hours? In 2002 an eighteen-year-old high school senior was\nsuspended after he (with help from some friends) unfurled a banner during the Olympic torch relay\nthrough his town. The student, Joseph Frederick, was not in school that day and was standing across\nthe street from the school when he unfurled the banner (Figure 5.4 "Joseph Frederick and Bong Hits\n4 Jesus"). When asked later what the banner meant, Frederick replied that it was a nonsensical\nphrase he saw on a sticker while snowboarding. Frederick sued his high school principal for violating\nhis First Amendment rights and won in the lower courts. On appeal, however, by a 5\xe2\x80\x934 decision the\nSupreme Court held that the school, which has a zero-tolerance policy on drug use, could restrict a\nstudent\xe2\x80\x99s prodrug message even in these circumstances. [11]\nAnother important restriction on governmental authority actually appears twice in the Constitution.\nThe due process clause appears in both the Fifth Amendment (\xe2\x80\x9cNo person shall\xe2\x80\xa6be deprived of life,\nliberty or property without due process of law\xe2\x80\x9d) and the Fourteenth Amendment (\xe2\x80\x9cNor shall any\nState deprive any person of life, liberty, or property, without due process of law\xe2\x80\x9d). The Fifth\nAmendment applies to the federal government, and after the Civil War, the Fourteenth Amendment\nmade due process applicable to the states as well. At its core, due process means \xe2\x80\x9cfundamental\nfairness and decency.\xe2\x80\x9d The clause requires that all government action that involves the taking of life,\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n167\n\n\x0cliberty, or property be done fairly and for fair reasons. Notice that the due process clause applies only\nto government action\xe2\x80\x94it does not apply to the actions of private citizens or entities such as\ncorporations or, for that matter, to actions of private universities and colleges.\nAs interpreted by the courts, the due process clause contains two components. The first is\ncalled procedural due process. Procedural due process requires that any government action that takes\naway life, liberty, or property must be made fairly and using fair procedures. In criminal cases, this\nmeans that before a government can move to take away life, liberty, or property, the defendant is\nentitled to at least adequate notice, a hearing, and a neutral judge. For example, in 2009 the\nSupreme Court held that a state Supreme Court judge\xe2\x80\x99s refusal to remove himself from a case\ninvolving a big campaign donor violated the procedural due process clause promise for a neutral\njudge.\n\nHyperlink: The Biased Judge\nhttp://www.npr.org/templates/story/story.php?storyId=105143851\nHugh Caperton, a small coal mine operator in West Virginia, sued the giant Massey Coal Company,\nalleging that Massey used illegal tactics to force him out of business. A jury awarded Caperton more than\nfifty million dollars in damages. When Massey appealed the case to the West Virginia Supreme Court, he\nspent more than three million dollars on a campaign to defeat an incumbent judge and promote another\njudge, who then refused to excuse himself from the appeal and ended up casting the swing vote in a 3\xe2\x80\x932\ndecision to overturn the fifty-million-dollar award. On appeal to the Supreme Court, the Court held that\nthe judge\xe2\x80\x99s actions violated procedural due process.\n\nThe second component of the due process clause is substantive due process. Substantive due process\nfocuses on the content of government legislation itself. Generally speaking, government regulation is\njustified whenever the government can articulate a rational reason for the regulation. In certain\ncategories, however, the government must articulate a compelling reason for the regulation. This is\nthe case when the regulation affects a fundamental right, which is a right deeply rooted in American\nhistory and implicit in the concept of ordered liberty. The government must also set forth compelling\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n168\n\n\x0creasons for restricting the right to vote or the right to travel. Since substantive due process is a fairly\namorphous concept, it is often used as a general basis for any lawsuit challenging government\nprocedures or laws that affect an individual\xe2\x80\x99s or company\xe2\x80\x99s civil liberties.\n\nHyperlink: A Question of Ethics\nWhen Can a State Force Sterilization?\nhttp://www.usatoday.com/news/health/2009-06-23-eugenics-carrie-buck_N.htm\nIn the early 1920s, the state of Virginia experimented with a eugenics program in an attempt to improve\nthe human race by eliminating \xe2\x80\x9cdefects\xe2\x80\x9d from the human gene pool. As part of this program, Virginia\napproved a law that would allow the forced sterilization of inmates in state institutions. Eighteen-year-old\nCarrie Buck became the first woman sterilized under this program. Buck, who had been raped by a\nnephew, was committed to the Virginia State Colony for Epileptics and Feeble-minded in Lynchburg,\nVirginia. Her birth mother was also committed, as was her daughter. When Buck challenged Virginia\xe2\x80\x99s law\nat the Supreme Court, Justice Oliver Wendell Holmes overruled her due process objections, holding that\n\xe2\x80\x9cit is better for all the world, if instead of waiting to execute degenerate offspring for crime, or to let them\nstarve for their imbecility, society can prevent those who are manifestly unfit from continuing their\nkind\xe2\x80\xa6Three generations of imbeciles are enough.\xe2\x80\x9d\n\n[12]\n\nBuck became the first of tens of thousands of\n\nAmericans forced to undergo sterilization as part of a general belief in eugenics, a belief apparently shared\nby members of the Supreme Court. Read the linked article to learn more about Carrie Buck, including the\ntotal lack of any evidence of mental defect when she was sterilized.\n\nBusinesses have used the substantive due process clause to limit the award of punitive damages in\ntort cases. They argue that a startlingly high punitive damage award is a state-sanctioned deprivation\nof property, which means the due process clause is implicated. Furthermore, if the award is grossly\nexcessive, then due process is violated. In 1996 the Supreme Court heard an appeal from German\nautomobile manufacturer BMW arising from a case from Alabama. [13]The plaintiff argued that\nalthough he bought his car new, it had in fact suffered some paint damage while in transit to the\ndealer, and the damage was not disclosed to him. When he found out about the prior damage, he\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n169\n\n\x0csued BMW, arguing that BMW\xe2\x80\x99s policy (which is that if damage to new cars can be repaired for 3\npercent of the car\xe2\x80\x99s value or less, then the car can be repaired and sold as new) damaged the resale\nvalue of his car. It cost six hundred dollars to fix the actual damage to his car, and the jury awarded\nhim four thousand dollars in compensatory damages for the lost resale value on his car. The jury\nthen awarded him four million dollars in punitive damages, which the Alabama Supreme Court\nreduced to two million. The Supreme Court found the punitive damages award unconstitutional\nunder the due process clause. In its holding, the Court said that there are three factors that\ndetermine if a punitive damage award is too high. First is the degree of reprehensibility of the\ndefendant\xe2\x80\x99s conduct. Second is the ratio between the compensatory and punitive damage award;\ngenerally, this ratio should be less than ten. Finally, courts should compare the punitive damage\naward with civil or criminal penalties awarded for similar misconduct. The Court reiterated its\nholding again in a case involving a $145 million punitive damage award against State Farm in a case\nwhere the compensatory award was one million dollars. [14] Interestingly, Justices Scalia and Thomas,\nboth conservative and generally seen as friendly to business interests, dissent from this view, finding\nthat nothing in the due process clause prevents high punitive damage awards.\nThe final constitutional protection we\xe2\x80\x99ll consider here is the Equal Protection Clause of the Fourteenth\nAmendment. The clause states that \xe2\x80\x9cNo state shall deny to any person within its jurisdiction the\nequal protection of the laws.\xe2\x80\x9d As discussed previously, this clause incorporates Constitutional\nprotections against the states in addition to the federal government. Although drafted and adopted in\nresponse to resistance to efforts at integration of African Americans in the South after the Civil War,\nthe promise of the Equal Protection Clause (enshrined at the Supreme Court building, Figure 5.5\n"U.S. Supreme Court Building") continues to find application in all manner of American public life\nwhere discrimination is an issue.\nFigure 5.5 U.S. Supreme Court Building\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n170\n\n\x0cSource: Photo courtesy of UpstateNYer,http://en.wikipedia.org/wiki/File:CourtEqualJustice.JPG.\n\nThe Equal Protection Clause is implicated anytime a law limits the liberty of some people but not\nothers. In other words, it operates to scrutinize government-sponsored discrimination. While the\nword \xe2\x80\x9cdiscrimination\xe2\x80\x9d has a negative connotation, in legal terms not all discrimination is illegal. A\ncriminal law might discriminate against those who steal, for example, in favor of those who don\xe2\x80\x99t\nsteal. The Equal Protection Clause seeks to determine what forms of discrimination are permissible.\nTo establish a guideline for courts to use in answering equal protection cases, the Supreme Court has\nestablished three standards of review when examining statutes that discriminate. The three\nstandards are known as minimal scrutiny, intermediate scrutiny, and strict scrutiny.\nIn the minimal scrutiny test, think of the courts turning on a twenty-watt lightbulb to look at the\nstatute. There\xe2\x80\x99s enough light to see the statute, but the light is so dim that the judges won\xe2\x80\x99t examine\nthe statute in great detail. Under this standard, government needs to put forth only a rational basis\nfor the law\xe2\x80\x94the law simply has to be reasonably related to some legitimate government interest. If\nthe judge is satisfied that the law is based on some rational basis (keeping in mind that with the\ntwenty-watt lightbulb, the inquiry isn\xe2\x80\x99t very deep), then the law passes equal protection. Thus, a law\nthat imprisons thieves easily passes minimal scrutiny, since there are many rational reasons to\nimprison thieves. As a matter of course, the vast majority of cases that are scrutinized under minimal\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n171\n\n\x0cscrutiny easily pass review. Most laws fall into this category of scrutiny by default\xe2\x80\x94courts apply\nheightened scrutiny only in special circumstances. Even under this low standard, however,\ngovernments must be able to articulate a rational basis for the law. For example, in 1995 Colorado\napproved a state constitutional amendment that would have prevented any city, town, or county in\nColorado from recognizing homosexuals as a protected class of citizens. The Supreme Court struck\ndown the constitutional amendment, finding there was no rational basis for it and that it was in fact\nmotivated by a \xe2\x80\x9cbare desire to harm a politically unpopular group.\xe2\x80\x9d[15]\nThe intermediate scrutiny test is reserved for cases where the government discriminates on the basis\nof sex or gender. Under this test, the government has to prove that the law in question is\nsubstantially related to an important government interest. Think of the courts turning on a sixty-watt\nlightbulb in this test, because they\xe2\x80\x99re expecting the government to provide more than just a rational\njustification for the law. Using this test, courts have invalidated gender restrictions on admissions to\nnursing school, laws that state only wives can receive alimony, and a higher minimum drinking age\nfor men. In one important case, the Supreme Court held that the system for single-sex education at\nthe Virginia Military Institute violated the Equal Protection Clause. [16] On the other hand, courts\nhave been willing to tolerate gender discrimination in the male-only Selective Service (military draft)\nsystem.\nThe strict scrutiny test is used when the government discriminates against a suspect class. Under this\ntest, the government has to prove that the law is justified by a compelling governmental interest, that\nthe law is narrowly tailored to achieve that goal or interest, and that the law is the least restrictive\nmeans to achieve that interest. Here, the courts are turning on a one-hundred-watt lightbulb in\nexamining the law, so they can examine the law in great detail to find justification. The standard is\nreserved for only a few classifications: laws that affect \xe2\x80\x9cfundamental rights\xe2\x80\x9d such as the rights in the\nBill of Rights and any government discrimination that affects a \xe2\x80\x9csuspect classification\xe2\x80\x9d such as race\nor national origin. In practice, when courts find that strict scrutiny applies, a law is very often struck\ndown as unconstitutional because it\xe2\x80\x99s so hard for government to pass this standard of review.\nCertainly, most laws that discriminate on the basis of race are struck down on this basis. There are a\nfew exceptions, however, where the Supreme Court has held that racial discrimination may be\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n172\n\n\x0cpermissible even under strict scrutiny. The first case rose in the height of World War II, when the\nfederal government sought to intern Japanese Americans into camps on the basis that they may pose\na national security risk. Fred Korematsu sued the federal government under the equal protection\nclause, arguing that as an American citizen the government was unfairly discriminating against him\non the basis of race, especially in light of the fact that Americans of Italian and German descent were\nnot treated similarly. In a 6\xe2\x80\x933 decision, the Supreme Court sided with the government. [17] Although\nthat decision has never been overturned, the U.S. government officially apologized for the\ninternment camps in the 1980s, paid many millions of dollars in reparations, and eventually awarded\nFred Korematsu the Presidential Medal of Freedom.\nA second case involving the use of racial discrimination surrounds the issue of affirmative action in\nhigher education. Many elite colleges and universities would have no problem filling their entire\nentering class with stellar academic students with high grade point averages and standardized testing\nscores. If they did this, however, their classrooms would generally look quite similar, as these\nstudents tend to come from a largely white, upper-middle-class socioeconomic profile. In a belief\nthat diversity adds value to the classroom learning experience, the University of Michigan added\n\xe2\x80\x9cpoints\xe2\x80\x9d to an applicant\xe2\x80\x99s profile if the applicant was a student athlete, from a diverse racial\nbackground, or from a rural area in Michigan. When this practice was challenged, the Supreme Court\nfound that this point system operated too much like a race quota, which has been illegal since the\n1970s, and overturned the system. [18] In a challenge by a law school applicant denied admission,\nhowever, the Supreme Court upheld the law school\xe2\x80\x99s system, which rather than assigning a\nmathematical formula, used a system where race was only a \xe2\x80\x9cpotential plus factor\xe2\x80\x9d to be considered\nwith many other factors. [19] After extensive briefing, including a record number of amicus briefs, the\nCourt found that diversity in higher education is a compelling enough state interest that schools\ncould consider race in deciding whether or not to admit students. The Court did caution, however,\nthat schools should move toward race-neutral systems and that affirmative action should not last\nmore than twenty-five more years.\n\nKEY TAKEAWAYS\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n173\n\n\x0cThe Bill of Rights provides key civil liberties to all Americans and persons on U.S. soil. These liberties are\nnever absolute, subject to competing interests that courts must balance in making their decisions. These\nrights also vary from time to time and are generally designed to protect the weakest in society rather than\nthe strongest. Many, but not all, of the restrictions on government activity found in the Bill of Rights also\napply to the states through incorporation. The First Amendment prohibits the government from\nestablishing religion and from restricting the free exercise thereof. The First Amendment also prohibits the\ngovernment from restricting the freedom of speech. Political speech is protected to the fullest extent by\nthe First Amendment, while obscene and defamatory speech is not protected at all but subject to the\ndoctrine of prior restraint. Corporations have some free speech rights under the corporate speech\ndoctrine. Generally speaking, states may impose reasonable time, place, and manner restrictions on the\ndelivery of speech. Procedural due process requires that the government use fair procedures anytime it\nseeks to deprive a citizen of life, liberty, or property. Substantive due process requires the government to\narticulate a rational basis for passing laws or, when fundamental rights are involved, to articulate a\ncompelling reason to do so. Substantive due process has been used by the Supreme Court to limit punitive\ndamage amounts. Equal protection requires the government to justify discrimination. In cases of racial\ndiscrimination, courts apply strict scrutiny to the law. In cases involving sex or gender discrimination, the\ncourts apply an intermediate level of scrutiny, and in all other cases, courts apply a minimal basis of\nscrutiny.\n\nEXERCISES\n1.\n\nAlthough the First Amendment prohibits the government from establishing religion, there is no prohibition\non spending money to support religious life generally. For example, the White House Office of Faith-based\nand Neighborhood Partnerships provides funding to several religious organizations, including\norganizations that maintain discriminatory policies toward gays and lesbians and routinely engage in\nproselytizing activity. Do you believe that public money should be used to fund these groups? Why or why\nnot?\n\n2.\n\nIn 2006 Ohio passed a law requiring all public schools that receive a donation of a plaque or poster with\nOhio\xe2\x80\x99s state motto, \xe2\x80\x9cIn God We Trust,\xe2\x80\x9d to display the donation prominently in a school cafeteria or\nclassroom. Do you believe this law is a violation of the First Amendment? Why or why not?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n174\n\n\x0c3.\n\nDuring the 2004 Super Bowl halftime show, a performance by Janet Jackson and Justin Timberlake ended\nin a \xe2\x80\x9cwardrobe malfunction\xe2\x80\x9d when Janet Jackson\xe2\x80\x99s breast was exposed for a split second. CBS was fined\nmore than half a million dollars for this violation after a record number of complaints were filed with the\nFCC. Do you believe that the government\xe2\x80\x99s action was fair?\n\n4.\n\nIn 1969 the Supreme Court ruled that school officials could not restrict students from wearing black\narmbands as a peace sign protesting the U.S. involvement in the Vietnam War, ruling that students do not\nshed their constitutional rights at the schoolhouse gates.\n\n[20]\n\nIn 2007 the Supreme Court held that school\n\nofficials could restrict students from engaging in speech that might undermine the school\xe2\x80\x99s zero-tolerance\npolicy on drug use. What factors do you think might explain the Court\xe2\x80\x99s decisions in these two cases?\n5.\n\nTry to find out if the Supreme Court has ever overturned Buck v. Bell. Do you believe that an attempt by\nthe state to force sterilization on mentally disabled women would survive a due process challenge today?\nIf the government is permitted to force sterilization, does that mean that the government also has the\npower to force women to have children if it can articulate compelling enough reasons to do so?\n\n6.\n\nLaws discriminating on the basis of age fall into the minimal basis scrutiny category. A state that wishes to\nraise the drinking age to twenty-five or the driving age to twenty, for example, needs to put forward only a\nrational basis for that law. Do you believe that age should fall into this category or into one of the other\ntwo categories for heightened review??\n\n7.\n\nDo you believe that public universities should be able to consider race as a factor in deciding whether or\nnot to admit a student? If a university is unable to consider race, how else might it design an admissions\nprogram to achieve a diverse classroom? What would have been the impact if the Grutter case had been\ndecided in favor of the plaintiff?\n\n[1] District of Columbia v. Heller, 554 U.S. ___ (2008),http://www.law.cornell.edu/supct/html/07290.ZS.html (accessed October 2, 2010).\n[2] McDonald v. Chicago, 561 U.S. ___ (2010),http://www.supremecourt.gov/opinions/09pdf/081521.pdf (accessed October 2, 2010).\n[3] Kitzmiller v. Dover Area School District, 400 F. Supp. 2d 707 (M.D. Pa. 2005).\n[4] Van Orden v. Perry, 545 U.S. 677 (2005).\n[5] Texas v. Johnson, 491 U.S. 397 (1989).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n175\n\n\x0c[6] Miller v. California, 413 U.S. 15 (1973).\n[7] F.C.C. v. Pacifica, 438 U.S. 726 (1978).\n[8] Nike v. Kasky, 539 U.S. 654 (2003).\n[9] Citizens United v. Federal Election Commission, 558 U.S. ___ (2010), http://www.fec.gov/\nlaw/litigation/cu_sc08_opinion.pdf (accessed October 2, 2010).\n[10] ACLU v. Ashcroft, 535 U.S. 564 (2002).\n[11] Morse v. Frederick, 551 U.S. 393 (2007).\n[12] Buck v. Bell, 274 U.S. 200 (1927).\n[13] BMW of North America Inc. v. Gore, 517 U.S. 559 (1996).\n[14] State Farm Mut. Automobile Ins. Co. v. Campbell, 538 U.S. 408 (2003).\n[15] Romer v. Evans, 517 U.S. 620 (1996).\n[16] United States v. Virginia, 518 U.S. 515 (1996).\n[17] Korematsu v. United States, 323 U.S. 214 (1944).\n[18] Gratz v. Bollinger, 539 U.S. 244 (2003).\n[19] Grutter v. Bollinger, 539 U.S. 306 (2003).\n[20] Tinker v. Des Moines Independent Community School District, 393 U.S. 503 (1969).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n176\n\n\x0c5.4 Concluding Thoughts\nFor being such a short document, the Constitution can be complex to interpret. The needs of a varied\nand diverse nation, as well as corporate enterprises, all demand a constitutional framework that is\nrigid enough to provide strict checks against tyranny by the majority, while flexible enough to adapt\nto new changing societal values and mores, as well as rapidly changing business conditions.\nUnderstanding the framework of government established by the Constitution, the powers of each\nbranch of government, and the substantive rights afforded to individuals and companies is a critical\npart of being an informed citizen. As our nation faces a new century with both uncertain currents and\na future brighter than the Founding Fathers could have envisioned, the Constitution will continue to\nprovide bedrock principles to ensure the \xe2\x80\x9cblessings of liberty\xe2\x80\x9d to all.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n177\n\n\x0cChapter 6\n\nContracts\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand what a contract is, how a contract is formed, the types\nof law that govern contracts, the elements of common-law contract formation, and defenses to contracts.\nYou will learn about performance and discharge, breach, and remedies. You will also understand\nimportant differences between common-law contracts and contracts between merchants under the\nUniform Commercial Code (UCC). You will recognize commonly used clauses in contracts and their\nimportance. You will also learn about assignment, delegation, and parol evidence. At the conclusion of this\nchapter, you should be able to answer the following questions:\n1.\n\nWhat is a contract?\n\n2.\n\nHow is a contract formed?\n\n3.\n\nWhen does common law govern contract formation, and when is the UCC relevant?\n\n4.\n\nWhat are the defenses to performance of a contract?\n\n5.\n\nWhat does it mean to breach a contract, and what are the consequences of breach?\n\n6.\n\nWhat are remedies for breach of contract?\n\n7.\n\nWhat common clauses can be used to accomplish certain goals, such as ensuring expediency, limiting\nliability, or restricting assignment?\n\nClint Eastwood had a long-term relationship with Sondra Locke. Sadly, the relationship deteriorated\nand, allegedly, ended on unfriendly terms. The couple never married, but they shared a household\nfor many years, and they worked on many professional projects together. When the relationship\nended, Locke sued Eastwood for various causes of action. To settle the case, Eastwood proposed,\namong other things, that if Locke dropped the lawsuit against him, he would secure a development\ndeal for Locke at Warner Bros. Inc. Locke was not only an actress; she was also a director. No doubt\nassuming that this deal would advance her professional interests and, at the same time, bring a longstanding personal dispute to an end, Locke agreed. Locke entered into a settlement agreement with\nEastwood, and as promised, she contemporaneously entered into an agreement with Warner Bros.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n178\n\n\x0cThe agreement with Warner Bros. had two components. First, it required Locke to submit work that\nshe was interested in developing, before she submitted it elsewhere. Warner Bros. was to accept or\nreject the work within thirty days. For this part of the contract, Locke would receive $250,000 per\nyear for three years. Second, the contract was a $750,000 \xe2\x80\x9cpay or play\xe2\x80\x9d deal, which gave Warner\nBros. a choice between using Locke\xe2\x80\x99s services as a director and paying Locke a fee. Though Locke did\nnot know this, Eastwood agreed to reimburse Warner Bros. for the cost of this contract if she did not\nhave success in developing her projects or using her director services. Warner Bros. paid the $1.5\nmillion contemplated under the contract, but it did not develop any of Locke\xe2\x80\x99s thirty proposed\nprojects, and it did not hire her to direct any films.\nLocke argued that the agreement had been a sham, because Warner Bros. had never intended to\nmake films with her. She also argued that its only motivation for entering into the contract with her\nwas to help Eastwood in settling her earlier claims against him. Locke sued Warner Bros. for a\nnumber of claims, including a breach of the implied covenant of good faith and fair dealing, and fraud.\nShe alleged that she was deprived of the benefit of the bargain and that Warner Bros. had no\nintention of honoring its agreement with her. Warner Bros. won at trial, and Locke appealed.\nThe California Court of Appeals found that while the creative decisions of Warner Bros. were not\nappropriate for judicial review, acting in bad faith by refusing to consider the merits of Locke\xe2\x80\x99s\nproposals was a matter for the courts. The court also noted that even though the contractual sum of\nmoney was paid, that alone did not constitute performance under the contract. Part of the value of\nthe contract for Locke was the opportunity to work on projects that would earn additional money and\npromote and enhance Locke\xe2\x80\x99s career. Moreover, the appellate court found that if Warner Bros. never\nintended to work with Locke but had entered into the contract solely to accommodate Eastwood,\nthen a lack of good faith might be inferred. [1]\nWhat do you think about this case? After all, Locke was compensated the amount of money explicitly\ncontemplated under the contract. Should it matter whether one party acts in good faith or not? We\nmight say that this contract contains all necessary elements to be enforceable, and it looks on its face\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n179\n\n\x0cas if it has been performed. However, a lack of good faith by one party could lead to damages. After\nthe court\xe2\x80\x99s decision, the parties settled for an undisclosed amount.\nContracts are a fundamental part of doing business. A contract is a legally enforceable promise. As\nyou know, breaking promises is a big deal. Ethical questions arise when promises are broken. For\nexample, what if you promised to mow your elderly neighbor\xe2\x80\x99s lawn because you wanted to help him,\nbut then you never got around to doing it? Wouldn\xe2\x80\x99t you feel guilty about watching his grass grow\ninto tall weeds?\nWhen the promise is a legally enforceable promise, feeling guilty about breaking the promise is not\nthe only fallout. When a legally enforceable promise is broken, the injured party can seek damages. In\ncontracts, this usually means that the party who breaches the contract must pay the injured party an\namount that would make that party whole again. Also, some people disagree about whether\nbreaching a legally enforceable promise\xe2\x80\x94that is, a contract\xe2\x80\x94carries any ethical implications. For\ninstance, if a company decides that it is less expensive to pay damages than fulfill its promise by\nperforming under a contract, it might make the decision to breach based on rational decision\nmaking. That is, since it will be less expensive to breach, it makes sense to breach. Others disagree\nwith this approach, pointing out that reliance on promises is an important part of business that\nprovides necessary stability, regardless of whether keeping the promise makes economic sense or\nnot.\nIf you had a business, would you breach a contract to save money? Why or why not?\nContracts are agreements between two or more parties. Generally speaking, contracts are a form\nof private law, because the terms of the contract are binding on those parties but not on everyone. The\ncontract representsmutual assent to a bargained-for exchange between parties.\nGenerally speaking, in the United States parties may enter into contracts for whatever they wish and\nunder any terms that they agree on. In other words, parties may assent to agreements even if those\nagreements represent bad bargains. However, there are certain external restrictions on our abilities\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n180\n\n\x0cto form contracts. Additionally, certain internal (to the contract) restrictions may exist on our\nabilities to exercise rights or to engage in other contracts.\nLegal restrictions, external to the contract, limit our ability to bargain. For example, if you wanted to\nhire someone to work for your company, you could not contract with that person to work onehundred-hour workweeks at twenty-five cents per hour. Even if you could find someone to work\nunder those conditions and even if you both agreed to those terms of the contract, our statutory and\nregulatory laws prohibit you from entering into a contract with those terms. Such wages would\nviolate minimum wage laws.\nThere may also be restrictions that are internal to the contract. Imagine that you entered into an\nemployment contract with a company to work for $55,000 per year, plus benefits, and for a term of\ntwo years. You might be pretty happy about that. But what if, one month later, another company\noffered you the same position at its company, but for a salary of $65,000 per year, plus benefits. The\nbetter offer does not invalidate your first contract. In fact, in such a case, your first contract would\nprobably contain a noncompete clause that would prohibit you from working in a similar capacity for\na specified length of time and geographic area. So even if you decided to breach your first contract to\nenter into the second, you would be prohibited from doing so under the noncompete clause.\n\nKey Takeaways\nContracts are legally enforceable promises that, if breached, result in compensable damages. Contracts\nare a fundamental part of doing business, which require not only performance of the terms of the contract\nbut also good faith in dealing. Parties may enter into a contract for any agreement with terms, providing\nthe agreement is legal. Also, restrictions on ability to contract may be external, such as those imposed by\nlaw, or they may be internal, such as those imposed by clauses like noncompete agreements.\n\n[1] Locke v. Warner Bros. Inc., 57 Cal. App. 4th 354 (1997).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n181\n\n\x0c6.1 Formation\nLEARNING OBJECTIVES\n1.\n\nFind out when the Uniform Commercial Code (UCC) is the appropriate law to apply and when the\ncommon law is the appropriate law.\n\n2.\n\nLearn the elements of common-law contracts.\n\n3.\n\nIdentify the difference between common-law contracts and contracts between merchants.\n\nA contract is a legally enforceable promise. Therefore, it is important to know whether promises\nmade are legally enforceable. You certainly have made many promises in your life. You have\nprobably broken a few promises, too. For example, if you promised your best friend that you would\nbe best friends forever, but then your relationship changed, we might say that is a broken promise.\nHowever, you would not be held legally liable to pay damages for breaking that promise. On the\nother hand, if you promised your bank that you would make payments to it in exchange for the bank\nloaning money to you to purchase a car, and if you broke that promise by failing to pay as scheduled,\nthen you have broken a legally enforceable promise. The bank could seek damages from you to make\nitself whole again. What is the difference between these two promises? Why would you have to pay\ndamages to the bank but not to your former best friend? More specifically, why is one considered a\nbreach of contract and the other simply a broken promise?\nThis section explores contract formation. We can examine the elements of formation to determine\nwhether the contract is valid or whether it suffers some deficiency that renders it not legally\nenforceable.\nIn the United States, two primary sources of law govern our contracts: the common law and the\nUniform Commercial Code. The Uniform Commercial Code (UCC) article 2 governs contracts between\na merchant and the sale of goods. Essentially, the UCC contains two sets of rules for contracts. One\nset involves rules for everyone, and the other set involves rules for merchants. In this section, we will\nexplore the UCC as it applies to merchants. Chiefly, we will examine how the UCC requirements\ndiffer from common law in contract formation\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n182\n\n\x0cHowever, we will first address common-law contracts. Common law governs contracts for services as\nwell as contracts not otherwise governed by the UCC. It is important to recognize the elements of\ncommon-law contract formation because they are more stringent than the requirements for\nformation between merchants under the UCC. If all elements of common-law contract formation do\nnot exist, then the contract may be void or voidable.\nThe elements of common-law contract formation include offer, acceptance, and consideration. Offer\nand acceptance together form mutual assent. Additionally, to be enforceable, the contract must be\nfor a legal purpose and parties to the contract must have capacity to enter into the contract.\nAn offer gives power of acceptance to another party, and it includes the agreement\xe2\x80\x99s essential\nelements, which must be definite and certain. For example, if an offeror says to you, \xe2\x80\x9cI offer to sell\nyou my scooter for four hundred dollars,\xe2\x80\x9d then that offer is valid. It contains the price, the person to\nwhom the offer is made, and the object of the offer (i.e., the scooter). It creates a power of acceptance\nin you, the offeree.\nImportantly, in common-law contracts, the acceptance must be amirror image of the offer to\nconstitute valid acceptance. This means that the acceptance must be precisely the same as the offer.\nIf the acceptance is not precisely the same, then it will fail to meet the requirements of an acceptance,\nand it will not constitute a valid element of formation in contract. To accept the offer, the offeree\ncould say something like this: \xe2\x80\x9cI agree to buy your scooter for four hundred dollars.\xe2\x80\x9d If\na counteroffer is made, then that would not be acceptance, because the counteroffer would not be a\nmirror image of the offer itself. So, for example, if the offeree said, \xe2\x80\x9cI agree to buy your scooter for\nthree hundred dollars,\xe2\x80\x9d that would not be an acceptance. In fact, a counteroffer is a rejection of the\noffer. Once an offeree rejects an offer\xe2\x80\x94either outright (e.g., by declining to accept) or through\ncounteroffer, the offeror is free to walk away from the failed negotiation. In this example, he no\nlonger has to sell his scooter at all, not even if the offeree changes his mind and agrees to pay four\nhundred dollars. Likewise, if the offeror revokes an offer before the offeree accepts, then the power of\nacceptance has been withdrawn by that revocation. The offeror would no longer have to sell the item\noriginally offered. If the offeror wished to limit the time that an offer was valid, he could do so by\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n183\n\n\x0climiting the time that the offer may be accepted. If the offer is not accepted during that time, then the\nofferor is not required to honor any acceptance that is made after expiration of the offer.\nWhat if you saw an advertisement for a scooter for sale at a local shop? Perhaps the advertisement\nlooked like this:\nDo you think that this advertisement should create the power of acceptance in you, a potential\ncustomer? The fact is that an advertisement is not an offer. It is simply an invitation to bargain.\nAdvertisements are requests for people to make offers. This places the power of acceptance on the\nmerchant, who is free to reject offers or to choose to whom he sells. Of course, certain statutory\nprotections exist today to protect consumers against unscrupulous merchants who might engage in\nunethical behavior, such as bait-and-switch or false advertising, or race-based denial of services or\nrefusal to contract. Specifically, consumer protection statutes and civil rights statutes, respectively,\nwould protect consumers in such circumstances.\nIf an offer is valid, then the acceptance must be a mirror image, as mentioned previously.\nA bilateral contract is a contract in which both parties make a promise. The previous example is an\nexample of a bilateral contract. The following is a promise for a promise:\nThe offeror says, \xe2\x80\x9cI offer to sell you my scooter for four hundred dollars.\xe2\x80\x9d\nThe offeree replies, \xe2\x80\x9cI agree to buy your scooter for four hundred dollars.\xe2\x80\x9d\n\nSpecifically, it is a promise to sell the scooter in exchange for a promise to buy the scooter for four\nhundred dollars. Since this is a promise for a promise, then this is a bilateral contract.\nA unilateral contract is one in which the accepting party may only accept through an action. Here is\nan example:\nThe offeror says, \xe2\x80\x9cI will sell this scooter to the first person who puts four hundred dollars cash in\nmy hands.\xe2\x80\x9d\nThe offeree says nothing but places four hundred dollars cash into the offeror\xe2\x80\x99s hands.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n184\n\n\x0cThis is a promise for an action. Specifically, it is a promise to sell the scooter in exchange for the\naction of placing four hundred dollars cash into the offeror\xe2\x80\x99s hands.\nCommon-law contracts can be either bilateral or unilateral.\nAdditionally, all common-law contracts must contain valid consideration. This means that there\nmust be a bargained-for exchange of acts or promises, and both parties must incur\nnew legal detriment or obligations as a result of the contract. Imagine that you have accepted a new\nposition with a company. You have a valid employment contract that you\xe2\x80\x99ve successfully negotiated\nprior to beginning work. All terms of the contract are valid, and both parties are bound to the\ncontract. Basically, this means that you have agreed to work for a specified period of time, and your\nemployer has agreed to compensate you with a specified salary and benefits in exchange for your\nwork. So far, so good, right?\nNow, imagine that during your first week, your boss appears in your office and asks you to sign a new\ncontract that, in essence, is a noncompete agreement. This means that your employer now wants you\nto sign a new contract agreeing not to compete with the company if you decide to terminate your\nemployment arrangement. The employer wants you to make this promise, but the employer does not\noffer anything additional in return. For the purposes of this example, let\xe2\x80\x99s say that you sign the new\nagreement. Is this new agreement valid and binding on you? Probably not. Why? Because the\ncompany has not suffered any new legal detriment or obligation as a result of the contract. You have\nagreed to refrain from competing with the company if you leave, but the company itself has not given\nyou anything in return for your promise. To make this contract binding against you, your employer\nshould have provided consideration. For example, it could have asked you to sign the noncompete\nagreement in consideration of an additional one thousand dollars of salary per year. Then, the\ncontract would have consideration and it would have a much greater chance of being found to be\nvalid. Better yet, the company should have negotiated the noncompete agreement along with your\noriginal contract before you assumed your new position.\nLet\xe2\x80\x99s continue our example of an offeror who offers to sell his scooter for four hundred dollars. He\nsays, \xe2\x80\x9cI offer to sell you my scooter for four hundred dollars.\xe2\x80\x9d If you reply, \xe2\x80\x9cI agree to buy your\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n185\n\n\x0cscooter for four hundred dollars, if I don\xe2\x80\x99t find one that I like more,\xe2\x80\x9d then that does not constitute\nvalid consideration. This is because you have placed a condition on the consideration. In essence,\nyou have made what appears to be a promise to do something, but instead of being a promise, it is\nonly an illusion of a promise. This is called an illusory promise, and it does not constitute valid\nconsideration. There is no legal detriment to you here, because you might find a scooter that you like\nmore than the one offered by the offeror. You have a way out. A legal detriment is a detriment (or\nburden or obligation) that is legally enforceable. You cannot \xe2\x80\x9cget out\xe2\x80\x9d of the promise without\nsuffering legal detriment. The other party must be able to rely on the promise for it to constitute valid\nconsideration. The thing bargained for can be an act or a promise (either to do something or to\nrefrain from doing something.)\nAdditionally, for a contract to be valid, the subject matter of the contract must be for a legal purpose.\nIf a distributor of illegal drugs hires a pilot to fly his illegal cargo to a particular place in exchange for\npayment, this is a contract for an illegal subject matter. If the drug dealer fails to honor his\nagreement to pay, or if the pilot fails to honor his agreement to transport the cargo, neither aggrieved\nparty will find a remedy in our courts, even if the elements of contract are all present and perfectly\nformed.\nMoreover, the parties to contract must have capacity to enter into the contract for its terms to be\nenforceable against them. Adults of sound mind have capacity. Minors lack legal capacity, but they\nmay enter into contracts that they may cancel at their sole option. In other words, a minor who\nenters into a contract with a party who has capacity may void the contract, but the other party may\nnot. This means that any contract with a minor is voidable by the minor under the infancy doctrine.\nLet\xe2\x80\x99s compare common-law contract formation with UCC contract formation. Recall that common\nlaw governs contracts for services and contracts not governed by the UCC. Article 2 of the UCC\ngoverns the sale of goods, which is defined by \xc2\xa72-105 and includes things that are moveable, but not\nmoney or securities. It does not include land or houses. Contracts between merchants are also\ngoverned by article 2 of the UCC. Generally speaking, \xc2\xa72-104 defines a merchant as a person who\ndeals in goods or holds himself out as having special knowledge or skill regarding the practices or\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n186\n\n\x0cgoods that are the subject of the transaction. Since contracts law is a state law issue, each state can\nhave different laws related to contracts. The UCC seeks to provide uniformity to contracts law among\nthe different states. However, like other uniform laws, the UCC does not become a law until state\nlegislatures adopt it as law. All fifty states have adopted some version of the UCC.\nAs you can imagine, contracts between merchants do not always contain offers that include definite\nterms, and acceptances are not always mirror images. Merchants typically place a purchase order\nwhen they wish to purchase materials, and the seller often sends an invoice with the order when it\nships. Merchants frequently use boilerplate language in their individual purchase orders and invoices.\nObviously, not every merchant\xe2\x80\x99s contract will contain the same language as those of other merchants.\nThis can lead to discrepancies between terms that would be fatal in common-law contract formation,\notherwise known as battle of the forms. However, the UCC provides more flexibility in contract\nformation than exists in common-law contracts, thereby accommodating the reality of business\npractices. The requirements for common-law contract formation would be too burdensome for\nmerchants. Can you imagine if every merchant had to issue offers with definite terms and receive\nmirror image acceptances for every item that it sold or purchased to have valid, enforceable\ncontracts? Such a burden might cause commerce to come to a screeching halt. Or it might lead to\nmany contracts disputes.\nThe UCC also embodies some elements of the Statute of Frauds. The Statute of Frauds requires\ncertain types of contracts to be in writing to be enforceable. Specifically, it requires contracts to be in\nwriting for goods priced at five hundred dollars or more and signed by the defendant, for those\ncontracts to be enforceable. Other important types of contracts relevant to business that must be in\nwriting and signed by the defendant to be enforceable include contracts for any interest in land,\npromises to pay the debts of another, and contracts that cannot be performed within one year. The\ntypes of contracts that are contemplated by the Statute of Frauds but are not captured by the UCC\nare often embodied in state statutes. The peculiar name\xe2\x80\x94the Statute of Frauds\xe2\x80\x94is derived from its\nearly incarnation in seventeenth-century England, when a statute was passed by parliament to\nreduce or prevent fraud in property transactions and other important civil matters.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n187\n\n\x0cOf primary concern to students of business are the differences between common-law contracts and\nthe UCC. When analyzing a contracts issue, identification of the type of law that governs the contract\nshould be addressed first. This is because you cannot know which rule applies unless you know\nwhich type of law is applicable.\nThe primary differences between common-law contracts and the UCC are in the UCC\xe2\x80\x99s relaxation of\nvarious common-law contract formation requirements. See Table 6.1 "Differences between Contract\nFormations by Type of Law" for a comparison between common-law and UCC contract formation\nrequirements. When a battle of the forms ensues between merchants, for example, the conflicting\nterms are not fatal to the contract. This is a major departure from the mirror image rule required by\ncommon-law contracts. For the UCC, the primary issue is whether the parties intended to enter into\na binding agreement. New or additional terms included in an offer will become part of the contract\non acceptance. Terms that conflict with each other will \xe2\x80\x9cfall out\xe2\x80\x9d of the contract and be replaced by\nUCC gap fillers, which can create the terms of the contract. Likewise, terms that are left open will be\nfilled in. Gap fillers are terms provided by the UCC, and they can be inserted into a contract when\nthose terms are not definite. While prices, delivery dates, warranties, and other terms can be \xe2\x80\x9cfilled\nin\xe2\x80\x9d by the UCC gap fillers, quantity cannot. Quantity, therefore, is an essential term that must be\nspecified in the contract for it to be binding.\nTable 6.1 Differences between Contract Formations by Type of Law\n\nUCC\n\nCommon Law\n\nAny manner that shows agreement to contract (e.g., words,\nactions, writing)\n\nMirror image acceptance required\n\nQuantity term required; other terms may be filled in with gap\nfillers\n\nEssential terms must be definite\n\nContracts between merchants; contracts for sale of goods\npriced at $500 or more\n\nContracts for services and for interest in\nreal property\n\nKEY TAKEAWAYS\nA contract is a legally enforceable promise. Common law and the UCC are different sources of contract\nlaw. Common law is the appropriate type of law for service contracts and contracts that do not fall under\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n188\n\n\x0cthe UCC, like real estate contracts. The UCC governs contracts involving the sale of goods with a price of\nfive hundred dollars or more and in contracts between merchants. Common-law contract formation\nrequires a valid offer, acceptance, and consideration. The parties must have capacity, and the subject\nmatter must be a legal purpose. The UCC relaxes formation requirements by allowing the use of gap fillers\nfor undefined or conflicting terms and by allowing a contract to be formed by any manner that shows\nagreement to contract. Quantity is a required term for contracts governed by the UCC.\n\nEXERCISES\n1.\n\nIf a contract was not entered in good faith, do you think that fact alone should matter? Consider Locke v.\nWarner Bros. Inc., which was discussed in the introduction to this chapter. All essential elements of the\ncontract appear to have existed, and the parties performed as required by the wording of the contract.\nHow can lack of good faith be shown?\n\n2.\n\nHas anyone ever broken a promise to you? Were those promises legally enforceable promises? Why or\nwhy not? Be sure to analyze the agreement by checking to see if all elements of contract formation were\npresent. Remember to first determine whether the promise was one governed by the UCC or by common\nlaw.\n\n3.\n\nWhat are the dangers inherent to making a counteroffer? Imagine that you really wanted to sell your\nhouse. You receive an attractive offer, but you wondered whether you might be able to sell the house for\na little more money. What types of things should you think about before submitting a counteroffer?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n189\n\n\x0c6.2 Performance and Discharge, Breach, Defenses, Equitable\nRemedies\nLEARNING OBJECTIVES\n1.\n\nLearn what constitutes performance.\n\n2.\n\nUnderstand what it means to discharge obligations in a contract.\n\n3.\n\nExplore different standards of performance.\n\n4.\n\nExamine breach.\n\n5.\n\nExplore defenses to breach.\n\n6.\n\nLearn about equitable remedies.\n\nA contract is an enforceable promise. When the promise is fulfilled, then the contract terms have\nbeen satisfied. This means that the parties are discharged from the contract, because they have\nalready fulfilled their legal duties under it. That is, they have satisfactorily performed their\nobligations under the contract. Performance simply means undertaking the legal duties imposed on\nus by the terms of the contract. This is certainly what parties hope for when they enter into a\ncontract\xe2\x80\x94the successful execution of the terms of the contract and subsequent discharge from it.\nBut how do we know whether the contract terms have been performed? Sometimes it\xe2\x80\x99s easy to\ndetermine. For instance, if I offer to sell you my scooter for four hundred dollars, you agree to buy\nmy scooter for four hundred dollars, and we exchange those items, then we have fulfilled our\nobligations under the terms of the contract. We formed a contract, we fully performed our\nobligations under it (known as complete performance), and we are subsequently discharged from\nfurther duties arising under that contract.\nIn other cases, whether a party has performed can be trickier to determine. For example, imagine\nthat you hire a builder to construct a new home for you. You specify all dimensions of the home, as\nwell as your chosen building materials. Certainly this would be a very detailed contract. Imagine that\nall essential elements have been determined and that the contract is valid. In short, the builder\nagrees to build your specified home, and you agree to pay the builder the agreed on price. Imagine\nthat everything goes according to plan. When your home has been constructed, you visit it for the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n190\n\n\x0cfirst time. To your dismay, you see that the foyer has been tiled in red ceramic, even though you\nclearly specified\xe2\x80\x94and the contract clearly reflected\xe2\x80\x94that the foyer should be tiled in blue ceramic.\nHowever, on your further inspection, every other item specified in the contract has been completely\nperformed. Would we say that the builder has performed his duties under this contract? The item at\nissue is the problem with the foyer tile. Does this error rise to breach? More importantly, does this\nexcuse your obligations under the contract to pay the builder for his work?\nWhen a party fails to perform under the terms of the contract without a legally justifiable reason, the\nparty is said to be in breach of the contract. However, in a service contract\xe2\x80\x94such as a service to build\na house\xe2\x80\x94the standard of performance is substantial performance. This means that the performing\nparty acted in good faith and conveyed enough benefit of the contract to the other party so that the\nother party can use the benefit for its intended purpose, and the defects arising under the contract\nmay be remedied by money damages. A material breach in a service contract is when a party has not\nsubstantially performed under the terms of the contract. A minor breach is when the party has\nsubstantially performed but has not strictly performed. In our example, installation of the red tile in\nthe foyer would not rise to material breach, because presumably the builder acted in good faith, he\nproduced a house that is capable of being used for its intended purpose, and the defects (the red tile)\ncan be remedied through monetary damages. They simply need to be replaced by blue tiles. This was\na minor breach. If this were your contract, you would have to pay the builder as required under the\ncontract, less the cost of replacing the tile.\nConsider the firing of Texas Tech\xe2\x80\x99s head football coach, Mike Leach, in Note 6.47 "Hyperlink: Coach\nMike Leach" to practice your analytical skills. Try to identify what additional information you would\nneed to determine whether substantial performance exists, or whether the contract has been\nmaterially breached.\nSometimes, substantial performance is not adequate. Adherence to a strict performance standard\nrequires express terms in the contract to that effect and circumstances where such a high standard is\nreasonable. In our scooter example, if you tried to give the offeror three hundred dollars in cash and\none hundred dollars in postage stamps, then that would most likely not satisfy the terms of the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n191\n\n\x0ccontract. You might recall that the contract was a bargain for a scooter in exchange for four hundred\ndollars. Here, strict performance makes sense and is reasonable.\nPerformance to the standard of personal satisfaction can be enforced if the contract expressly requires\nit. This means that the performance under the contract is scrutinized subjectively, either by one party\nto the contract or by a third-party beneficiary specified in the contract. If the subject of the contract\nis something for which approval is dependent on someone\xe2\x80\x99s subjective opinion, like personal taste,\nthen assessment can be made on a subjective standard providing this standard is clearly specified in\nthe contract. For example, if you owned a piano bar, and you wished to hire a truly inspired pianist\nfor entertainment, you might enter into a contract with a pianist subject to a personal satisfaction\nstandard. Even if that person could tickle the ivory flawlessly, you might decide that his or her music\nis technically accurate but not truly inspired. Providing that your contract with the pianist allows for\npersonal satisfaction to be the standard of performance, you may terminate that contract based on\nhis or her failure to meet the personal satisfaction standard. This standard is unlike the substantial\nperformance standard, which requires an objective assessment based on\nthe reasonable person standard. Referring again to Note 6.47 "Hyperlink: Coach Mike Leach", which\nstandard appears to be controlling Texas Tech\xe2\x80\x99s decision to terminate Coach Leach\xe2\x80\x99s contract\xe2\x80\x94\npersonal satisfaction or substantial performance? Which standard is appropriate for a contract for\ncoaching services?\n\nHyperlink: Coach Mike Leach\nHead football coach Mike Leach of Texas Tech was fired for breach of contract. He had recently signed a\n$12.7 million contract for five years, and he had been named by the Associated Press as the Big XII Coach\nof the Year in 2008. However, that didn\xe2\x80\x99t stop Texas Tech from firing him, citing breach of performance\nas the reason for the termination. Under the terms of his contract, he was to \xe2\x80\x9cassure the fair and\nresponsible treatment of student-athletes in relation to their health, welfare, and discipline.\xe2\x80\x9d Allegedly,\nCoach Leach forced a student athlete to stand in a shed after the athlete was diagnosed with a mild\nconcussion. Leach\xe2\x80\x99s supporters argue that the \xe2\x80\x9cshed\xe2\x80\x9d was a comfortable garage-like room with a cooler\nand a fan and that Coach Leach was simply having the player stand inside, out of the sun, in accordance\nwith medical orders. Others argue that this was a sadistic punishment that was inappropriately levied\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n192\n\n\x0cagainst an injured player. Was Leach being cruel, or was he being protective of his charge in accordance\nwith his contract terms?\nUnderlying this controversy are allegations that the firing occurred because Leach interviewed with\nanother university unbeknownst to Texas Tech and because he has a colorful personality that might\noffend some people. For instance, he allegedly blamed his players\xe2\x80\x99 \xe2\x80\x9cfat little girlfriends\xe2\x80\x9d for distracting\nthem to their defeat against Texas A&M.\nCoach Leach was fired just before receiving an alleged $800,000 contractual bonus.\nCheck out the story here:\nhttp://www.cnn.com/2009/US/12/31/texas.tech.leach/index.html?iref=allsearch\nCheck out the video of the story here:\nhttp://sports.espn.go.com/ncf/bowls09/news/story?id=4781981\nWatch Coach Leach here:\nhttp://sports.espn.go.com/ncf/bowls09/news/story?id=4781981\nWatch speculation about Coach Leach\xe2\x80\x99s likelihood of being hired here:\nhttp://sports.espn.go.com/ncf/bowls09/news/story?id=4781981\nSee the exercises in this section for related questions and discussion.\n\nAs mentioned previously, when the promises in a contract have been fulfilled based on the\nappropriate standard\xe2\x80\x94substantial performance, strict performance, or personal satisfaction\xe2\x80\x94then\nthe parties are discharged. However, when a material breach occurs, the injured party may bring a\nclaim for damages. But that isn\xe2\x80\x99t necessarily the end of the story. The breaching party may have a\nvalid reason for breaching the contract. These valid reasons are known as defenses to contract. These\ndefenses include formation problems, lack of capacity, illegality of subject matter, impossibility,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n193\n\n\x0cduress, unconscionability, undue influence, violation of the Statute of Frauds requirement that\ncertain types of contracts must be in writing to be enforceable against the defendant, exceeding the\nstatute of limitations, mistake, misrepresentation, fraud, commercial impracticability, and\nfrustration of purpose. Bankruptcy discharge is a permanent legal excuse from performance, and it\nwill discharge obligations that are dischargeable by law if the debtor successful fulfills his obligations\nunder the bankruptcy. Obligations that are not dischargeable by law will not be permanently\ndischarged by a bankruptcy. However, during the bankruptcy, the performance of contract terms\nrequiring payment of debt incurred prior to filing the bankruptcy petition is suspended by the court\nuntil the bankruptcy is terminated either by successful completion of the bankruptcy or by dismissal\nof the case.\nFormation problems in common-law contracts relate to whether the offer, acceptance, and\nconsideration were valid. For example, if the offer did not contain the essential terms in definite and\ncertain form, then that offer will not be valid. If I offered to sell you my house for a fair price, it would\nnot be a sufficient offer because the price term is an essential element, and in this offer it is vague. To\nsay that a house will be sold \xe2\x80\x9cfor a fair price\xe2\x80\x9d is not specific. Likewise, in a common-law contract, if\nthe acceptance is not a mirror image of the offer, then the acceptance will not be valid. Similarly, if\nconsideration does not firmly commit the parties to the deal, then consideration will fail, as is the\ncase with an illusory promise. For example, if I offered to sell you my house for $150,000, and you\nagreed to buy it \xe2\x80\x9cif you like it,\xe2\x80\x9d then that is not a firm commitment. Consideration will fail, and the\ncontract has not formed. As a practical matter, how can this defense be used? The defendant simply\nneeds to show that the contract was never formed in the first place, due to one or more deficiencies\nin formation. Keep in mind, however, that if the Uniform Commercial Code (UCC) is the relevant\ntype of law, formation is much simpler than in common law. For example, all essential elements do\nnot need to be stated in definite and certain terms (but quantity must be stated), and acceptance\ndoes not need to be a mirror image of the offer. Accordingly, in contracts in which the UCC is the\nrelevant type of law, this defense can be more challenging to successfully mount.\nSometimes when all elements of the contract are not present, the court will enforce the promise\nthrough an equitable remedy to avoid a perceived injustice that would occur if the contract failed\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n194\n\n\x0cbased on a formation defect. Quasi-contract and promissory estoppel are two types of equitable\nremedies that a court may impose. When detrimental reliance is found, an equitable remedy can\nsubstitute for consideration. This allows the court to enforce the terms of the \xe2\x80\x9ccontract,\xe2\x80\x9d even\nthough, technically speaking, there was no contract to begin with.\nQuasi-contract is determined when one party will receive a benefit from the other unjustly\n(unjust enrichment), and the party who tendered the benefit reasonably expected to be paid for it. The\nparty who received the benefit knew that the other party reasonably expected to be paid. For\nexample, imagine that your neighbor hired painters to paint his house, but the painters accidentally\nappeared at your house to work. Instead of sending them away, you decided to let them paint your\nhouse, but you did not tell them that they were at the wrong house. At the end of the job, they\ndemanded payment. You point out that they never had a contract with you. While this would be true\nin fact, the issue is that you would be unjustly enriched by their painting of your house if you were\nnot made to pay. Additionally, you knew that the painters would reasonably expect to be paid for\ntheir services, and you did nothing to stop them. This would be a good case for a court to impose the\nequitable remedy of quasi-contract. The damages awarded in such case are called quantum meruit,\nwhich means \xe2\x80\x9cas much as is deserved.\xe2\x80\x9d The painters will receive the value of their services in\ndamages. Compare this situation with one in which you were on vacation when the painters painted\nyour house. You knew nothing of their presence. In such a case, quasi-contract would not be imposed\nas an equitable remedy because you were not aware of their presence. In fact, you would have a\npotential claim against the painters for interfering with your property and entering your land without\nyour permission. Promissory estoppel is another equitable remedy. It is imposed on parties when\none party detrimentally relied on another\xe2\x80\x99s promise, and to avoid injustice, the enforcement of the\npromise is required. Like quasi-contract, when promissory estoppel is used, there is some formation\nproblem with the contract so, technically speaking, no contract exists.\nThe remaining defenses discussed in this chapter are relevant if the contract is valid. That is, there\nare no formation problems. For example, if a party lacks capacity to enter into a binding contract,\nthat can be used as a defense. When people lack the mental ability to understand, they lack capacity.\nSometimes, it may seem that someone understands, even though he or she might actually lack legal\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n195\n\n\x0ccapacity. This is the case with minors. Though some may certainly understand the terms of a\ncontract, they lack the legal capacity to be bound to it. That means that they can disaffirm the\ncontract if they wish. Likewise, someone who suffers from a temporary or permanent cognitive defect\nlacks capacity to be bound to a contract. This may be the case with an infant, a person who suffers\nfrom dementia, or a person who has other profound cognitive or mental impairment. Use of alcohol\nor drugs may impair capacity, but the courts are reluctant to find this as a convincing defense,\nparticularly if the person voluntarily imbibed in the alcohol or drug use themselves. If they were\ninvoluntarily drugged, however, then lack of capacity can be a good defense. If someone does not\nread or speak the language in which the contract is written, that can also indicate a lack of capacity.\nIf the subject matter of a contract or the terms of the contract are illegal, then the contract may be\nvoid at the outset, or it may become void if the subject matter or the terms of the contract become\nillegal after the contract is formed. The former case can be illustrated by imagining a contract for the\nproduction of illegal drugs. A defense to performance is that the contract itself concerns an illegal\nsubject matter. A court will not step in to such a contract to enforce its promises.\nThe latter case of illegality of the terms of the contract is an example of impossibility as a defense.\nImpossibility is a defense that can be used when performing the contract has become truly\nimpossible. For example, if you entered into a contract to do business in a country that was\nsubsequently placed on a no-trade list by the federal government, then you would be excused from\nperforming your obligations under that contract, because it would violate federal law for you to\nperform as promised. It would be impossible, and impossibility would be a valid defense. Sometimes\nimpossibility does not involve the legality of the subject matter or the terms of the contract. Instead,\nit might simply be a matter of the destruction of the subject matter of the contract. In our scooter\nexample, imagine that before the transaction was completed, the scooter was crushed by the trash\ncollector by accident. The subject matter of the contract was destroyed, and so it would be impossible\nfor the offeror to perform. The offeror would not need to find another scooter to sell to fulfill the\nobligations under the contract. Instead, he or she would use the defense of impossibility.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n196\n\n\x0cAnother defense to contract performance is duress. If a party suffers from duress when entering the\ncontract, that party will have a valid defense. Duress means that the party had no other reasonable\nalternative but to enter into the contract. The party was coerced into entering into the agreement.\nFor example, imagine that you entered into a contract for automobile insurance. Part of your\ninsurance contract requires your insurance company to defend you in the event of a lawsuit arising\nfrom a traffic accident. Imagine that you are involved in a traffic accident and your insurance\ncompany refuses to defend you. This is bad news, because you will still need to mount a defense. You\nwill probably expend a great deal of money defending yourself, not to mention trying to launch a\ncomplaint against your insurance company for breach of contract. After spending all of your savings\nand borrowing just to pay your bills, imagine that your insurance company comes to you with an\noffer to pay you fifty thousand dollars if you sign a waiver that it has no liability to you. You will\nprobably sign that waiver and take the money. Why? Because you have no reasonable alternative.\nThis is an example of economic duress, and it is likely that no court would enforce the waiver for the\nbenefit of the insurance company given such facts. The insurance company forced you into signing\nan agreement with it that you would not have signed if you had any other reasonable alternative.\nUnconscionability is a defense used when the contract contains markedly unfair terms against the\nparty with less bargaining power or sophistication than the party who created the terms and induced\nthe other party to sign it. For example, imagine a biotech company discovering a cure for cancer from\na plant growing on the private lands of an indigenous people. Imagine that the indigenous people did\nnot understand the importance of the discovery, and they did not understand the value of it. If the\nbiotech company offered to pay for the absolute and complete rights to the plant with ten dollars and\na bag of flour, that contract might be said to be unconscionable.\nUndue influence is a defense that can be used when one party ceases to be able to exercise his or her\nfree will due to the superior power and influence exerted over that party by the other. For example,\nimagine an elderly person who is completely isolated from social contact due to poor health and\nremote living conditions. That person might be quite lonely and eager for company. Say that an\nunscrupulous person entered that elderly person\xe2\x80\x99s life and exerted influence over that person so that\nthe elderly person really could not exercise his free will any longer. If, consequently, the elderly\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n197\n\n\x0cperson entered into a contract with the other party to transfer all of his wealth to that person, we\nmight say that this is a case of undue influence. How might this happen? Maybe the unscrupulous\nintruder is the only human contact that the elderly person has, and maybe he or she led the wealthy\nelderly person to believe that the only way to salvation is by handing over his assets.\nRemember, too, that the Statute of Frauds requires certain contracts to be in writing and signed by\nthe defendant to be enforceable against the defendant. If those types of contracts are not in writing,\nthat can be used as a defense to performance. Contracts for any interest in land, in consideration of\nmarriage, and to pay the debts of another that cannot be performed within one year and contracts for\nthe sale of goods with a price of five hundred dollars or more are all examples of contracts that are\nrequired to be in writing to be enforceable according to the Statute of Frauds. If a contract exists for\nthese items, but the contract is not in writing, it may be performed. However, if there is a dispute\narising under the contract, it will not be enforced because it violates the Statute of Frauds\nrequirement for a writing.\nThe statute of limitations is an affirmative defense that can be raised by a defendant to argue that the\ncomplaint is being brought too late, by law, to do anything about it. This means that if a dispute\narises under a contract, then the plaintiff must bring a complaint concerning that dispute within a\ncertain time period. Every state has different statutes of limitations for different types of disputes.\nContracts statutes of limitations range from three to ten years, depending on whether the contract\nwas oral or written, and depending on the jurisdiction.\nMistake is rarely a successful defense to contract, but it is a defense nonetheless. Mistake does not\nmean bad bargaining. After all, we have the freedom to bargain badly, and the courts will not step in\nto save us if we do so. For instance, if you agree to buy a house for $170,000, but the house is only\nworth $150,000, you may have bargained badly, particularly if the seller did not deceive you in any\nway. The court will not step in to rewrite the contract or allow you to use mistake as a defense to\nexcuse your performance. Indeed, the court will enforce the terms of the contract if it is a valid\ncontract. Mistake refers to something that is truly a mistake either by one party or by both. If the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n198\n\n\x0cparties to a contract truly make a mistake with respect to essential terms of the contract, then that\ncan be used as a defense to performance.\nMisrepresentation and fraud are also defenses to contract. Misrepresentation is when a party makes\na false statement that induces the other party to enter into the contract. Fraud is a closely related\nconcept, and it simply means that one party has used deception to acquire money or property. Often,\nunscrupulous salespeople will commit fraud or misrepresent the subject matter of the contract in\nsuch a way that the other party will enter into the contract. However, fraud and misrepresentation\nboth may be used as successful defenses in such circumstances.\nCommercial impracticability is a defense that can be used when fulfilling a contract has become\nextraordinarily difficult or unfair for one party.\nFrustration of purpose is when the contract has become essentially worthless to one party, though\nthe event giving rise to that state was nonexistent or unknown to both parties to the contract at\nformation.\nFinally, sometimes a party to a contract files for bankruptcy protection. When that party is required\nto pay a debt that was incurred before the bankruptcy was filed, that duty is suspended temporarily\nor permanently when the bankruptcy is filed through the court\xe2\x80\x99s automatic stay. In other words, the\ndebt does not have to be paid during the course of the bankruptcy. At the conclusion of the\nbankruptcy, if the debtor is successful in bankruptcy and if the contract obligation is a dischargeable\ndebt, then the debt will never have to be paid. The debt is, in fact, discharged. Bankruptcy is a\ndefense to performance of contract for debtors who file for bankruptcy protection.\nRemedies for breach of contract are typically monetary damages. Expectation damages, including\ncompensatory and consequential damages, can be recovered. However, consequential damages may\nnot be speculative. Indeed, they must be foreseeable to both parties at the time of the contract\nformation to constitute damages by breach. Specific performance might be required under certain\ntypes of contracts, such as in contracts for land. For example, in contracts for real property, the\nassumption is that land is unique. Therefore, monetary damages are not adequate, because\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n199\n\n\x0c\xe2\x80\x9creplacement\xe2\x80\x9d land cannot be found that would be like the land that is the subject of the contract.\nImportantly, specific performance is not an appropriate remedy for service contracts, given the\nprohibition against involuntary servitude in the Thirteenth Amendment to the U.S. Constitution.\nFinally, it is important to note that on breach, the injured party has a duty to mitigate his damages.\nThis means that he must avoid damages by making reasonable efforts to do so. If a tenant breaches a\ncontract by moving out of his apartment before the lease is over, the landlord will be able to recover\ndamages from that tenant for breaking the lease (i.e., breaching the contract). However, the landlord\nalso has a duty to mitigate those damages by trying to find another tenant.\n\nKEY TAKEAWAYS\nA contract is an enforceable promise. Parties to the contract must perform according to the relevant\nstandard\xe2\x80\x94substantial performance for most service contracts, personal satisfaction, complete\nperformance, or strict performance. Once parties have performed, they are discharged from further\nobligations under the contract. Failure to perform according to the requisite standard is a breach, which is\na compensable injury. A breach may be minor or major. Several defenses exist to breach of contract.\n\nEXERCISES\n1.\n\nReferring to Note 6.47 "Hyperlink: Coach Mike Leach", what additional information would you need to\ndetermine whether Coach Leach\xe2\x80\x99s services fell below substantial performance and were a material breach\nor whether he substantially performed his contract so that he did not materially breach it? Should\ncoaching services be evaluated based on substantial performance or personal satisfaction? Why?\n\n2.\n\nIn international business, it is very common for parties to contract not to read or speak the same language.\nIf someone sought to enter into a contract with you, but that party could not read the language in which\nyour contract was written, should you enter into that contract with that person? How can this problem be\novercome so that both parties can form a legally binding contract with each other?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n200\n\n\x0c6.3 Assignment, Delegation, and Commonly Used Contracts\nClauses\nLEARNING OBJECTIVES\n1.\n\nLearn about assignment and delegation.\n\n2.\n\nExamine novation.\n\n3.\n\nExplore restrictions on assignment, exculpatory clauses, noncompete clauses, mandatory arbitration\nclauses, acceleration clauses, and liquidated damages clauses.\n\n4.\n\nExplore the parol evidence rule.\n\nWhat if you formed a contract with a rock \xe2\x80\x99n\xe2\x80\x99 roll band for its services? Specifically, you wanted the\nband to play at your nightclub, because you thought that your customers would enjoy the band\nenough to pay to see it perform. You hired this specific band because you heard that it drew large\ncrowds of paying customers. Imagine your surprise when, as you anticipate the band\xe2\x80\x99s performance,\nyou discover that another band\xe2\x80\x94one you have never heard of\xe2\x80\x94has come to play instead of the\noriginal contracting band. On inquiry, you learn that the original band transferred its duties to\nperform to a lesser known band. Can it do that?\nContract elements\xe2\x80\x94the terms of the contract\xe2\x80\x94are important. They may, among other things,\nforeclose your ability to bring a complaint in court, they may render you unable to be hired in your\nprofession (at least within certain boundaries), or they may limit liability to a party that had a role in\ncausing injury to you. If you are not aware of these elements, then you may face an unpleasant\nsurprise if you act in a way contrary to the restrictions imposed by those terms. Likewise, contracts\npossess certain qualities that prohibit parties from acting in certain ways, unless those qualities are\nexpressly waived. This section identifies common properties of contracts, as well as commonly used\nelements of contracts. If you are negotiating a contract and you do not like a term, then you should\nnot agree to it. In law, there is a presumption that you have read, understood, and agreed to each and\nevery term of any contract to which you are a party. Arguing that you did not understand or that you\ndid not approve of a particular term in the contract will not be a valid excuse to performance. You\nshould know what you can expect when you enter into a contract. Are you getting the band that you\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n201\n\n\x0cwanted to hire to play in your nightclub, or are you really getting any band that the original band\nhappens to transfer its duties to?\nAs a preliminary matter, it is important to realize that contracts are, by law, assignable and\ndelegable. This means that the rights conveyed by the contract may be transferred to another party\nby assignment, unless an express restriction on assignment exists within the contract, or unless an\nassignment would violate public policy. Likewise, the duties imposed on a party may be transferred\nto another party by delegation, unless the contract expressly restricts delegation, or there is a\nsubstantial interest in personal performance by the original party to the contract, or if delegation\nwould violate public policy. In the case of a band hired to perform at a nightclub, an argument could\nbe made that the original band cannot delegate its duties under the contract because there was a\nsubstantial interest in personal performance by the original band. This would render the contract\nnondelegable. To be on the safe side, your contract with that band should have had a clause expressly\nprohibiting delegation.\nMany students have seen restrictions on assignment in the form of no-sublease clauses in leases with\nlandlords. Do you have a no-sublease clause in your lease? If so, that is a restriction on assignment.\nThis clause is necessary to prevent you from assigning your rights under the lease\xe2\x80\x94your rights to\ninhabit the premises\xe2\x80\x94to another party. It is necessary for the landlord to include that provision\nexpressly if she wishes to prevent you from subleasing the unit, because there is a presumption in\nlaw that assignment is permitted unless it is expressly prohibited by the contract or unless the\nassignment would violate public policy. Since it is unlikely that letting someone else live in your\nhousing unit in your absence would violate public policy, then the landlord must expressly prohibit\nthe assignment within the original contract if she wishes to prevent tenants from subleasing. A\nlandlord may have a very good reason to wish to prevent subleasing; she may wish to ensure that\neach tenant is creditworthy prior to allowing the tenant to live in the property.\nNote that in delegation and in assignment, the original contracting party is not \xe2\x80\x9coff the hook\xe2\x80\x9d if it\ntransfers its duties or rights to another party. For instance, if subleasing was not prohibited, and the\nnew tenant assumed the rights and duties imposed by the original contract, the original party to the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n202\n\n\x0ccontract is still liable for the payment of rent. If the subleasing tenant does not pay the rent, the\noriginal party to the lease is still liable. The way to excuse oneself from this liability is to form a\nthree-way novation with the original party and the new party, thereby excusing the exiting party from\nfuture liability arising under the contract. A novation is essentially a new contract that transfers all\nrights and duties to the new party to the contract and releases the previous party from any further\nobligation arising from the original contract.\nRestrictions on assignment or delegation are not the only common elements that can be found in\ncontracts. For example, you have probably encountered exculpatory clauses. An exculpatory clause is\nan express limitation on potential or actual liability arising under the subject matter of the contract.\nIn short, exculpatory clauses are often employed when risk of injury exists. They seek to limit one\nparty\xe2\x80\x99s liability to another. You most certainly have signed exculpatory agreements or contracts\ncontaining exculpatory clauses if you have participated in any potentially dangerous activity at a club\nor with an organized group that could incur liability from injuries suffered by its patrons or\nmembers. For example, if you join a kayaking club, you will most likely be asked to sign such an\nagreement to \xe2\x80\x9chold harmless\xe2\x80\x9d the club in the event of any accident or injury. However, despite the\nexistence of an exculpatory clause, liability will not be limited (that is, the liability limitations will be\nunenforceable) when the party who would benefit from the limitation on liability acted with gross\nnegligence, committed an intentional tort, or possessed greatly unequal bargaining power, or if the\nlimitation on liability violates public policy. Imagine that you signed an agreement to engage in\nkayaking activities with a kayaking group, but the leader of the group battered you with her oar\nbecause she was angry with you for mishandling your kayak. Since battery is an intentional tort, the\nexculpatory clause will not protect the kayaking organization from liability it incurred through the\nactions of its employee.\nAnother common contract element that you may have encountered is a noncompete clause.\nA noncompete clause attempts to restrict competition for a specified period of time, within a certain\ngeographic region, and for specified activities. Noncomplete clauses are generally valid against the\nparty who signed it if the time, place, and scope are reasonable. These are very common clauses in\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n203\n\n\x0cemployment contracts, particularly where the duties involved in employment are likely to involve\ntrade secrets or other proprietary information that the company wishes to protect.\nA mandatory arbitration clause is very common in consumer contracts and employment contracts.\nYou have certainly subjected yourself to the restrictions imposed by these clauses if you have signed\na contract for a credit card. Mandatory arbitration clauses require parties to a contract that contains\nsuch a clause to submit to mandatory arbitration in the event of a dispute arising under the contract.\nMandatory arbitration clauses frequently foreclose any possibility of appealing arbitration awards in\ncourt.\nAn acceleration clause commonly exists in contracts where periodic payments are contemplated by\nthe agreement. For example, if you signed a lease for your housing unit, then you most likely pay rent\non a month-to-month basis. If you breached your lease, you would still owe rent for each subsequent\nmonth contemplated by the lease agreement. This means that your landlord would have new injury\nevery month that you did not pay. An acceleration clause accelerates all payments due under the\ncontract on breach. This allows the injured party\xe2\x80\x94in this case, the landlord\xe2\x80\x94to sue for all damages\ndue for unpaid rent under that contract at once, rather than having to bring a new suit each month to\nseek monthly unpaid rent.\nA liquidated damages clause allows parties to set the amount of damages in the event of breach.\nAgreeing to a damage amount before any breach occurs can save money and time spent litigating.\nProviding that the liquidated damages clause does not look like a penalty, the clause will be valid and\nenforced by a court that hears a dispute arising under the contract. For example, imagine that you\nentered into a contract for the sale of your car. If the liquidated damages clause provided for two\nthousand dollars of damages in the event of breach, that will probably be a valid liquidated damages\nclause, providing that your car is an \xe2\x80\x9caverage\xe2\x80\x9d car. However, if the liquidated damages clause\nprovided for one million dollars of damages payable by the breaching party, then that would not be\nenforceable by the court because it looks like a penalty. The proposed liquidated damages far exceed\nthe value of the car that is the subject of the agreement.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n204\n\n\x0cOf course, there are additional common elements to contracts. This is not an exhaustive study of\npossible provisions, though it is a list of commonly encountered elements. For example, time of\nperformance is often included as a separate provision. However, time for performance is an essential\nelement in common-law contract formation, and without it, the contract may fail due to lack of\ndefinite and certain terms in formation.\nA major assumption made about a written contract is that it is integrated, which means that it\ncontains the entire expression of the parties\xe2\x80\x99 agreement. That means that any statements made\nbefore the parties signed the contract are not part of the contract, unless those statements are\nmemorialized in the contract itself. In fact, any statements or actions that are not captured within the\nfour corners of the contract are considered parol evidence, and they will not be used to interpret the\nmeaning of the contract.\n\nKEY TAKEAWAYS\nParties to contracts must not only take care to form the agreement so that it is legally enforceable, but\nthey must also be aware of the properties of contracts in general, as well as specific provisions contained\nwithin contracts to which they are a party. Properties of contracts include ability to assign, delegate, and\nexclude parol evidence. Several types of contracts clauses are commonly used to restrict rights and limit\nliability.\n\nEXERCISES\n1.\n\nThink of an example of an exculpatory clause that you have signed. For what type of activity would you be\nunwilling to sign an exculpatory clause? If your refusal to sign the exculpatory clause or agreement\nprevented you from participating in that activity, would you still refuse to sign it?\n\n2.\n\nDo you think that too many limitations and restrictions can be placed on parties in a contract? Should\nthere be more government regulation and standardization of contract terms between private parties?\nWhy or why not?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n205\n\n\x0c6.4 Concluding Thoughts\nContracts are an integral part of business. Without contracts, promises would not be enforceable,\nwhich would wreak havoc on our financial stability, both individually and professionally.\nThe law presumes that people who sign contracts have read the contract and understood its terms.\nOf course, contract language includes many terms of art, and simply reading a contract alone may\nnot be enough to fully understand its implications. Contracts for important matters should be\nreviewed and explained by attorneys, so that parties who enter into contracts do not do so without\nunderstanding the agreement.\nIt\xe2\x80\x99s important to understand the implications of making promises. If those promises carry legal\nduties, then, barring a defense, the promise will need to be performed so that the obligation or duties\narising under that promise can be discharged. If the promise is not performed, and if there are no\ndefenses, then the contract has been breached. Breach is an actionable claim, with the goal of\nrecovering the loss and placing the nonbreaching party back to the position that he or she would\nhave been in if the contract had not been breached.\nRecognizing fundamental elements of contracts and how to incorporate considerations important to\nyou when entering into them can go far toward ensuring business success. Likewise, the failure to\nrecognize the traps and tricks that can be incorporated into contracts can derail a good business idea.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n206\n\n\x0cChapter 7\n\nTorts\nLEARNING OBJECTIVES\nWhenever a company or individual acts unreasonably and causes injury, that person or company may be\nliable for a tort. In some cases it doesn\xe2\x80\x99t matter how careful or reasonable the company or individual is\xe2\x80\x94\nthey may be liable for any injury resulting from their actions. Torts are an integral part of our civil law, and\nin this chapter, you\xe2\x80\x99ll learn about what kinds of torts exist and how to defend yourself or your company\nfrom potential tort liability. Specifically, you should be able to answer the following questions:\n1.\n\nWhat are torts?\n\n2.\n\nWhat are intentional torts, and how does one defend against an accusation of one?\n\n3.\n\nWhat is negligence and how does it affect virtually all human activity?\n\n4.\n\nWhat is strict liability and how does it affect businesses engaged in making and selling products?\n\n5.\n\nWhat are the arguments for and against tort reform?\n\nFigure 7.1 A Typical Construction Site\n\nLook at the picture in Figure 7.1 "A Typical Construction Site". You\xe2\x80\x99ve probably seen a similar picture\nof a construction site near where you live, with multiple orange traffic cones (with reflective stripes\nso they can be seen at night) and a large sign warning vehicles not to attempt to drive on the road.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n207\n\n\x0cNow imagine the picture without the traffic cones, warning signs, or caution tape. If you were\ndriving, would you still attempt to drive on this road?\nMost of us would probably answer no, since the road is obviously under construction and attempting\nto drive on it may result in severe damage to property (our vehicles) and personal injury. Similarly,\npedestrians, skateboarders, and bicyclists will likely steer clear of this road even if it wasn\xe2\x80\x99t clearly\nmarked or roped off. So if the dangers associated with this construction are obvious, why would the\nconstruction workers go through the time and expense of setting up the traffic cones, sign, and tape?\nThe answer has to do with tort law. A tort can be broadly defined as a civil wrong, other than breach\nof contract. In other words, a tort is any legally recognizable injury arising from the conduct (or\nnonconduct, because in some cases failing to act may be a tort) of persons or corporations. The other\narea of civil law that corporations have to be concerned about is contract law. There are several key\ndifferences between torts and contracts.\nFirst is the realm of possible plaintiffs. In contract law, only persons that you have a contract with, or\nyou are a third-party-beneficiary to (such as when you are named the beneficiary to a life insurance\npolicy and the company refuses to pay the claim), can possibly sue you for breach of contract. In tort\nlaw, just about anyone can sue you, as long as they can establish that you owe them some sort of\nlegally recognized duty. The second key difference is damages, or remedies. In contract law, damages\nare usually not difficult to calculate, as contract law seeks to place the parties in the same position as\nif the bargain had been performed (known as compensatory damages). Compensatory damages also\napply in tort law, but they are much more difficult to calculate. Since money cannot bring the dead\nback to life or regrow a limb, tort law seeks to find a suitable monetary equivalent to those losses,\nwhich as you can imagine is a very difficult thing to do. Additionally, tort law generally allows for the\naward of punitive damages, something never permitted in contract law.\nThere is also some intersection between tort law and criminal law. Often, the same conduct can be\nboth a crime and a tort. If Claire punches Charlie in the gut, for example, without provocation and\nfor no reason, then Claire has committed the tort of battery and the crime of battery. In the tort case,\nCharlie could sue Claire in civil court for money damages (typically for his pain, suffering, and\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n208\n\n\x0cmedical bills). That case would be tried based on the civil burden of proof\xe2\x80\x94preponderance of the\nevidence. That same action, however, could also lead Charlie to file a criminal complaint with the\nprosecutor\xe2\x80\x99s office. Society is harmed when citizens punch each other in the gut without provocation\nor justification, so the prosecutor may file a criminal case against Claire, where the people of the\nstate would sue her for the crime of battery. If convicted beyond a reasonable doubt, Claire may have\nto pay a fine to the people (the government) and may lose her liberty. Charlie gets nothing\nspecifically from Claire in the criminal case other than the general satisfaction of knowing that his\nattacker has been convicted of a crime.\nYou might recall from Chapter 3 "Litigation" that the standard of proving a criminal case (beyond a\nreasonable doubt) is far higher than the standard for proving a civil case (a preponderance of\nevidence). Therefore, if someone is convicted of a crime, he or she is also automatically liable in civil\ntort law under the negligence per se doctrine. For that reason, criminal defendants who wish to avoid\na criminal trial are permitted to plead \xe2\x80\x9cno contest\xe2\x80\x9d to the criminal charges, which permits the judge\nto sentence them as if they were guilty but preserves the right of the defendant to defend a civil tort\nsuit.\nPerhaps more than any other area of law, tort law is a reflection of American societal values.\nContracts are enforced because they protect our expectation that our promises are enforced.\nCriminal law is the result of elected legislatures prohibiting behavior that the community finds\noffensive or immoral. Tort law, on the other hand, is generally not the result of legislative debate or\ncommittee reports. Each tort case arises out of different factual situations, and a jury of peers is\nasked to decide whether or not the tortfeasor (the person committing the tort) has violated a certain\nsocietal norm. Additionally, we expect that when an employee is working for the employer\xe2\x80\x99s benefit\nand commits a tort, the employer should be liable. Under the respondeat superior doctrine, employers\nare indeed liable, unless they can demonstrate the employee was on a frolic and detour at the time he\nor she committed the tort.\nThe norms that society protects make up the basis for tort law. For example, we have an expectation\nthat we have the right to move freely without interference unless detained pursuant to law. If\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n209\n\n\x0csomeone interferes with that right, he or she commits the tort of false imprisonment. We have an\nexpectation that if someone spills a jug of milk in a grocery store, the store owners will promptly\nwarn other customers of a slippery floor and clean up the spill. Failure to do so might constitute the\ntort of negligence. Likewise, we expect that the products we purchase for everyday use won\xe2\x80\x99t\nsuddenly and without explanation injure us, and if that happens then a tort has taken place.\nIt has been said many times that tort law is a unique feature of American law. In Asian countries that\nfollow a Buddhist tradition, for example, many people have a belief that change is a constant part of\nlife and to resist that change is to cause human suffering. Rather than seeking to blame someone else\nfor change (such as an injury, death, or damage to personal property), a Buddhist may see it as part\nof that person\xe2\x80\x99s or thing\xe2\x80\x99s \xe2\x80\x9cnature\xe2\x80\x9d to change. In countries with an Islamic tradition, virtually all\nevents are seen as the will of God, so an accident or tragedy that leads to injury or death is accepted\nas part of one\xe2\x80\x99s submission to God. In the United States, however, the tradition is one of questioning\nand inquiry when accidents happen. Indeed, it can be said with some truth that many Americans\nbelieve there is no such thing as an accident\xe2\x80\x94if someone is injured or killed unexpectedly, we almost\nimmediately seek to explain what happened (and then often place blame).\nTorts can be broadly categorized into three categories, depending on the level of intent demonstrated\nby the tortfeasor. If the tortfeasor acted with intent to cause the damage or harm that results from his\nor her action, then an intentional tort has occurred. If the tortfeasor didn\xe2\x80\x99t act intentionally but\nnonetheless failed to act in a way a reasonable person would have acted, then negligence has taken\nplace. Finally, if the tortfeasor is engaged in certain activities and someone is injured or killed, then\nunder strict liability the tortfeasor is held liable no matter how careful or careless he or she may have\nbeen. In this chapter, we\xe2\x80\x99ll explore these three areas of torts carefully so that by the end of the\nchapter, you\xe2\x80\x99ll understand the responsibilities tort law imposes on both persons and corporations.\nThe chapter concludes with a brief discussion of other issues that affect torts, including tort reform.\n\nKey Takeaways\nA tort is a civil wrong (other than breach of contract) arising out of conduct or nonconduct that violates\nsocietal norms as determined by the judicial system. Unlike contracts and crimes, torts do not require\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n210\n\n\x0clegislative action. Torts protect certain expectations we cherish in a free society, such as the right to travel\nfreely and to enjoy our property. There are three primary areas of tort law, classified depending on the\nlevel of intent demonstrated by the tortfeasor.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n211\n\n\x0c7.1 Intentional Torts\nLEARNING OBJECTIVES\n1.\n\nExplore what constitutes an intentional tort.\n\n2.\n\nStudy various intentional torts in detail.\n\n3.\n\nExamine the defenses to intentional torts.\n\nExamine Figure 7.2 "A Coworker Attacks". The office worker on the right has grabbed the office worker on\nthe left and is strangling him. This conduct is clearly criminal, and it is also tortious. Since the tortfeasor\nhere has acted intentionally by grabbing his colleague\xe2\x80\x99s neck, the tort is considered intentional. (It is, in\nfact, likely assault and battery.)\nIn an intentional tort, the tortfeasor intends the consequences of his or her act, or knew with substantial\ncertainty that certain consequences would result from the act. This intent can be transferred. For example,\nif someone swings a baseball bat at you, you see it coming and duck, and the baseball bat continues to\ntravel and hits the person standing next to you, then the person hit is the victim of a tort even if the person\nswinging the bat had no intention of hitting the victim.\nIn addition to the physical pain that accompanies being strangled by a coworker, the victim may also feel a\ngreat deal of fear. That fear is something we expect to never have to feel, and that fear creates the basis for\nthe tort of assault. An assault is an intentional, unexcused act that creates in another person a reasonable\napprehension or fear of immediate harmful or offensive contact. Note that actual fear is not required for\nassault\xe2\x80\x94mere apprehension is enough. For example, have you ever gone to sit down on a chair only to\nfind out that one of your friends has pulled the chair away, and therefore you are about to fall down when\nyou sit? That sense of apprehension is enough for assault. Similarly, a diminutive ninety-pound woman\nwho attempts to hit a burly three-hundred-pound police officer with her bare fists is liable for assault if\nthe police officer feels apprehension, even if fear is unlikely or not present. Physical injuries aren\xe2\x80\x99t\nrequired for assault. It\xe2\x80\x99s also not necessary for the tortfeasor to intend to cause apprehension or fear. For\nexample, if someone pointed a very realistic-looking toy pistol at a stranger and said \xe2\x80\x9cgive me all your\nmoney\xe2\x80\x9d as a joke, it would still constitute assault if a reasonable person would have perceived fear or\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n212\n\n\x0capprehension in that situation. The intentional element of assault exists here, because the tortfeasor\nintended to point the realistic-looking toy pistol at the stranger.\nA battery is a completed assault. It is any unconsented touching, even if physical injuries aren\xe2\x80\x99t present. In\nbattery, the contact or touching doesn\xe2\x80\x99t have to be in person. Grabbing someone\xe2\x80\x99s clothing or cane,\nswinging a baseball bat at someone sitting in a car, or shooting a gun (or Nerf ball, for that matter, if it\xe2\x80\x99s\nunconsented) at someone is considered battery. Notice that assault and battery aren\xe2\x80\x99t always present\ntogether. Shooting someone in the back usually results in battery but not assault since the victim didn\xe2\x80\x99t\nsee the bullet coming and therefore did not feel fear or apprehension. Similarly, a surgeon who performs\nunwanted surgery or a dentist who molests a patient while the patient is sedated has committed battery\nbut not assault. Sending someone poisoned brownies in the mail would be battery but not assault. On the\nother hand, spitting in someone\xe2\x80\x99s face, or leaning in for an unwanted kiss, would be assault and possibly\nbattery if the spit hit the victim\xe2\x80\x99s face, or the kiss connected with any part of the victim\xe2\x80\x99s body.\nWhen someone is sued for assault or battery, several defenses are available. The first is consent. For\nexample, players on a sports team or boxers in a ring are presumed to have consented to being\nbattered. Self-defense and defense of others are also available defenses, bearing in mind that any selfdefense must be proportionate to the initial force.\nA battery must result in some form of physical touching of the plaintiff. When that physical touching is\nabsent, courts sometimes permit another tort to be claimed instead, the tort of\nintentional infliction of emotional distress (IIED). In a sense, IIED can be thought of as battery to\nemotions, but a great deal of caution is warranted here. Many people are battered emotionally every day\nto varying degrees. Someone may cut you off in traffic, leading you to curse at him or her in anger. A\nstranger may cut in line in front of you, leading you to exclaim in indignation. A boyfriend or girlfriend\nmay decide to break off a relationship with you, leading to hurt feelings and genuine grief or pain. None of\nthese situations, nor any of the normal everyday stresses of day-to-day living, are meant to be actionable\nin tort law. The insults, indignities, annoyances, or even threats that we experience as part of living in\nmodern society are to be expected. Instead, IIED is meant to protect only against the most extreme of\nbehaviors. In fact, for a plaintiff to win an IIED case, the plaintiff has to demonstrate that the defendant\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n213\n\n\x0cacted in such a manner that if the facts of the case were told to a reasonable member of the community,\nthat community member would exclaim that the behavior is \xe2\x80\x9coutrageous.\xe2\x80\x9d Notice that the standard here is\nobjective; it\xe2\x80\x99s not enough for the plaintiff to feel that the defendant has acted outrageously. In some states,\nthe concern that this tort could be abused and result in frivolous litigation has led to the additional burden\nthat the plaintiff must demonstrate some physical manifestation of the psychological harm (such as\nsleeplessness or depression) to win any recovery.\n\nHyperlink: Does Picketing a Fallen Soldier\xe2\x80\x99s Funeral Constitute IIED or\nConstitutionally Protected Speech?\nhttp://www.npr.org/templates/story/story.php?storyId=5192571\nThe Westboro Baptist Church is a small (approximately seventy-member) fundamentalist church based in\nTopeka, Kansas. Members of the church, led by their pastor, Fred Phelps, believe that American soldier\ndeaths in Iraq and Afghanistan are punishment from God for the country\xe2\x80\x99s tolerance of homosexuality.\nChurch members travel around the country to picket at the funerals of fallen soldiers with large bold\nsigns. Some of the signs proclaim \xe2\x80\x9cThank God for Dead Soldiers.\xe2\x80\x9d In 2006 members of the church\npicketed the funeral of Marine Lance Corporal Matthew Snyder, and Snyder\xe2\x80\x99s father sued Phelps and the\nchurch for IIED and other tort claims. The jury awarded Snyder\xe2\x80\x99s family over $5 million in damages, but\non appeal, the U.S. Court of Appeals for the Fourth Circuit overturned the verdict. The court found the\nspeech \xe2\x80\x9cdistasteful and repugnant\xe2\x80\x9d but pointed out that \xe2\x80\x9cjudges defending the Constitution must\nsometimes share their foxhole with scoundrels of every sort, but to abandon the post because of the poor\ncompany is to sell freedom cheaply. It is a fair summary of history to say that the safeguards of liberty\nhave often been forged in controversies involving not very nice people.\xe2\x80\x9d\n\n[1]\n\nAdding insult to injury, the\n\nCourt of Appeals ordered Snyder\xe2\x80\x99s family to pay over $16,000 in legal fees to the church, which led to an\n[2]\n\noutpouring of support for Snyder on Facebook. The U.S. Supreme Court has accepted the case.\nAlthough the standard for outrageous conduct is objective, the measurement is made against the\nparticular sensitivities of the plaintiff. Exploiting a known sensitivity in a child, the elderly, or pregnant\nwomen can constitute IIED. A prank telephone call made by someone pretending to be from the army to a\nmother whose son was at war, telling the mother her son has been killed, would most certainly be IIED.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n214\n\n\x0cCompanies must be careful when handling sensitive employment situations to avoid potential IIED\nliability. This is especially true when terminating or laying off employees. Such actions must be taken with\ncare and civility. Similarly, companies involved in a lot of public interactions should be careful of this tort\nas well. Bill collectors and foreclosure agencies must be careful not to harass, intimidate, or threaten the\npeople they deal with daily. In one foreclosure case, for example, Bank of America was sued by a mortgage\nborrower when the bank\xe2\x80\x99s local contractor entered the home of the borrower, cut off utilities, padlocked\nthe door, and confiscated her pet parrot for more than a week, causing severe emotional distress.\n\n[3]\n\nIn\n\n2006, Walgreens was sued for IIED when pharmacists accidentally stapled a form to patient drugs that\nwas not meant to be seen by patients. The form was supposed to annotate notes about patients, but some\npharmacists filled in the form with comments such as \xe2\x80\x9cCrazy! She\xe2\x80\x99s really a psycho! Do not say her name\ntoo loud; never mention her meds by name.\xe2\x80\x9d\n\n[4]\n\nFigure 7.3 Russell Christoff\n\nSource: http://www.sfgate.com/c/pictures/2005/02/02/mn_nestle_model2.jpg.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n215\n\n\x0cAnother intentional tort is the invasion of privacy. There are several forms of this tort, with the most\ncommon being misappropriation. Misappropriation takes place when a person or company uses someone\nelse\xe2\x80\x99s name, likeness, or other identifying characteristic without permission. For example, in 1986 model\nRussell Christoff posed for a photo shoot for Nestl\xc3\xa9 Canada for Taster\xe2\x80\x99s Choice coffee. He was paid $250\nand promised $2,000 if Nestl\xc3\xa9 used his photo on its product. In 2002 he discovered Nestl\xc3\xa9 had indeed\nused his photo on Taster\xe2\x80\x99s Choice coffee without his permission (Figure 7.3 "Russell Christoff"), and he\nsued Nestl\xc3\xa9 for misappropriation. A California jury awarded him over $15 million in\n[5]\n\ndamages. Misappropriation can be a very broad tort because it covers more than just a photograph or\ndrawing being used without permission\xe2\x80\x94it covers any likeness or identifying characteristic. For example,\nin 1988 Ford Motor Company approached Bette Midler to sing a song for a commercial, which she\ndeclined to do. The company then hired someone who sounded just like Midler to sing one of Midler\xe2\x80\x99s\nsongs, and asked her to sound as much like Midler as possible. The company had legally obtained the\ncopyright permission to use the song, but Midler sued anyway, claiming that the company had committed\nmisappropriation by using someone who sounded like her to perform the commercial. An appellate court\nheld that while Ford did not commit copyright infringement, it had misappropriated Midler\xe2\x80\x99s right to\npublicity by hiring the sound-alike,\n\n[6]\n\nand a jury awarded her over $400,000 in damages.\n\nIn addition to someone\xe2\x80\x99s voice, an identifying characteristic can be the basis for misappropriation. For\nexample, Samsung Electronics ran a series of print advertisements to demonstrate how long-lasting their\nproducts can be. The ads featured a common item from popular culture along with a humorous tagline.\nOne of the ads featured a female robot dressed in a wig, gown, and jewelry posed next to a game show\nboard that looked exactly like the game show board from Wheel of Fortune (Figure 7.4 "Samsung\nAdvertisement"). The tagline said, \xe2\x80\x9cLongest-running game show. 2012 A.D.\xe2\x80\x9d An appellate court held that\nVanna White\xe2\x80\x99s claim for misappropriation was valid, writing \xe2\x80\x9cthe law protects the celebrity\xe2\x80\x99s sole right to\nexploit [their identity] value whether the celebrity has achieved her fame out of rare ability, dumb luck, or\n[7]\n\na combination thereof.\xe2\x80\x9d The lesson for companies is that in product marketing, permission must be\ncarefully obtained from all persons appearing in their marketing materials, as well as any persons who\nmight have a claim to their likeness or identifying characteristic in the materials.\nFigure 7.4 Samsung Advertisement\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n216\n\n\x0cSource: Photo courtesy of the U.S. federal government,http://commons.wikimedia.org/wiki/File:White-v-samsungdissent-appendix-2.png.\n\nVideo Clip: Is a Single Name a Likeness or Identifying Characteristic?\nInvasion of privacy can also take the form of an invasion of physical solitude. Actions such as window\npeeping, eavesdropping, and going through someone\xe2\x80\x99s garbage to find confidential information such as\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n217\n\n\x0cbank or brokerage statements are all examples of this form of tort. Media that are overly aggressive in\npursuing photos of private citizens may sometimes run afoul of this tort.\nAnother important intentional tort for businesses is false imprisonment. This tort takes place when\nsomeone intentionally confines or restrains another person\xe2\x80\x99s movement or activities without justification.\nThe interest being protected here is your right to travel and move about freely without impediment. This\ntort requires an actual and present confinement. If your professor locks the doors to the classroom and\ndeclares no one may leave, that is false imprisonment. If the professor leaves the doors unlocked but\ndeclares that anyone who leaves will get an F in the course, that is not false imprisonment. On the other\nhand, a threat to detain personal property can be false imprisonment, such as if your professor grabs your\nlaptop and says, \xe2\x80\x9cIf you leave, I\xe2\x80\x99ll keep your laptop.\xe2\x80\x9d Companies that engage in employee morale-building\nactivities should bear in mind that forcing employees to do something they don\xe2\x80\x99t want to do raises issues\nof false imprisonment. False imprisonment is especially troublesome for retailers and other businesses\nthat interact regularly with the public, such as hotels and restaurants. If such a business causes a\ncustomer to become arrested by the police, for example, it may lead to the tort of false imprisonment. In\none case, a pharmacist who suspected a customer of forging a prescription deliberately caused the\ncustomer to be detained by the police. When the prescription was later validated, the pharmacist was sued\nfor false imprisonment. Businesses confronted with potential thieves are permitted to detain suspects\nuntil police arrive at the establishment; this is known as the shopkeeper\xe2\x80\x99s privilege. The detention must be\nreasonable, however. Store employees must not use excessive force in detaining the suspect, and the\ngrounds, manner, and time of the detention must be reasonable or the store may be liable for false\nimprisonment.\nIntentional torts can also be committed against property. Trespass to land occurs whenever someone\nenters onto, above, or below the surface of land owned by someone else without the owner\xe2\x80\x99s permission.\nThe trespass can be momentary or fleeting. Soot, smoke, noise, odor, or even a flying arrow or bullet can\nall become the basis for trespass. A particular trespass problem takes place in suburban neighborhoods\nwithout clearly marked property lines between homes. Children are often regular trespassers in this area,\nand even if they are trespassing, homeowners are under a reasonable duty of care to ensure they are not\nharmed. When there is an attractive nuisance on the property, homeowners must take care to both warn\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n218\n\n\x0cchildren about the attractive nuisance and protect them from harm posed by the attractive nuisance. This\ndoctrine can apply to pools, abandoned cars, refrigerators left out for collection, trampolines, piles of sand\nor lumber, or anything that might pose a danger to children and that they cannot understand or\nappreciate. There may be times, however, when trespass is justified. Obviously, someone invited by the\nowner is not a trespasser; such a person is considered an invitee until the owner asks him or her to leave.\nSomeone may have a license to trespass, such as a meter reader or utility repair technician. There may\nalso be times when it may be necessary to trespass\xe2\x80\x94for example, to rescue someone in distress.\nTrespass to personal property is the unlawful taking or harming of another\xe2\x80\x99s personal property without\nthe owner\xe2\x80\x99s permission. If your roommate borrowed your vehicle without your permission, for example, it\nwould be trespass to personal property. The tort of conversion takes place when someone takes your\nproperty permanently; it is the civil equivalent to the crime of theft. If you gave your roommate\npermission to borrow your car for a day and he or she stole your car instead, it would be conversion rather\nthan trespass. An employer who refuses to pay you for your work has committed conversion.\nAnother intentional tort is defamation, which is the act of wrongfully hurting a living person\xe2\x80\x99s good\nreputation. Oral defamation is considered slander, while written defamation is libel. To be liable for\ndefamation, the words must be published to a third party. There is no liability for defamatory words\nwritten in a secret diary, for example, but there is liability for defamatory remarks left on a Facebook wall.\nIssues sometimes arise with regard to celebrities and public figures, who often believe they are defamed\nby sensationalist \xe2\x80\x9cnews\xe2\x80\x9d organizations that cover celebrity gossip. The First Amendment provides strong\nprotection for these news organizations, and courts have held that public figures must show\nactual malice before they can win a defamation lawsuit, which means they have to demonstrate the media\noutlet knew what it was publishing was false or published the information with reckless disregard for the\ntruth. This is a much higher standard than that which applies to ordinary citizens, so public figures\ntypically have a difficult time winning defamation lawsuits. Of course, truth is a complete defense to\ndefamation.\nDefamation can also take place against goods or products instead of people. In most\nstates, injurious falsehood (or trade disparagement) takes place when someone publishes false\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n219\n\n\x0cinformation about another person\xe2\x80\x99s product. For example, in 1988 the influential product testing\nmagazine Consumer Reports published a test of the Suzuki Samurai small SUV, claiming that it \xe2\x80\x9ceasily\nrolls over in turns.\xe2\x80\x9d Product sales dropped sharply, and Suzuki sued Consumers Union, the publisher, for\ntrade disparagement. The case was settled nearly a decade later after a long and expensive legal battle.\nBusinesses often make claims about their products in marketing their products to the public. If these\nclaims are false, then the business may be liable for the tort of misrepresentation, known in some\nstates as fraud. Fraud requires the tortfeasor to misrepresent facts (not opinions) with knowledge that\nthey are false or with reckless disregard for the truth. An \xe2\x80\x9cinnocent\xe2\x80\x9d misrepresentation, such as someone\nwho lies without knowing he or she is lying, is not enough\xe2\x80\x94the defendant must know he or she is lying.\nFraud can arise in any number of business situations, such as lying on your r\xc3\xa9sum\xc3\xa9 to gain employment,\nlying on a credit application to obtain credit or to rent an apartment, or in product marketing. Here, there\nis a fine line between puffery, or seller\xe2\x80\x99s talk, and an actual lie. If an advertisement claims that a particular\ncar is the \xe2\x80\x9cfastest new car you can buy,\xe2\x80\x9d then fraud liability arises if there is in fact a car that travels faster.\nOn the other hand, an advertisement that promises \xe2\x80\x9cunparalleled luxury\xe2\x80\x9d is only puffery since it is\nopinion. Makers of various medicinal supplements and vitamins are often the target of fraud lawsuits for\nmaking false claims about their products.\nFinally, an important intentional tort to keep in mind istortious interference. This tort, which varies\nwidely by state, prohibits the intentional interference with a valid and enforceable contract. If the\ndefendant knew of the contract and then intentionally caused a party to break the contract, then the\ndefendant may be liable. In 1983 oil giant Pennzoil made a bid for a smaller oil rival, Getty Oil. A\ncompetitor to Pennzoil, Texaco, found out about the deal and approached Getty with another bid for a\nhigher amount, which Getty then accepted. Pennzoil sued Texaco, and a jury awarded over $10 billion in\ndamages.\n\nKEY TAKEAWAYS\nAssault is any intentional act that creates in another person a reasonable fear or apprehension of harmful\nor offensive contact. A battery is a completed assault, when the harmful or offensive contact occurs. The\nintentional infliction of emotional distress (IIED) is extreme and outrageous conduct that intentionally\ncauses severe emotional distress to another person. In some states, IIED requires a demonstration of\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n220\n\n\x0cphysical harm such as sleeplessness or depression. This is a difficult tort to win because of its inherent\nclash with values embodied by the First Amendment. Misappropriation is the use of another person\xe2\x80\x99s\nname, likeness, or other identifying characteristic without permission. False imprisonment occurs when\nsomeone intentionally confines or restrains another person\xe2\x80\x99s movement without justification. Trespass is\nthe entry onto land without the owner\xe2\x80\x99s permission, while conversion is the civil equivalent of the theft\ncrime. Defamation is the intentional harm to a living person\xe2\x80\x99s reputation, while trade disparagement takes\nplace when someone publishes false information about someone else\xe2\x80\x99s product. Fraudulent\nmisrepresentation is any intentional lie involving facts. Tortious interference is the intentional act of\ncausing someone to break a valid and enforceable contract.\n\nEXERCISES\n1.\n\nMembers of the Westboro Baptist Church claim that the First Amendment protects them from IIED\nlawsuits since they are expressing a political opinion by picketing at soldier funerals. The pickets take place\non public property and in compliance with local picketing laws. If the plaintiffs win the case, the church is\nunlikely to have the money to satisfy the judgment and may seek bankruptcy. Do you believe that this\nconduct is extreme and outrageous enough to constitute a tort? Why or why not?\n\n2.\n\nIn 1983 Hustler magazine (owned by publisher Larry Flynt) ran a print advertisement patterned after a\nCampari liquor ad campaign. The real ad campaign featured celebrities \xe2\x80\x9ctalking about their first time\xe2\x80\x9d in a\nquestion-and-answer interview format, slowly revealing that the celebrities were speaking about their first\ntime drinking Campari. The Hustler advertisement featured fundamentalist preacher Jerry Falwell, who\nwas running a campaign against pornography at the time, and insinuated that Falwell had lost his virginity\nto his mother. Falwell sued Flynt and the magazine, and a jury awarded Falwell $150,000 in damages. The\nSupreme Court overturned the verdict on appeal on grounds of the First Amendment, holding that as a\npublic figure, Falwell had to endure the advertisement.\n\n[8]\n\nDo you believe that celebrities and public figures\n\nshould have a harder time winning IIED lawsuits? Why or why not?\n3.\n\nDo you believe that an \xe2\x80\x9cidentifying characteristic\xe2\x80\x9d should be protected by the tort of misappropriation, or\ndo you believe that society has gone too far in recognizing property rights? A First Amendment exception\nexists for comedians who engage in satire and comedy (think of Tina Fey\xe2\x80\x99s impersonation of Sarah Palin\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n221\n\n\x0cduring the 2008 presidential campaign, for example). Does it make sense to you that comedians like Fey\nand John Stewart can make money through misappropriation, but other businesses cannot?\n4.\n\nLook at the advertisement featured in Note 7.21 "Video Clip: Is a Single Name a Likeness or Identifying\nCharacteristic?". Do you think that the ad is referring to Lindsay Lohan? Has the name \xe2\x80\x9cLindsay\xe2\x80\x9d become\nso linked to Lohan that companies run the risk of being sued if they use the name Lindsay in\nadvertisements? What if the advertisement had used a name like \xe2\x80\x9cOprah\xe2\x80\x9d or \xe2\x80\x9cCher\xe2\x80\x9d?\n\n5.\n\nDefamation law only protects the living. Some legal commentators believe that defamation should also\nprotect the dead. See, for example, law professor Jonathan Turley\xe2\x80\x99s opinion in the Washington\nPost here:http://www.washingtonpost.com/wpdyn/content/article/2006/09/15/AR2006091500999_pf.html. Turley points out examples of how the dead\nhave been defamed, such as the character of William Murdoch in the 1997 movie Titanic, where he was\nportrayed as a murderous nut. In reality, survivors reported he took heroic actions to save passengers. Do\nyou believe defamation should be extended to protect the dead as well as the living?\n\n[1] Snyder v. Phelps, 580 F.3d 206 (4th Cir.\n2009),http://pacer.ca4.uscourts.gov/opinion.pdf/081026.P.pdf (accessed September 27, 2010).\n[2] \xe2\x80\x9cI Support Al Snyder in His Fight against Westboro Baptist Church,\xe2\x80\x9d\nFacebook.http://www.facebook.com/group.php?v=wall&ref=ts&gid=355406162379 (accessed September 27,\n2010).\n[3] James Hagerty, \xe2\x80\x9cBank Sorry for Taking Parrot,\xe2\x80\x9d Wall Street Journal, March 11, 2010, A1.\n[4] \xe2\x80\x9cWalgreens Pharmacists Mock You behind Your Back,\xe2\x80\x9d The Consumerist, March 8,\n2006, http://consumerist.com/2006/03/walgreens-pharmacists-mock-you-behind-your-back.html (accessed\nSeptember 27, 2010).\n[5] Jaime Holguin, \xe2\x80\x9c$15.6M Award for Coffee \xe2\x80\x98Mug,\xe2\x80\x99\xe2\x80\x9d CBSnews.com, February 2,\n2005,http://www.cbsnews.com/stories/2005/02/01/national/main670754.shtml (accessed September 27, 2010).\n[6] Midler v. Ford Motor Company, 849 F.3d 460 (9th Cir. 1988).\n[7] White v. Samsung Electronics America, 971 F.2d 1395 (9th Cir. 1992).\n[8] Hustler Magazine v. Falwell, 485 U.S. 46 (1988).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n222\n\n\x0c7.2 Negligence\nLEARNING OBJECTIVES\n1.\n\nLearn about whom we owe duties to under the tort of negligence.\n\n2.\n\nExplore how those duties can be legally breached.\n\n3.\n\nDiscuss how causation, both actual and proximate, can affect liability.\n\n4.\n\nExamine the requirement to demonstrate damages to win a negligence suit.\n\n5.\n\nUnderstand various defenses to negligence.\n\nVideo Clip: The Crash of Continental Flight 3407\nOrdinarily, we don\xe2\x80\x99t expect perfectly good airplanes to fall out of the sky for no reason. When it\nhappens, and it turns out that the reason was carelessness or a failure to act reasonably, then the tort\nof negligence may apply. All persons, as established by state tort law, have the duty to act reasonably\nand to exercise a reasonable amount of care in their dealings and interactions with others. Breach of\nthat duty, which causes injury, is negligence. Negligence is distinguished from intentional torts\nbecause there is a lack of intent to cause harm. If a pilot intentionally crashed an airplane and\nharmed others, for example, the tort committed may be assault or battery. When there is no intent to\nharm, then negligence may nonetheless apply and hold the pilot or the airline liable, for being\ncareless or failure to exercise due care.\nNote that the definition of negligence is purposefully broad. Negligence is about breaching the duty\nwe owe others, as determined by state tort law. This duty is often broader than the duties imposed by\nlaw. Colgan Air, for example, may have been fully compliant with applicable laws passed by Congress\nwhile still being negligent. In a way, the law of negligence is an expression of democracy at the\ncommunity and local level, because ultimately, citizen juries (as opposed to legislatures) decide what\nconduct leads to liability.\nTo prove negligence, plaintiffs have to demonstrate four elements are present. First, they have to\nestablish that the defendant owed a duty to the plaintiff. Second, the plaintiff has to demonstrate that\nthe defendant breached that duty. Third, the plaintiff has to prove that the defendant\xe2\x80\x99s conduct\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n223\n\n\x0ccaused the injury. Finally, the plaintiff has to demonstrate legally recognizable injuries. We\xe2\x80\x99ll address\neach of these elements in turn.\nFirst, the plaintiff has to demonstrate that the defendant owed it a duty of care. The general rule in\nour society is that people are free to act any way they want to, as long as they don\xe2\x80\x99t infringe on the\nfreedoms or interests of others. That means that you don\xe2\x80\x99t owe anyone a special duty to help them in\nany way. For example, if you\xe2\x80\x99re driving along a deserted rural highway at night in a snowstorm, and\nyou see a car ahead of you fishtail and drive into a ditch, you are entitled to keep driving and do\nnothing, not even report the accident, because you don\xe2\x80\x99t owe that driver any special duty. On the\nother hand, if you ran a stop sign, which then caused the other driver to drive into a ditch, you would\nowe that driver a duty of care.\nAnother way to look at duty is to consider whether or not the plaintiff is a foreseeable plaintiff. In\nother words, if the risk of harm is foreseeable, then the duty exists. Take, for instance, the act of\nlittering with a banana peel. If you carelessly throw away a banana peel, then it is foreseeable that\nsomeone walking along may slip on it and fall, causing injuries. Under tort law, by throwing away the\nbanana peel you now owe a duty to anyone who may be walking nearby who might walk on that\nbanana peel, because any of those persons might foreseeably step on the peel and slip.\nAn emerging area in tort law is whether or not businesses have a duty to warn or protect customers\nfor random crimes committed by other customers. By definition, crimes are random and therefore\nnot foreseeable. However, some cases have determined that if a business knows about, or should\nknow about, a high likelihood of crime occurring, then that business must warn or take steps to\nprotect its customers. For example, in one case a state supreme court held that when a worker at\nBurger King ignored a group of boisterous and loud teenagers, Burger King was liable when those\nteenagers then assaulted other customers. [1] In another case, the Las Vegas Hilton was held liable for\nsexual assault committed by a group of naval aviators because evidence at trial revealed that the\nhotel was aware of a history of sexual misconduct by the group involved.\nThe concept of duty is broad and extends beyond those in immediate physical proximity. In a famous\ncase from California, for example, a radio station with a large teenage audience held a contest with a\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n224\n\n\x0cmobile DJ announcing clues to his locations as he moved around the city. The first listener to figure\nout his location and reach him earned a cash prize. One particular listener, a minor, was rushing\ntoward the DJ when the listener negligently caused a car accident, killing the other driver. During a\nnegligence trial, the radio station argued that hindsight is not foreseeability and that the station\ntherefore did not owe the dead driver a duty of care. The California Supreme Court held that when\nthe radio station started the contest, it was foreseeable that a young and inexperienced driver may\ndrive negligently to claim the prize and that therefore a duty of care existed. [2] Radio stations should\ntherefore be very careful when running promotional contests to ensure that foreseeable deaths or\ninjuries are prevented. This lesson apparently eluded Sacramento station KDND, which in 2007 held\na contest titled \xe2\x80\x9cHold Your Wee for a Wii\xe2\x80\x9d where contestants were asked to drink a large amount of\nwater without going to the bathroom for the chance of winning a game console. An otherwise healthy\ntwenty-eight-year-old mother died of water intoxication hours after the contest, which led to a\nlawsuit and a $16 million jury verdict.\nThe general rules surrounding when a duty exists can be modified in special situations. For example,\nlandowners owe a duty to exercise reasonable care to protect persons on their property from\nforeseeable harm, even if those persons are trespassers. If you are aware of a weak step or a faucet\nthat dispenses only scalding hot water, for example, you must take steps to warn guests about those\nknown dangers.\nBusinesses owe a duty to exercise a reasonable degree of care to protect the public from foreseeable\nrisks that the owner knew or should have known about. There are many foreseeable ways for\ncustomers to be injured in retail stores, from falling objects improperly placed on high shelves, to\nlight fixtures exploding or falling due to improper installation, to customers being injured by forklifts\nin so-called warehouse stores. One particular area of concern for businesses is liquid on walking\nsurfaces, which can be very dangerous. Spilled product (milk, orange juice, wine, etc.), melted ice or\nsnow, or rain can cause slick situations, and if a store knows about such a condition, or should have\nknown about it, then the store must quickly warn customers and remedy the situation.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n225\n\n\x0cBusiness professionals such as doctors, accountants, dentists, architects, and lawyers owe a special\nduty to act as a reasonable person in their profession. Professional negligence by these professionals\nis known as malpractice. The government estimates that between forty-four thousand and ninetyeight thousand people die each year in hospitals due to medical mistakes, the vast majority of them\npreventable. [3]\nOnce duty has been established, negligence plaintiffs have to demonstrate that the defendant\nbreached that duty. A breach is demonstrated by showing the defendant failed to act reasonably,\nwhen compared with a reasonable person. It\xe2\x80\x99s important to keep in mind that this reasonable person\nis hypothetical and does not actually exist. This reasonable person is never tired, sleepy, angry, or\nintoxicated. He or she is reasonably careful\xe2\x80\x94not taking every single precaution to prevent accidents\nbut considering his or her actions and consequences carefully before proceeding. In reality, once a\nduty has been established, the presence of injury or harm is usually enough to satisfy the \xe2\x80\x9cbreach of\nduty\xe2\x80\x9d requirement.\nThe third element of negligence is causation. In deciding whether there is causation, courts have to\nconsider two questions. First, courts query as to whether there is causation in fact, also known as\nbut-for causation. This form of causation is fairly easy to prove. But for the defendant\xe2\x80\x99s actions,\nwould the plaintiff have been injured? If yes, then but-for causation is proven. For example, if you\nare texting while driving and you hit a pedestrian because your attention was diverted, then but-for\ncausation is easily met, because \xe2\x80\x9cbut for\xe2\x80\x9d your actions of texting while driving, you would not have\nhit the pedestrian.\nThe second question is tougher to establish. It asks whether the defendant\xe2\x80\x99s actions were the\nproximate cause of the plaintiff\xe2\x80\x99s injury. In asking this question, courts are expressing a concern that\ncausation-in-fact can be taken to a logical but extreme conclusion. For example, if a speeding truck\ndriver crashes his or her rig and causes the interstate highway to be shut down for several hours,\ncausing you to become stuck in traffic and miss an important interview, you could argue that but for\nthe truck driver\xe2\x80\x99s negligence, you may have landed a new job. It would not be fair, however, to hold\nthe truck driver liable for all the missed appointments and meetings caused by a subsequent traffic\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n226\n\n\x0cjam after the crash. At some point, the law has to break the chain of causation. The truck driver may\nbe liable for injuries caused in the crash, but not beyond the crash. This is proximate causation.\n\nVideo Clip: Palsgraf v. Long Island Railroad Company\nIn determining whether proximate cause exists, we once again use the foreseeability test, already\nused for determining whether duty exists. If an injury is foreseeable, then proximate cause exists. If it\nis unforeseeable, then it does not.\nIn some cases it can be difficult to pinpoint a particular source for a product, which then makes\nproving causation difficult. This is particularly true inmass tort cases where victims may have been\nexposed to dangerous substances from multiple sources over a number of years. For example,\nassume that you have been taking a vitamin supplement for a number of years, buying the\nsupplement from different companies that sell it. After a while the government announces that this\nsupplement can be harmful to health and orders sales to stop. You find out that your health has been\naffected by this supplement and decide to file a tort lawsuit. The problem is that you don\xe2\x80\x99t know\nwhich manufacturer\xe2\x80\x99s supplement caused you to fall ill, so you cannot prove any specific\nmanufacturer caused your illness. Under the doctrine of joint and several liability, however, you don\xe2\x80\x99t\nhave to identify the specific manufacturer that sold you the drug that made you ill. You can simply\nsue one, two, or all manufacturers of the supplement, and any of the defendants are then liable for\nthe entirety of your damages if they are found liable. This doctrine has been used in cases involving\nasbestos production and distribution.\nThe final element in negligence is legally recognizable injuries. If someone walks on a discarded\nbanana peel and doesn\xe2\x80\x99t slip or fall, for example, then there is no tort. If someone has been injured,\nthen damages may be awarded to compensate for those injuries. These damages take the form of\nmoney, as there is nothing tort law can do to bring back the dead or regrow lost limbs, and tort law\ndoes not allow for incarceration. Money is therefore the only appropriate measure of damages, and it\nis left to the jury to decide how much money a plaintiff should be awarded.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n227\n\n\x0cThere are two types of award damages in tort law. The first, compensatory damages, seeks to\ncompensate the plaintiff for his or her injuries. Compensatory damages can be awarded for medical\ninjuries, economic injuries (such as loss of a car, property, or income), and pain and suffering. They\ncan also be awarded for past, present, and future losses. While medical and economic damages can\nbe calculated using available standards, pain and suffering is a far more nebulous concept. Juries are\noften left to their conscience to decide what amount of money can compensate for pain and suffering,\nbased on the severity and duration of the pain as well as its impacts on the plaintiff\xe2\x80\x99s life.\nThe second type of damage award is known as punitive damages. Here, the jury is awarded a sum of\nmoney not to compensate the plaintiff but to deter the defendant from ever engaging in similar\nconduct. The idea behind punitive damages is that compensatory damages may be inadequate to\ndeter future bad conduct, so additional damages are necessary to ensure the defendant corrects its\nways to prevent future injuries. Punitive damages are available in cases where the defendant acted\nwith willful and wanton negligence, a higher level of negligence than ordinary negligence. Bear in\nmind, however, that there are constitutional limits to the award of punitive damages.\nA defendant being sued for negligence has three basic affirmative defenses. An affirmative defense is\none that is raised by the defendant essentially admitting that the four elements for negligence are\npresent, but that the defendant is nonetheless not liable for the tort. The first defense is\nassumption of risk. If the plaintiff knowingly and voluntarily assumes the risk of participating in a\n\ndangerous activity, then the defendant is not liable for injuries incurred. For example, if you decide\nto bungee jump, you assume the risk that you might be injured during the jump. It\xe2\x80\x99s common for\nbungee jumpers to experience burst blood vessels in the eye, soreness in the back and neck region,\nand twisted ankles, so these injuries are not compensable. On the other hand, you can only assume\nrisks that you know about. When a person bungee jumps, one of the first steps is for the jump\noperator to weigh the jumper, so that the length of the bungee can be adjusted accordingly. If this is\nnot done properly, the jumper may overshoot or undershoot the expected bottom of the jump. While\nyou can assume known risks from bungee jumping, you cannot assume unknown risks, such as the\nrisk that a jump operator may negligently calculate the length of the bungee rope.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n228\n\n\x0cA related doctrine, the open and obvious doctrine, is used to defend against suits by persons injured\nwhile on someone else\xe2\x80\x99s property. For example, if there is a spill on a store\xe2\x80\x99s floor and the store\nowner has put up a sign that says \xe2\x80\x9cCaution\xe2\x80\x94Slippery Floor,\xe2\x80\x9d yet someone decides to run through the\nspill anyway, then that person would lose a negligence lawsuit if he or she slips and falls because the\nspill was open and obvious. Use of the open and obvious doctrine varies widely by state, with some\nstates allowing it to be used in a wide variety of premises liability cases and other states\ncircumventing its usefulness.\nBoth the assumption of risk and open and obvious defenses are not available to the defendant who\ncaused a dangerous situation in the first place. For example, if you negligently start a house fire while\nplaying with matches and evacuate the house with your roommates, if one of your roommates\ndecides to reenter the burning house to rescue someone else, you cannot rely on assumption of risk\nas a defense since you started the fire.\nThe second defense to negligence is to allege that the plaintiff\xe2\x80\x99s own negligence contributed to his or\nher injuries. In a state that follows the contributory negligence rule, a plaintiff\xe2\x80\x99s own negligence, no\nmatter how minor, bars the plaintiff from any recovery. This is a fairly harsh rule, so most states\nfollow the comparative negligence rule instead. Under this rule, the jury is asked to determine to what\nextent the plaintiff is at fault, and the plaintiff\xe2\x80\x99s total recovery is then reduced by that percentage. For\nexample, if you jaywalk across the street during a torrential thunderstorm and a speeding car strikes\nyou, a jury may determine that you are 20 percent at fault for your injuries. If the jury decides that\nyour total compensatory damage award is $1 million, then the award will be reduced by $200,000 to\naccount for your own negligence.\nFinally, in some situations, the Good Samaritan law may be a defense in a negligence suit. Good\nSamaritan statutes are designed to remove any hesitation a bystander in an accident may have to\nproviding first aid or other assistance. They vary widely by state, but most provide immunity from\nnegligent acts that take place while the defendant is rendering emergency medical assistance. Most\nstates limit Good Samaritan laws to laypersons (i.e., police, emergency medical service providers,\nand other first responders are still liable if they act negligently) and to medical actions only.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n229\n\n\x0cKEY TAKEAWAYS\nNegligence imposes a duty on all persons to act reasonably and to exercise due care in dealing and\ninteracting with others. There are four elements to the tort of negligence. First, the plaintiff must\ndemonstrate the defendant owed the plaintiff a duty. If the risk of injury is foreseeable, then the\ndefendant owes the plaintiff a duty. Second, there must be a breach of that duty. A breach occurs when\nthe defendant fails to act like a reasonable person. Professional negligence is known as malpractice. Third,\nthe plaintiff must demonstrate that the defendant caused the plaintiff\xe2\x80\x99s injuries. Both causation-in-fact\nand proximate causation must be proven. Finally, the plaintiff must demonstrate legally recognizable\ninjuries, which include past, present, and future economic, medical, and pain and suffering damages.\nDefendants can raise several affirmative defenses to negligence, including assumption of risk, comparative\nor contributory negligence, and in some cases, Good Samaritan statutes.\n\nEXERCISES\n1.\n\nDoes a private investigator owe a duty of care to potential victims of crime if their clients use information\nobtained by the investigator to commit the crime? In 2003 a court held the answer is yes. In that case, an\nInternet-based investigative firm charged fees to a client to find out the Social Security number, place of\nemployment, and home and work addresses of a third party. The client then used the information to stalk\nand kill the third party. The court held that since the risk of harm is foreseeable, the company owed the\nthird party a duty of care. See Remsburg v. Docusearch, Inc., 816 A.2d 1001 (N.H. 2003).\n\n2.\n\nIn January 2001 a New York man attended a family birthday party at a Benihana restaurant, where chefs,\nwhile cooking at the table, routinely throw pieces of food for diners to catch with their mouths. The man\nwrenched his neck while ducking a piece of flying shrimp, requiring treatment by several doctors. By that\nsummer, doctors determined surgery was necessary to treat numbness in his arm. Five months after\nsurgery, he checked into the hospital with a high fever and died. The family sued Benihana for $10 million\nin damages, claiming that the fever was the result of surgery, which in turn was the result of the chef\xe2\x80\x99s\nactions in throwing food at diners. Do you believe that Benihana should be liable for the man\xe2\x80\x99s death?\nWhy or why not?\n\n3.\n\nWhat kind of duty of care do cities that own and operate public transportation systems owe to the paying\nand traveling public? On February 4, 2010, Shaun Mills was traveling home on a public bus in Jacksonville\nBeach, Florida. He missed his regular stop, so he got off at the next stop. The sidewalk at this bus stop was\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n230\n\n\x0cclosed, so he crossed the street and was hit by a car. The remarkable accident was captured on video.\nSeehttp://today.msnbc.msn.com/id/36310494. Mills survived and is suing the bus company. In this case,\nwhat defenses are available to the defendant bus company?\n4.\n\nMedical malpractice claims tens of thousands of lives per year, leaving victims and their families little\nrecourse except through the tort system. Most doctors purchase medical malpractice insurance policies to\npay a claim in case they are sued, but in some cases these premiums can be exorbitantly high. The fear of\nmedical malpractice suits also drives some doctors to practice \xe2\x80\x9cdefensive medicine,\xe2\x80\x9d which further\nincreases the price of health care for everyone. How do you think the legal system can best balance these\ntwo competing interests?\n\n[1] Iannelli v. Burger King Corp., 145 N.H. 190 (2000).\n[2] Weirum v. RKO General, 15 Cal.3d 40 (1975).\n[3] U.S. Department of Health and Human Services, Agency for Healthcare Research and Quality, \xe2\x80\x9cReducing Errors\nin Health Care: Translating Research Into Practice,\xe2\x80\x9d April 2000,http://www.ahrq.gov/qual/errors.htm (accessed\nSeptember 27, 2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n231\n\n\x0c7.3 Strict Liability\nLEARNING OBJECTIVES\n1.\n\nExplore what strict liability is and when it applies.\n\n2.\n\nUnderstand how a product may be unreasonably dangerous, triggering strict liability.\n\n3.\n\nLearn about how a product\xe2\x80\x99s warnings and labels are a part of a product\xe2\x80\x99s safe design.\n\n4.\n\nExamine defenses available to strict product liability.\n\nIntentional torts require some level of intent to be committed, such as the intent to batter someone.\nNegligence torts don\xe2\x80\x99t require intent to harm but require some level of carelessness or\nneglect. Strict liability torts require neither intent nor carelessness. In fact, if strict liability applies, it\nis irrelevant how carelessly, or how carefully, the defendant acted. It doesn\xe2\x80\x99t matter if the defendant\ntook every precaution to avoid harm\xe2\x80\x94if someone is harmed in a situation where strict liability\napplies, then the defendant is liable.\nSince this rule can have harsh consequences, it applies in a only few limited circumstances. One of\nthose circumstances is when the defendant is engaged in an ultrahazardous activity. An\nultrahazardous activity is one that is so inherently dangerous that the risk to human life is great if\nanything wrong happens, so the person carrying out the ultrahazardous activity is held strictly liable\nfor those activities. Transporting dangerous chemicals or nuclear waste, for example, is inherently\ndangerous. If the chemicals spill, it is very difficult, if not impossible, to prevent injury to property or\npersons. Similarly, businesses that use dynamite, such as building demolition crews, run the risk that\nno matter how careful they are, people or property could be damaged by intentionally igniting\ndynamite. Therefore, strict liability applies.\nStrict liability also applies when restaurants, bars, and taverns serve alcohol to minors or visibly\nintoxicated persons. This activity is dangerous, and there is a high risk of probability that these\npatrons, if they drive, will injure others. Many states have dram shop acts that impose strict liability\nin this circumstance.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n232\n\n\x0cYou might wonder why defendants are held strictly liable if they are acting reasonably or are even\nbeing ultracautious. As with most issues in law, the answer lies in social policy. In essence, strict\nliability torts exist because businesses that engage in covered activities (such as transporting\nhazardous chemicals or operating bars) profit from those activities. They are also in the best position\nto ensure that every precaution can be taken to avoid an unexpected event, which may have\ncatastrophic consequences. Victims of these events are often innocent members of the public who are\nnot in any position to avoid being injured and therefore should not be denied a legal remedy simply\nbecause the defendant took prudent precautions. This social policy concern is also expressed in the\nmost important area of strict liability application, strict product liability.\nIn strict product liability, any retailer, wholesaler, or manufacturer that sells an unreasonably\ndangerous product is strictly liable. For example, Toyota recently disclosed that it had manufactured\nand sold several vehicle models with faulty accelerators, leading to several cases of unintended\nacceleration and subsequent deaths. Vehicles that accelerate unintentionally are clearly\nunreasonably dangerous. In this case, the manufacturer (Toyota Japan), the wholesaler or importer\n(Toyota\xe2\x80\x99s U.S. sales company), and the retailer (local dealers) are all strictly liable for injuries caused\nby these faulty accelerators. Note, however, that strict liability applies only to commercial sellers. If a\nprivate citizen sold his or her Toyota on Craigslist, for example, he or she would not be strictly liable\nfor selling an unreasonably dangerous product.\nTo demonstrate that a product is unreasonably dangerous, plaintiffs have two theories available to\nthem. First, they might allege that the product was defective because of a flaw in the manufacturing\nprocess. Under this theory, the vast majority of products being produced turn out fine, but due to\nsome sort of production defect, a few samples or a batch turns out defective. If these defective\nsamples are sold to the public, the manufacturer or seller is strictly liable. A light bulb factory that\nmanufactures a million safe light bulbs, for example, and then manufacturers one that explodes\nwhen it is turned on due to some production defect, is strictly liable for the injuries caused. Similarly,\na frozen pizza factory that produces thousands of pizzas without any trouble would be strictly liable if\none frozen pizza is produced that contains foreign contaminants because of a production defect such\nas an inattentive worker or machine breakdown.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n233\n\n\x0cSecond, a product may be defective because of a design defect. Here, there is nothing wrong with the\nmanufacturing or production of the product. Rather, the product is defective because it was designed\nincorrectly or in a manner that causes the product to be unreasonably dangerous. Engineers\ncontinually work to design products to be as safe as possible, but in some cases the product is\nnonetheless dangerous, and the manufacturer or seller is strictly liable. For example, starting in 1991\nseveral Boeing 737 jetliners began experiencing unexpected movement in the rudder, leading to\nseveral high-profile crashes including a USAir flight in Pittsburgh that killed 132 people. [1] During\nthe course of investigation, the government discovered that the part that controls the rudder gets\nvery cold in flight, and when it is injected with hot hydraulic fluid, the part can jam and move the\nrudder in the opposite direction of what the pilot is calling for. This design defect was eventually\nfixed by upgrading the rudder control systems on all existing Boeing 737s worldwide.\n\nHyperlink: What\xe2\x80\x99s Wrong with the Tire?\nhttp://www.time.com/time/business/article/0,8599,128198,00.html\nIn 1999 Ford customers in the Middle East began experiencing tread separation problems on Ford\nExplorer SUVs. The tires would disintegrate, leading to a loss of control and often a rollover crash. The\ncompany initially believed that the problem was limited to the Middle East because of unique\ncharacteristics there such as extremely hot weather, lowered tire inflation pressures for driving in sand,\nand harsh operating environments. Soon, however, vehicles in the United States, especially in hotter\nregions of the country, began experiencing the same problems. The death toll mounted to over 170 deaths\nand over 700 injuries from these accidents. Ford\xe2\x80\x99s investigation led the company to believe that certain\nfifteen-inch tires manufactured by Firestone were to blame; virtually all the accidents involved Firestone\ntires manufactured in one plant in Decatur, Illinois (now closed). Similar vehicles equipped with\nGoodyear tires rarely experienced tread separation problems. Firestone, on the other hand, blamed the\nFord Explorer for being defectively designed. Firestone argued that the Explorer lacked critical safety\nfeatures to lower the center of gravity, reduce the propensity to roll over, and lessen the chance of\nunderinflating the tires. Firestone pointed out that the same tires did not experience any problems when\ninstalled on GM vehicles. Whether the fault lay with a production defect in Firestone tires or design defect\nin Ford Explorers, both companies were strictly liable. Ford spent over $3 billion recalling the tires and\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n234\n\n\x0cended its one-hundred-year relationship with Firestone. Congress also responded, passing a federal law\nrequiring all vehicles to be equipped with tire pressure monitoring systems.\n\nMany product liability cases arise from the defective design theory because courts have held that the\nwarning labels on products, as well as accompanying literature, are all part of a product\xe2\x80\x99s design. A\nproduct that might be dangerous if used in a particular way, therefore, must have a warning label or\nother caution on it, so that consumers are aware of the risk posed by that product. Manufacturers\nmust warn against a wide variety of possible dangers from using their products, as long as the injury\nis foreseeable. If consumer misuse is foreseeable, manufacturers must warn against that misuse as\nwell. For these reasons, window blinds come with warnings about choking hazards posed by the rope\nused to raise and lower them, and hair dryers come with warnings about operating them in bathtubs\nand showers.\nWhile you may think that these warnings are a little silly, keep in mind that products can harm or kill\npeople who don\xe2\x80\x99t know how to use them correctly. For example, in one case, a woman traveling in\nthe passenger seat of a GM SUV was killed in a low-speed collision in a parking lot when airbags\ndeployed in a collision. The woman was killed because her seat was reclined and rather than being\nrestrained by the seat and seatbelt, she \xe2\x80\x9csubmarined\xe2\x80\x9d underneath the seat belt and hit the deploying\nairbag. When her family sued GM, the company argued that seats and seatbelts work only when the\nseat is in an upright position and that the owner\xe2\x80\x99s manual warns not to recline the seat when the\nvehicle is in motion. The family argued successfully that this warning was not clear and conspicuous\nenough, and that as a result many people travel with their seat reclined. Do you believe the lack of a\nclear and conspicuous warning about the danger of traveling with the seat reclined makes a vehicle\xe2\x80\x99s\ndesign defective?\n\nHyperlink: A Near-Fatal Mistake Due to Labeling?\nhttp://www.usatoday.com/life/people/2007-12-04-quaid-lawsuit_N.htm\nFigure 7.9\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n235\n\n\x0cShould these labels be more distinctive to prevent mistakes?\nSource: http://www.steadyhealth.com/articles/What_do_Anticoagulants_do__a667.html.\nIn November 2007 actor Dennis Quaid and his wife Kimberly were celebrating the birth of their newborn\ntwins at Cedars-Sinai Medical Center in Los Angeles. The twins suffered a staph infection, and doctors\nprescribed a blood thinner to prevent blood clots. The blood thinner, Heparin, comes in two doses, with\nthe heavier dose one thousand times more potent than the lower dose. However, the two doses come in\nsimilar packaging with blue labels. Nurses at the hospital inadvertently gave the twins the higher dose,\nnearly killing the twins. In Indianapolis earlier that year, three premature infants did in fact die from\noverdosing on Heparin. The Quaids are suing the manufacturer, arguing that the labels on the drug\nrepresent a design defect because it is too easy to confuse the two doses. The manufacturer, Baxter\nHealthcare, has since changed the design to include a red warning label that must be torn off before the\ndrug can be used.\n\nThere are several defenses to strict product liability. Since product liability is strict liability, the\nplaintiff\xe2\x80\x99s contributory or comparative negligence is not a defense. However, assumption of risk can\nbe a defense. As in negligence, the user must know of the risk of harm and voluntarily assume that\nrisk. For example, someone cutting carrots with a sharp knife voluntarily assumes the risk that the\nknife may slip and cut him or her, meaning he or she cannot sue the knife manufacturer. However, if\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n236\n\n\x0cthe knife blade unexpectedly detaches from the knife handle because of a design or production\ndefect, and injures the user, then there is no assumption of risk since the user would not have known\nabout that particular risk.\nProduct misuse is another defense to strict product liability. If the consumer misuses the product in a\nway that is unforeseeable by the manufacturer, then strict liability does not apply. Modifying a lawn\nmower to operate as a go-kart, for instance, is product misuse. Note that manufacturers are still\nliable for any misuse that is foreseeable, and they must take steps to warn against that misuse. A\nrelated defense is known as the commonly known danger doctrine. If a manufacturer can convince a\njury that the plaintiff\xe2\x80\x99s injury resulted from a commonly known danger, then the defendant may\nescape liability.\n\nKEY TAKEAWAYS\nIn areas where strict liability applies, the defendant is liable no matter how careful the defendant was in\npreventing harm. Carrying out ultrahazardous activities results in strict liability for defendants. Another\narea where strict liability applies is in the serving of alcohol to minors or visibly intoxicated persons. A\nlarge area of strict liability applies to the manufacture, distribution, and sale of unreasonably dangerous\nproducts. Products can be unreasonably dangerous because of a production defect, design defect, or both.\nA product\xe2\x80\x99s warnings and documentation are a part of a product\xe2\x80\x99s design, and therefore inadequate\nwarnings can be a basis for strict product liability. Assumption of risk, product misuse, and commonly\nknown dangers are all defenses to strict product liability.\n\nEXERCISES\n1.\n\nIs the risk of death from smoking a commonly known danger? It may be today, but in the fifties and sixties,\nthe tobacco industry undertook an extraordinary campaign to convince the public that there was no harm\nin smoking cigarettes, and even suggested that smoking may have health benefits.\nSee http://tobacco.stanford.edu for a collection of some of the print advertising from this era. Should\nolder plaintiffs who grew up viewing these advertisements be allowed to sue tobacco companies under\nstrict product liability? Why or why not?\n\n2.\n\nIs fast food or restaurant food an unreasonably dangerous product? Many nutritionists and doctors\nbelieve that excessive consumption of fast food and restaurant food can lead to obesity, high blood\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n237\n\n\x0cpressure, heart disease, diabetes, and other health complications including premature death. You may be\nsurprised at exactly how bad these food products can be for you.\nSeehttp://www.youtube.com/watch?v=MtgOmChwAm4 for an example of how unhealthy eating out at\nItalian restaurants can be. Should these food producers therefore take steps to make their product less\ndangerous or to warn about the dangers of overconsumption? Should Congress pass legislation such as\nthe Personal Responsibility in Food Consumption Act to immunize the food industry from product liability\nsuits?\n3.\n\nStella Liebeck, an elderly grandmother, received third-degree burns when she spilled coffee purchased at a\nMcDonald\xe2\x80\x99s drive-through. At trial, experts testified that McDonald\xe2\x80\x99s coffee was too hot to be consumed\nat the point of purchase, was hotter than any other restaurant\xe2\x80\x99s coffee or coffee brewed at home, and was\nso hot that third-degree burns would result within three to five seconds of coming into contact with the\nskin. McDonald\xe2\x80\x99s also conceded that the coffee was brewed extremely hot for commercial (profit) reasons,\nbecause most customers wanted coffee to be hot throughout their commute. After finding the company\nliable, the jury awarded Mrs. Liebeck two days\xe2\x80\x99 worth of coffee sales at McDonald\xe2\x80\x99s, an amount equivalent\nto $2.7 million, in punitive damages. The award, although reduced to much less than that, set off a\nfirestorm of criticism that has not died down to this day. Do you believe that it\xe2\x80\x99s possible for coffee to be\nunreasonably dangerous? Seehttp://www.hotcoffeethemovie.com for one filmmaker\xe2\x80\x99s perspective on this\ncase.\n\n[1] \xe2\x80\x9cWhen Jets Crash: How Boeing Fights to Limit Liability,\xe2\x80\x9d Seattle Times, October 30,\n1996, http://seattletimes.nwsource.com/news/local/737/part04 (accessed September 27, 2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n238\n\n\x0c7.4 Concluding Thoughts\nTort law is continually changing and adapting to societal expectations about the freedoms and\ninterests we expect to protect. Although it has endured for many years, recent debates have sought to\nrecast the viability of tort law in political terms. The Republican Party platform, for example,\nmaintains that the rule of tort trial lawyers threatens America\xe2\x80\x99s \xe2\x80\x9cglobal competitiveness, denies\nAmericans access to the quality of justice they deserve, and puts every small business one lawsuit\naway from bankruptcy.\xe2\x80\x9d [1] Many businesses see tort lawsuits as a nuisance at best and ruinous at\nworst, and would like to see them disappear altogether. Consumer rights activists, on the other hand\n(and often backed by plaintiff lawyer groups), believe that tort lawsuits are the most effective way to\nkeep corporations honest and prevent them from putting profits before safety. This debate has led to\nseveral proposals for tort reform among the various states, or by the federal government.\nThese reforms can take several different forms. One common reform is to impose a statute of repose\non product liability claims. These statutes function like a statute of limitations and bar plaintiffs from\nfiling tort claims after a certain period of time has lapsed. For example, in 1994 President Clinton\nsigned the General Aviation Revitalization Act into law, imposing an eighteen-year statute of repose\non product liability claims brought against general aviation aircraft manufacturers such as Cessna\nand Piper. The law allowed these manufacturers to once again launch new light aircraft production in\nthe United States. Another popular tort reform is a cap on punitive damages. President George W.\nBush supported a nationwide punitive damage cap of $250,000 for medical malpractice claims, but\nCongress did not pass any such law. Other reforms call for eliminating defective design as a basis for\nrecovery, barring any claims if a product has been modified by the consumer in any way, and\nallowing for the state-of-the-art defense (if something was \xe2\x80\x9cstate of the art\xe2\x80\x9d at the time it was\nproduced then no strict liability can apply).\nOccasionally Congress passes legislation that provides industry-wide tort lawsuit protection for\ncertain industries. For example, in 2005 President George W. Bush signed the Protection of Lawful\nCommerce in Arms Act. The law shields firearm manufacturers and dealers from product liability\nlawsuits for crimes committed with their products. Many industries have tried to obtain this form of\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n239\n\n\x0cindustry-wide protection, either from Congress or from judicial rulings. Most recently, drug\nmanufacturers hoped for industry-wide protection by arguing that if the Food and Drug\nAdministration approved drug labels, labeling lawsuits would be preempted by the Constitution. The\nSupreme Court rejected this argument in 2009. [2]\nIn spite of these efforts at tort reform, torts remain an important and viable part of civil law. All\nbusinesses, of all sizes and across all industries, must maintain a keen understanding of the duties\nand responsibilities imposed by tort law. Being able to understand, and even embrace, these duties\ncan help businesses thrive while keeping consumers and customers safe.\n\n[1] Republican National Committee, \xe2\x80\x9c2008 Republican Platform,\xe2\x80\x9d\n2008,http://www.gop.com/2008Platform/Economy.htm#7 (accessed September 27, 2010).\n[2] Wyeth v. Levine, 555 U.S. ___ (2009), http://www.law.cornell.edu/supct/html/06-1249.ZS.html (accessed\nOctober 2, 2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n240\n\n\x0cChapter 8\n\nThe Property System\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand different classifications of property, including personal\nproperty and real property, as well as different types of interests in real property. You will also learn about\nmethods of acquisition and transfer of real property. At the conclusion of this chapter, you should be able\nto answer the following questions:\n1.\n\nWhat is the difference between real property and personal property?\n\n2.\n\nHow is ownership interest in personal property transferred?\n\n3.\n\nWhat interests in real property exist?\n\n4.\n\nHow is real property acquired and transferred?\n\n5.\n\nWhat legal relationships exist between landlord and tenants?\n\nThe concepts of property and ownership are fundamental to any society. Property refers to tangible\nand intangible items that can be owned. Ownership is a concept that means the right to exclude\nothers. Disputes over both have been at the root of conflicts and wars since time immemorial.\nWithout laws to protect property ownership, the stability of our society would be seriously\nundermined. For example, if law did not protect ownership interests in property, then people would\nhave to protect their property themselves. This means that people would have to hire their own\nsecurity forces to protect their property, or they would have to stand guard over their property\npersonally. It would be difficult to get anything else done. Such a system would likely result in the\ndevelopment of powerful factions. Those with the greatest power would dominate property\nownership, and weaker members of society would be at their mercy. For example, one of the opening\nscenes of the movie Black Hawk Down illustrates a U.N. food distribution point in Mogadishu,\nSomalia. As depicted in that scene, people were waiting to receive the distribution of food, but a\npowerful, armed faction seized the cargo and opened fire on them. Obviously, such a system of\nproperty ownership would prove to be very unsettling, and it would lead to great instability in our\neconomic system.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n241\n\n\x0cOur legal system creates a peaceful means to acquire, retain, and divest of property, and to settle\nproperty disputes. It punishes those who operate outside of those rules. Indeed, those who do not\nacquire property lawfully or who do not settle property disputes within the confines of our legal\nsystem are subjected to criminal and civil penalties.\nIn the United States, our legal system ensures the ability to own property to everyone that the system\nrecognizes can own property. Of course, not everyone has always been able to own property. The\nhistory of the United States is replete with examples of exclusion from the property ownership\nsystem. For example, at various times and in different ways, married women, African Americans, and\npeople of Chinese and Japanese descent have been subject to restrictions regarding the ownership of\nreal property. Because property law is a state law issue, those restrictions and exclusions varied from\nstate to state. Today, no such restrictions exist. Indeed, even a nonhumanlegal person, such as a\ncorporation, can own property. However, some biological beings cannot own property. For example,\nnonhuman animals cannot own real or personal property in our legal system. This is because\nnonhuman animals are not legal persons. However, a nonhuman animal can be a beneficiary of\na trust in many states.\nMoreover, not everything is subject to ownership. For instance, the human body cannot be owned by\nanother, though historically, in legal systems that recognized slavery, certain human bodies could be\nowned. Today, public policy discourages the treatment of human body as personal property,\nrendering \xe2\x80\x9cgifts\xe2\x80\x9d of body parts to specific individuals largely suspect. For example, organ donees may\nhave a need for an organ destined for transplant into their own bodies after the donor\xe2\x80\x99s body dies,\nbut they do not have a legal right to it. [1]Similarly, the question regarding whether human genes may\nbe owned through patent is a hot topic. Check out Note 8.7 "Hyperlink: When DNA Is Isolated from\nthe Human Body, Is It Subject to Ownership by Patent?" and consider whether the benefits of\npatentability of certain body parts, like genes, might outstrip the concerns surrounding ownership of\nthe human body.\n\nHyperlink: When DNA Is Isolated from the Human Body, Is It Subject to\nOwnership by Patent?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n242\n\n\x0chttp://www.nytimes.com/2010/03/30/business/30gene.html\n\nBefore engaging in questions regarding the evolution of property ownership rights, it is necessary to\nlay the foundation for studying this fascinating area of law. It is this foundation to which we now\nturn. This chapter explores the differences between real and personal property, and the acquisition,\ntransfer, and protection of real and personal property interests. Additionally, it examines different\ninterests in real property.\n\nKey Takeaways\nThe U.S. legal system protects the rights to own, acquire, protect, and divest of real and personal property.\nThese protections are necessary for peaceful civil society. Historically, different groups of people have\nbeen subjected to discriminatory practices\xe2\x80\x94both legal and illegal\xe2\x80\x94regarding property ownership. Today,\nlegal persons can own, acquire, transfer, and sell property. However, not everything is subject to property\nownership concepts.\n\n[1] Colavito v. New York Organ Donor Network, 2006 NY Slip Op. 09320 (NY App. Ct. 2006).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n243\n\n\x0c8.1 Personal Property\nLEARNING OBJECTIVES\n1.\n\nDistinguish between personal property and real property.\n\n2.\n\nUnderstand classifications of property.\n\n3.\n\nExamine methods of acquisition of personal property.\n\n4.\n\nUnderstand the concept of bailment, and the legal duties associated with bailment.\n\nLet\xe2\x80\x99s begin with an understanding of the differences between types of property. This is important,\nbecause different laws apply to different types of property. While it might be perfectly legal to destroy\na piece of personal property\xe2\x80\x94like a chair\xe2\x80\x94without obtaining permission from the government,\ndestruction of real property is a different matter altogether. For example, the owner of an office\nbuilding who wishes to demolish it would be subject to many local laws, such as requirements to\nobtain the necessary permits. Such an activity might also be subject to further legal scrutiny, if the\nbuilding in question holds particular historic value, for example. Let\xe2\x80\x99s compare this to the\ndestruction of a chair, which is personal property. Even if the chair is the chair that Abraham Lincoln\nsat in while drafting the Emancipation Proclamation, as long as the chair is owned by the person who\nwishes to destroy it, the owner may simply load it into his or her truck and haul it to the dump. No\nspecial permission is required, because there are few legal restrictions to the destruction of private\nproperty.\nAs you can see, property can be classified as real or personal. Real property is land, and certain things\nthat are attached to it or associated with it. Real property is raw land, such as a forest or a field, as\nwell as buildings, like a house, a condominium, or an office building. Additionally, things that are\nassociated with land, like mineral rights, are also real property. People often talk about real property\nby using the term real estate, which reflects both the concept of real property and the ownership\ninterest concept of estate.\nMany businesses, from grocery stores to coffee shops to hotels, rely on real property for customers or\nclients to visit to conduct business. Today, many businesses are also conducted virtually, and have\nonly virtual shops. Virtual stores, such as those found on eBay, are not forms of real property.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n244\n\n\x0cHowever, certain virtual real properties, such as those found on Second Life, are traded for real\nmoney. Check out the two links in Note 8.13 "Hyperlink: \xe2\x80\x9cUnreal\xe2\x80\x9d Property" to read about this\n\xe2\x80\x9cproperty\xe2\x80\x9d boom, where real business occurs over nonreal property.\n\nHyperlink: \xe2\x80\x9cUnreal\xe2\x80\x9d Property\nhttp://realestate.msn.com/article.aspx?cp-documentid=13107800\nhttp://secondlife.com/land\nPersonal property is property that is not real property. Tangible propertyis something that can be\n\ntouched. Moveable, tangible personal property ischattel. Many businesses exist to sell personal\nproperty. For example, the primary purpose of retailers such as Wal-Mart, Amazon.com, and Sears is\nto sell personal property. Some property can also be described as fungible property. Property that can\neasily be substituted with identical property is said to be fungible. For example, if you bought a\npound of sugar from a container containing ten pounds of sugar, you wouldn\xe2\x80\x99t care which specific\ngrains of sugar made up your purchase, because all the sugar in the container is fungible. Other types\nof fungible goods include juices, oil, metals such as steel or aluminum, and physical monetary\ncurrency.\nSome personal property is intangible. Intangible property does not physically exist, but it is still\nsubject to ownership principles, including acquisition, transfer, and sale. For instance, the right to\npayment under a contract, the right to exclude others from a patented product, and the right to\nprohibit others from using copyrighted materials are all examples of intangible property.\nSounds simple, right? Your iPod, your flash drive, and your computer are all personal property. Your\ndorm room, apartment, or house is real property. So far, so good. But imagine that you found a\nJacuzzi for sale that you loved. You plunked down $5,000 to buy it, and you have it delivered to your\nhouse. You pay for construction of a deck to surround it and plumbing to service it. Is the Jacuzzi\npersonal property or is it real property? This is an example of personal property that becomes\nattached to the land as a fixture. A fixture is something that used to be personal property, but it has\nbecome attached to the land so that it is legally a part of the land. Fixtures are treated like real\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n245\n\n\x0cproperty. Accordingly, when real property is transferred, fixtures are transferred as a part of the real\nproperty. In our example, if you move, you will have to leave your beloved Jacuzzi behind, unless you\nmake express provisions to remove it. What if you were just renting? Since removing a fixture would\ncause substantial harm to the property, that fixture remains with the land. The landlord might be\nvery happy about that!\nSome things that are attached to the land are not fixtures but are part of the real property itself.\nImagine a farm with one thousand acres planted in corn. Is the corn crop personal property, or is it\nreal property? Or imagine a forest. Maybe the owner has been thinking about timbering the forest for\nsome extra money. Is the forest personal property, or is it real property? Both the corn crop and trees\nare examples of real property that can become personal property, if they are severed from the land.\nThis means that when an ear of corn is picked from the stalk, the ear of corn becomes personal\nproperty, even though while it was growing and still attached the land, it was real property. Likewise,\nwhen a tree is felled, that tree is transformed from real property to personal property.\nBesides property types, property can be classified by ownership, too. Personal property and real\nproperty can be private or public. Private property is owned by someone or something that is not the\ngovernment. Individuals, corporations, and partnerships, for instance, can own private property.\nPrivate property can include real property like land or buildings, and personal property, such as\nautomobiles, furniture, and computers. Property that is owned by the government is public property.\nYellowstone National Park and the Gifford Pinchot National Forest are both examples of public\nproperty that is real property. Public property can also include personal property, such as\nautomobiles, furniture, and computers owned by state or local governments.\n\nMethods of Acquisition of Personal Property\nPersonal property may be acquired for ownership in several different ways. For example, if you produce\nsomething, then you may own it, unless you are producing it in the capacity of your work for someone\nelse. If you buy four yards of wool fabric and sew a coat out of it, then you own that coat by virtue of\nhaving produced it with your own materials. This is ownership by production. However, if you sew a coat\nas part of your job while working for your employer, then the employer will own the coat.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n246\n\n\x0cIf you are in the business of producing coats to sell, then you may be a merchant, and the rules of\nthe Uniform Commercial Code (UCC) would govern transactions involving the sale of goods and the\npurchase of supplies from other merchants. Regardless of whether someone is a merchant or\nnot,purchase is a means of acquiring ownership. Indeed, in today\xe2\x80\x99s world, purchase may be the most\ncommon method of acquiring property.\nProperty may also be gifted. A gift is a voluntary transfer of property. Generally, the donor of the gift must\nintend to gift the property, the donor must deliver the gift, and the gift must be accepted by the intended\nrecipient, known as the donee. A conditional gift is a gift that requires a condition to be met before the gift\nwill transfer. For example, if your parents said, \xe2\x80\x9cYou can have a new car, if you graduate from school,\xe2\x80\x9d\nthen that would be an example of a conditional gift. If you do not graduate from school, then you cannot\nhave the gift of the car.\nWhat if you find something? Dating at least to the Institutes of Justinian in Roman law, the concept of\n\xe2\x80\x9cfinders keepers\xe2\x80\x9d is one known to every preschooler: finders keepers, losers weepers. However, in law,\nthings are not quite so simple. Property that someone finds can be classified in several ways. A finder of\npersonal property may claim ownership of the property if it is abandoned. The owners of abandoned\nproperty must intend to relinquish ownership in it. For example, if you take your chair to the landfill, you\nhave abandoned the chair. Someone may come along and take possession of it, which will place ownership\nof the chair in that person. If you change your mind later, that\xe2\x80\x99s too bad. The chair now belongs to the new\nowner. However, if the property is simply lost or mislaid, then the finder must relinquish it once the\nrightful owner demands its return. If the finder refuses to return lost or mislaid property to its rightful\nowner, the owner can sue for conversion, which is a tort. Conversion is intentional, substantial\ninterference with the chattel of another. Another classification of personal property applicable to found\nproperty is treasure trove. A treasure trove is money or precious metals, like gold, for which the concept of\n\xe2\x80\x9cfinders keepers\xe2\x80\x9d sometimes is applicable.\nImagine finding the next-generation iPhone just lying on a bar stool. It has not been released yet, but\nthere you are with an actual prototype in your hands! This is valuable property because it embodies the\ncutting-edge intellectual property of Apple, both in utility and design. Brian Hogan found himself in this\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n247\n\n\x0cposition. Apparently, an Apple software engineer had accidentally left the prototype on a bar stool one\nevening. Hogan decided to sell the prototype to Gizmodo, a tech site, which was willing to pay for it so that\nit could write an early and exclusive review of this soon-to-be hot item on the market. Gizmodo\nsubsequently discovered that Apple had lost an iPhone prototype and wanted it returned. Regardless of\nthat fact, Gizmodo dismantled the prototype and published photos on its Web site. Subsequently, it\nreturned the property to Apple.\n\n[1]\n\nWas the prototype of the next-generation iPhone abandoned, lost, mislaid, or a treasure trove? If Apple\nfiled a civil lawsuit against Gizmodo, what would the claim be and who should win? Since we know that\nApple wanted the property back, we know that it had no intention of relinquishing ownership of it.\nTherefore, the property was not abandoned. Since a next-generation iPhone is not money or precious\nmetals\xe2\x80\x94even though it is very valuable and worth a lot of money to Apple\xe2\x80\x94the concept of treasure trove\ndoes not apply. A phone is not actual coin or cash. In this case, the property was either lost or mislaid,\nbecause it was unintentionally relinquished or set down for later retrieval, but the owner had forgotten\nwhere it was placed. In either case, if the phone had not been returned, Apple could have brought a suit\nfor conversion. A successful conversion claim would have awarded damages to Apple. Just like any\nsuccessful conversion claim, damages would not include a requirement to return the property itself.\nIncidentally, California has captured the duty to return lost or mislaid property in its criminal statutes,\nand the facts of this case are being investigated for possible theft charges. Check out Note 8.32\n"Hyperlink: Finders Keepers?" for this story and two additional cautionary tales about claiming found\nproperty.\n\nHyperlink: Finders Keepers?\nBe careful what you wish for. These stories might seem like a miracle to the cash-strapped, but they are\ncautionary tales.\nNext-Generation iPhone\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n248\n\n\x0cGizmodo published the details of a found iPhone prototype herehttp://gizmodo.com/5520164/this-isapples-next-iphone, but the prototype became the subject of law enforcement and an Apple complaint, as\nseen here:http://www.cnn.com/2010/TECH/04/30/wired.iphone.finder/index.html?iref=allsearch\nCold Cash, Hot Lead\nThis found \xe2\x80\x9cmoney\xe2\x80\x9d along an interstate might be abandoned, lost, or mislaid, but it is unlikely to be\nclaimed by its rightful owner:\nhttp://www.cnn.com/video/#/video/us/2008/12/05/wa.found.money.KING?iref=allsearch\nA Renovator\xe2\x80\x99s Fantasy\nThis found money in the walls of a house might be an example of a treasure trove, but the treasure was\nquickly dissipated by legal troubles:\nhttp://www.cbsnews.com/stories/2007/12/13/eveningnews/main3617369.shtml and the\nepilogue:http://www.nytimes.com/2008/11/09/us/09house.html\n\nBailment\nSometimes it is necessary to intentionally leave personal property with someone else. For example,\nimagine that you own a cat. If your cat, which is considered to be chattel, needs to have surgery, you will\nneed to leave her at the veterinary hospital. Clearly, taking your cat to a veterinary hospital does not\nconstitute abandonment. Likewise, you have not lost or mislaid your cat. And, precious though she may\nbe, your cat is not subject to the concept of treasure trove. Instead, in this situation you will be known\nas bailor, and you will be seeking a bailment with your veterinarian. A bailor is someone in the rightful\npossession of personal property who gives the property to someone else to hold. A bailment is the\narrangement in which when the rightful possessor (such as the owner) of personal property gives the\nproperty to someone else to hold. The holding party, known as the bailee, agrees to accept the property\nand has the duty to return it. The bailee is someone who is in possession of someone else\xe2\x80\x99s property. In\nour example, you rightfully have possession of your cat because she is your personal property. You give\nyour cat to the veterinarian to hold, who has agreed to accept the cat. You also rightfully expect that the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n249\n\n\x0ccat will be returned to you on demand. Indeed, the veterinarian has a duty, by virtue of the bailment, to\nreturn the cat to you. Consider Note 8.36 "Hyperlink: Lost Dog", where Delta Airlines was the bailee of a\ndog, which it lost.\n\nHyperlink: Lost Dog\nCheck out this link. Do you think the remedy offered by Delta Airlines is adequate in this case? Why or\nwhy not?\nhttp://www.clickondetroit.com/news/23515167/detail.html\nThe bailee has certain duties to the bailor. For example, a bailee has a duty to take reasonable care of the\nproperty while the property is in his or her possession. This means different things for different types of\nbailment. If the bailee is the only party who benefits from the bailment, then the bailee must take\nextraordinary care with the personal property. A common example of a bailee being the only party who\nbenefits is where the owner of the property loans the property to someone for his or her use. For instance,\nif you loan your neighbor a snow shovel without asking for something in return, then your neighbor\nreceives the sole benefit of the bailment. His or her duty of care is that he or she must take extraordinary\ncare with the snow shovel. However, when both parties receive benefit from the bailment, such as when\nyou rent a DVD from Blockbuster, only the duty of ordinary care is imposed on the bailee. The bailee\nreceives the DVD and Blockbuster receives a rental fee. When the benefit of the bailment exists for the\nbenefit of the bailor only, then only minimum care is required. Gross negligence will give rise to liability,\nbut there is no great duty for the bailee to be as careful as he or she would be if he or she were receiving\nsome benefit. If someone asks you to hold his or her books while he or she jumps into a swimming pool,\nyou would have a minimum duty of care. If you lost the books, then you would not be liable. However, if\nyou intentionally threw the books into the pool, then you would be grossly negligent and liable for\ndamages.\nAn involuntary bailment is created when someone finds lost or mislaid property. The finder may not\ndestroy the property, though the duties that he or she owes regarding the property may vary from state to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n250\n\n\x0cstate. A voluntary bailment is created when intention exists to create the bailment, as described in the\nprevious paragraph.\nAs you can imagine, bailment is common in business. Examples of bailment in business include placing\npackages or goods with common carriers for delivery, warehousing goods with a third party prior to sale\nor delivery, or taking clients\xe2\x80\x99 or customers\xe2\x80\x99 automobiles in a valet service. Consider whether a business\nshould be able to disclaim bailment (and the duties that go along with bailment). For example, if a hotel\nrequired its guests to sign a \xe2\x80\x9cno bailment created\xe2\x80\x9d clause on check-in, should that excuse the hotel from\nliability if the guests\xe2\x80\x99 personal property is damaged while the property is left in the hotel?\n\nKEY TAKEAWAYS\nProperty is classified as real property or personal property, tangible or intangible, and private or public.\nPersonal property can be transformed into real property when it is affixed to the land. Real property can\nbe transformed into personal property when it is severed from the land. Personal property can be\nacquired for ownership through production, purchase, or gift or, in certain circumstances, by finding it.\nBailments are legal arrangements in which the rightful possessor of personal property leaves the property\nwith someone else who agrees to hold it and return it on demand.\n\nEXERCISES\n1.\n\nClassify the following as (1) personal property or real property, (2) tangible or intangible property,\nand (3) fungible property:\na.\n\nA prosthetic device, for example, an artificial leg\n\nb.\n\nAn expected inheritance of stock\n\nc.\n\nDraperies hanging in a dining room\n\nd.\n\nA bank account with a five-hundred-dollar balance\n\ne.\n\nA fictional story that you created\n\nf.\n\nA condominium on the thirty-second floor of a building in lower Manhattan\n\ng.\n\nThe right to receive payment for your work (e.g., wages, salary)\n\nh.\n\nA wig that someone is wearing\n\ni.\n\nA silo filled with wheat\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n251\n\n\x0cj.\n\nThe wheat in a silo\nWould you be willing to pay real money for nonreal property in a virtual world like Second Life? Why\n\nor why not? What are people buying when they buy virtual real property? How does this differ from\nbuying actual real property, like land?\nIf you found a prototype of the next-generation iPhone lying on a bar stool, what would you have\ndone with it? What would be the consequences of your chosen action?\nThink of an example of when you have asked for a bailment. Did you feel confident that you would\nreceive your personal property when you demanded it? Did you worry that it would be damaged in any\nway? If it had been misdelivered, what would your legal remedies be?\nShould bailees be permitted to disclaim liability for bailment agreements? Why or why not?\nAt major league baseball games, who do you think owns the baseball when it is being played, and\nwho owns it when the ball enters the stands where members of the public sit? Who owns the ball if a\nmember of the public picks it up?\n\n[1] Edward C. Baig, \xe2\x80\x9cGizmodo: Lost Next-Gen iPhone Returned to Apple,\xe2\x80\x9d USA Today, April 21,\n2010, http://www.usatoday.com/tech/products/2010-04-20-iphone_N.htm (accessed September 27, 2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n252\n\n\x0c8.2 Real Property\nLEARNING OBJECTIVES\n1.\n\nUnderstand the concept of real property.\n\n2.\n\nExamine methods of acquisition of real property.\n\n3.\n\nUnderstand different interests in real property, including ownership interests and scope of interests.\n\n4.\n\nExamine the landlord-tenant relationship.\n\nReal property is land, and certain things that are attached to it or associated with it. Real property\n\nincludes undeveloped land, like a forest or a field, and it includes buildings, such as houses,\ncondominiums, and office buildings. Real property also includes things associated with the land, like\nsubsurface rights. Fixtures are personal property that have become attached to the land, and they are\ntransferred with the land. Fixtures in a house include things like the lights affixed to the ceiling, the\nfurnace, and the bathtub. Plants and trees that grow on the land are real property until they are\nsevered from the land. For example, farmers\xe2\x80\x99 crops are part of their real property until they are\nseparated from the land, at which time they become personal property.\n\nMethods of Acquisition\nReal property may be acquired for ownership (the title may be obtained) in one of several ways. It may be\npurchased, inherited, gifted, or even acquired through adverse possession. Ownership rights are\ntransferred by title. Ownership of real property means that the owner has the right to possess the\nproperty, as well as the right to exclude others, within the boundaries of the law. If someone substantially\ninterferes with your use and enjoyment of your real property, you may bring a claim in nuisance (a form of\ntort law). For example, if a neighbor decides to start burning tires on his property, the smell of the\nburning tires might substantially interfere with your use and enjoyment of your property, so you would\nhave an actionable claim in nuisance. Similarly, if you own real property, you might rightfully seek\ndamages against those who enter your land without your consent or permission. This would be a trespass\nto land claim. Owners of real property may also sell the real property, in whole or in part.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n253\n\n\x0cThe most common way that real property is acquired is through purchase. Property law is a state law\nmatter, and state laws vary regarding conveyance of property. Typically, someone who is interested in\nacquiring real property will ask a third party, such as a real estate agent or a broker, to help locate a\nsuitable property and to facilitate the terms of the deal. The buyer and seller will negotiate a contract,\nwhich will contain all essential terms of the sale, such as location of the real property, price, fixtures that\nwill be excluded from sale, and the type of ownership interest that is being transferred. Both parties will\nperform their promises under the contract (e.g., the buyer will pay the seller, and the seller will transfer\nthe title via deed) to close the deal (\xe2\x80\x9cclosing\xe2\x80\x9d), and then the deed will be recorded. A contract for any\ninterest in property must be in writing to be valid against the defendant according to the\nStatute of Frauds.\nDifferent types of deeds convey different types of interests. A quitclaim deed, for instance, conveys\nwhatever interests in title that the grantor has in the property to the party to whom the quitclaim is given.\nOf course, that means if the grantor has no interests in the real property, a conveyance by quitclaim will\nnot grant any interests in the property. For example, if you grant a quitclaim deed to your friend for the\nEmpire State Building, then that means that you have transferred your interests in title to that building to\nyour friend. If you have no interests in the title to the Empire State Building to begin with, then on\nconveyance of the quitclaim deed, your friend will not have any interests in the building either. You\ncannot convey interests that you do not have. On the other hand, many states allow a warranty deed,\nwhich conveys title and a warranty against defects in title as well as encumbrances. Buyers typically\ndemand a warranty deed when they purchase property.\nAfter title is transferred by the deed, the deed is typically recorded. Recording the deed is not necessary\nfor ownership. However, recording a deed to property is important because it places others on notice that\nwhoever has recorded the deed to the property owns the property. Some states favor the rights of those\nwho record the deed first (under a race statute), while other states favor the rights of those who acquired\nthe interest first without notice of other claims to the property (under a notice statute).\nA race/notice system, which has a race/notice statute, is one in which priority is given to the first\nbona fide purchaser to record when there is a conflict in ownership claim. A bona fide purchaser is simply\na purchaser who takes title in good faith, with no knowledge of competing claims to title.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n254\n\n\x0cBesides outright purchase, another common way in which real property may be obtained is through\ninheritance. Real property may be bequeathed through a will or may transfer per state statutes when a\ndecedent dies intestate. Generally speaking, people have the right to dispose of their property as they wish\nwhen they die, providing that their will or other transfer instrument meets their state\xe2\x80\x99s requirements for\nvalidity. When someone dies intestate, state statutes will determine who among the decedent\xe2\x80\x99s relatives\nreceives the property. For example, state statutes often specify that property will go to the spouse, and if\nthere is no spouse, then to the children. If there are no children, then to the parents. If there are no living\nparents, then to the siblings, and so on. If no such person exists, the property may finally escheat to the\nstate.\nReal property may also be acquired through a gift. Providing that the person who is giving the property\nactually intends to make the gift of title, delivers the deed to the recipient, and the gift is accepted, then\nthe gift is valid. If one of these elements is not met, for instance, if the deed is not delivered to the\nintended party (or to a third party to hold for the intended party), then the gift has not been successfully\nmade, and the title will not be conveyed.\nA less common way to acquire real property is through the doctrine of adverse possession. Colloquially,\nthis is often referred to as \xe2\x80\x9csquatter\xe2\x80\x99s rights.\xe2\x80\x9d At its heart, this method of acquiring property captures the\ndeeply held belief that a land\xe2\x80\x99s value is in its use for profit. If a land sits idle at the owner\xe2\x80\x99s hands but\nsomeone else puts it to use, then the law may\xe2\x80\x94just may\xe2\x80\x94favor the user\xe2\x80\x99s claim to the land over that of the\nactual owner.\nAdverse possession is when someone who is not the owner of real property has claimed the real property\nfor his own. To be successful under this doctrine, several elements must be met. These include the\nfollowing:\n\xef\x82\xb7\n\nThe possessor must be in actual possession.\n\n\xef\x82\xb7\n\nThe possession must be open and notorious, which means that it must be obvious to others (visible).\n\n\xef\x82\xb7\n\nThe possession must be hostile, which means that it is against the actual owner\xe2\x80\x99s interests.\n\n\xef\x82\xb7\n\nThe possession must be continuous, which means that the possessor cannot have been evicted during\nthe statutory length of time required to obtain title through possession.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n255\n\n\x0c\xef\x82\xb7\n\nThe possession must be exclusive.\n\n\xef\x82\xb7\n\nThe state statutory length of time must be met, and this time varies from state to state. For example,\nsome states, like Maine, require a twenty-year period, while other states, like Nevada, require only a\nfive-year period.\n\nSome states\xe2\x80\x99 adverse possession laws also require that the possessor pay property taxes on the property\nduring the course of the adverse possession. If all of these elements are met, then the possessor can bring\na claim toquiet title. If successful, the possessor becomes the owner, without any compensation being\nmade to the former owner.\nAdverse possession and claims for quiet title often occur around property lines, where one party has\nroutinely used another\xe2\x80\x99s property because a fence has been misplaced. Other instances involve claims\nconcerning land owned by people who do not visit it, such as land owned in a remote area. Still other\nexamples exist in cases of ouster, when a tenant in common constructively or actually evicts others with\nvalid ownership interests. Remember that all elements of an adverse possession must occur for the entire\nstatutory length of time for an action for quiet title to be successful. This means, for instance, if the owner\nchecks on the property and finds someone there, the owner must interfere with those elements. The\nowner should evict the trespasser, and this can be accomplished by summoning the police. Doing so\nwould break the continuity requirement.\nA recent case in Boulder, Colorado, prompted the Colorado legislature to substantially alter the state\xe2\x80\x99s\nadverse possession laws. In that case, a married couple, composed of a judge and an attorney, met the\nrequirements for adverse possession and successfully brought an action for quiet title. In that case, the\nadverse possessors were clearly versed in the law. The actual owners of the property had purchased the\nland many years before to build a future retirement home. Check out Note 8.59 "Hyperlink: A Question of\nEthics" and see whether you think the Colorado legislature overreacted.\n\nHyperlink: A Question of Ethics\nIs adverse possession a legally sanctioned form of theft?\nhttp://www.denverpost.com/news/ci_7494276\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n256\n\n\x0cInterests and Scope\nOwning real property carries many responsibilities, as well as the potential for great profit and great\nliability. It is important to recognize the duties associated with property ownership, and learn how to\nprotect yourself against potential liability associated with it. For instance, if a toxic waste site is discovered\non your real property, you may very well be liable for its cleanup, even if you did not realize that such a\nsite was there when you purchased the land. Each buyer of real property has a duty to\nexercise due diligence when purchasing land. The idea is that you should have known about the site, if it\nwas discoverable on inspection. Knowing this, along with familiarity with the\nfederalComprehensive Environmental Response, Compensation, and Liability Act (CERCLA), helps us\nrecognize that we should never agree to buy land \xe2\x80\x9csight unseen,\xe2\x80\x9d or at least without a professional\ninspector that we trust. But what if an old toxic waste site is located on property that you wish to sell? You\nwould have a duty to disclose such a defect in the land to prospective buyers before conveying ownership.\nAdditionally, we must consider duties that landowners have to other people who enter the land. What are\nour duties to people who visit our home? Or our retail establishment? What if they are not invited but\ninstead are trespassers? These duties of landowners will vary depending on the status of the person who\nwas injured.\nWhat if a gold mine were discovered on land that you used to own? Can you profit from that discovery?\nProbably not, if you conveyed full ownership to someone else.\nAs these examples illustrate, it is important to know about the duties of landowners, how to limit\nliability associated with the ownership of land, and when severance of liability occurs. These types of\nquestions can be considered more fully when we consider ownership interests.\nAdditionally, it is important to know how an owner of real property may use the property, or the scope of\nhis or her rights. Consider these questions: If you owned a lot in the middle of a city, can you build an\napartment building that blocks the neighboring landowner\xe2\x80\x99s light? Or if you own a piece of raw land\nwhere you discover oil, can you drill on your land if it siphons oil from underneath your neighbor\xe2\x80\x99s land,\nor if it causes your neighbor\xe2\x80\x99s land to collapse due to lack of subsurface support? If you live on a coastline\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n257\n\n\x0cand your neighbor builds a dyke that causes your waterfront property line to erode so that over the years\nyour property is reduced in size, do you have an actionable claim against your neighbor? Conversely, if the\nebb and flow of water along the coastline increases your property due to natural accretion, do you own the\n\xe2\x80\x9cnew\xe2\x80\x9d property, even though it wasn\xe2\x80\x99t part of the original purchase? Consider water disputes, which are a\nvery hot topic in the western states. If you live next to a river, can you divert the entire stream of water,\neven if you wanted to divert it for a capricious reason? Imagine that you dreamed of having a very large\nprivate water park for your family, but you needed all the water in a river that adjoined your property to\nmake that dream a reality. If you diverted all that water, other riparian owners might very well have an\nactionable claim. What if it was a drought year and you relied on water from a river to irrigate your\ncommercial crops, but endangered salmon in the river needed the water for their habitat? Can you take\nthe water for your crop, or must the water be left in the river for the endangered salmon? These types of\nlegal questions can be addressed when we consider the scope of rights.\nThe following sections address duties of landowners, ownership interests, and scope of interest in real\nproperty.\n\nDuties of Landowners\nLandowners owe different duties to different types of people who enter their land. These responsibilities\nvary, depending on whether the person is a trespasser, a licensee, or an invitee.\nA trespasser is a person who voluntarily, intentionally enters the land of another without permission or\nprivilege. A landowner has a duty not to intentionally injure a trespasser. For instance, booby traps,\npitfalls, or anything of the sort are simply not permitted. Trespassers injured from such a trap have valid\nclaims against the landowner for injuries.\nA licensee is someone who has permission to be on the land. Landowners have a higher duty of care to\nsuch a person. Not only must a landowner not intentionally injure a licensee, but the landowner must also\nwarn the licensee of known defects. For example, if a landowner knows that the steps to his or her porch\nare icy, he or she has a duty to warn a licensee\xe2\x80\x94such as a visiting friend\xe2\x80\x94that those steps are icy. Failure\nto do so may result in liability for the landowner.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n258\n\n\x0cAn invitee is someone who has entered real property by invitation. Businesses have issued invitations to\nthe public. Public places have issued invitations to the public. Anyone who arrives at the invitation of an\nowner is an invitee. Landowners must inspect their property for defects, correct those defects when found,\nand warn invitees about such defects. This is why you will see a \xe2\x80\x9ccaution\xe2\x80\x9d sign on the floor of a grocery\nstore, after it has been mopped or after a liquid spill.\n\nOwnership Interests in Real Property\nDifferent types of interests may be owned in real property. For example, real property may be owned\nwithout restriction, subject only to local, state, and federal laws. Or ownership interests may be narrower,\nsubject to conditions, the violation of which can lead to loss of those ownership interests.\nThe most complete ownership interest is represented by fee simple absolute. The owner of property in fee\nsimple absolute has the greatest ownership interest recognized by law. Generally, if someone wants to buy\nreal property, he or she is looking to buy property in fee simple absolute.\nCompare that with a defeasible fee. A fee simple defeasible is subject to a condition of ownership or to\nsome future event. For instance, if you donated land to \xe2\x80\x9cthe City of Nashville, so long as it is used as a\npublic greenway,\xe2\x80\x9d then the land would be owned in defeasible fee by the City of Nashville, unless it\ndecided to do something else with the land, besides maintain it as a public greenway. Once the condition\nis violated, the land would revert back to either the original owner or whoever owned\nthe reversion interest, which is a future interest in real property.\nAnother ownership interest is a life estate. This interest is measured by the life of the owner in the life\nestate. If you wished to grant ownership rights in real property to your mother for the length of her life,\nbut then expected the property to be returned to you upon her death, you might grant a life estate to her.\nSimilarly, a common investment, known as a reverse mortgage, employs the concept of life estate. A\nreverse mortgage is an arrangement where the purchaser of real property agrees to allow the seller of the\nproperty to retain possession of the property for a specified period of time (such as the remainder of his or\nher life) in exchange for the ability to purchase the property at today\xe2\x80\x99s price. This can be an attractive\ninvestment, if the investor believes that the value of the property will increase in the future, and if the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n259\n\n\x0cinvestor does not need immediate possession of the property. These arrangements essentially gamble on\nlife expectancies of the sellers of real property by granting life estates to them in the property. However,\nsometimes this backfires. Check out Note 8.70 "Hyperlink: Reverse Mortgage" for an example of a seller\nwho outlived her investor in such an arrangement.\n\nHyperlink: Reverse Mortgage\n\xe2\x80\x9cIn life, one sometimes makes bad deals,\xe2\x80\x9d said Jeanne Calment, the oldest living woman in history,\nconcerning the investor who \xe2\x80\x9creverse mortgaged\xe2\x80\x9d her apartment.\nhttp://www.nytimes.com/1995/12/29/world/a-120-year-lease-on-life-outlasts-apartment-heir.html\nSometimes, more than one owner owns the interest in the property. Several types of co-ownership\ninterests are recognized in law. These ownership interests are important for matters of possession, right to\ntransfer, right to profits from the land, and liability. For example, tenancy in common describes an\nownership interest in which all owners have an undivided interest in the property, equal rights of\npossession, and a devisable interest. Compare this to a joint tenancy, which describes an ownership\ninterest in which the surviving owner has the right of survivorship. Imagine that you own a gold mine with\nyour partner, Frank. Would you rather have a tenancy in common or a joint tenancy? You would rather\nhave a joint tenancy because if Frank dies, then his interest in the gold mine would vest in you, rather\nthan in his heirs. After all, you may not want to be a partner with Frank\xe2\x80\x99s grandson (or whoever), but that\nis exactly what might happen with tenancy in common. Similarly, a tenancy by the entirety includes the\nright of survivorship, but it can only occur between a husband and wife. This concept is recognized in\nsome states, but not all states.\nThese different interests are created by specific wording in the instrument of conveyance. To create a\ntenancy in common, the language would be \xe2\x80\x9cTo John and Frank,\xe2\x80\x9d if John and Frank were to be the coowners. However, if a joint tenancy were intended, the conveyance would have to be more specific, like\nthis: \xe2\x80\x9cTo John and Frank, with rights of survivorship.\xe2\x80\x9d Note that John and Frank could not benefit from a\ntenancy by the entirety unless they lived in a state that recognized same-sex marriages, and unless they\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n260\n\n\x0cwere, in fact, married. Moreover, such questions have not yet arisen in our courts because the legal\nconcept of same-sex marriage is still nascent and, in many states, not yet recognized in law.\nNote that a tenant in tenancy in common may sell or transfer his or her rights without seeking permission\nfrom his or her cotenant. Imagine that you owned a farm with your best friend. At first, you agree to\nengage only in organic farming practices. Later, your friend wants to move to conventional farming\npractices. Since you do not want any part in the spraying of pesticides or herbicides on the land, you\ndecide to sell your interests to someone else. Even if your friend opposes the sale, he or she cannot block\nit. This is because cotenants in a tenancy in common have the unilateral right to transfer their interests in\nproperty. Imagine, later, that someone working on that land becomes very sick from a pesticide sprayed\nthere after you sold your interest. You would not be liable for any damages resulting from such an event,\nbecause your liability would be severed with the sale. Compare this to a joint tenancy, including tenancy\nby the entirety. To transfer one\xe2\x80\x99s interests, the consent and approval of the cotenant is required. In the\ncase that joint tenants disagree about the use of the property or its disposal, the courts can step in to grant\na partition of the land, which essentially results in a separate parcels being granted to the individual\ntenants. This recasts the formerly joint tenants into adjacent landowners, and it allows them to dispose of\nor use their property as each sees fit, with no rights to the other\xe2\x80\x99s property.\n\nScope of Interests in Real Property\nScope of ownership matters, because it is determinative of what can (or cannot) be done with the land.\nThe surface of the land and the buildings that are attached to the land are implicitly included when most\npeople contemplate the scope of ownership of real property. However, other interests can be parsed and\nconveyed separately, including subsurface or mineral rights, and right to light or right to a view.\nMoreover, water rights are granted differently, depending on whether the property is in the western or the\neastern United States. Additionally, easements and covenants grant certain rights to nonpossessors of\nland.\nSubsurface or mineral rights are rights to the substances beneath the actual surface of the land. If you are\ninteresting in drilling for oil, but you do not want to buy every piece of land where you might wish to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n261\n\n\x0cspeculate, then you probably are in the market to purchase or lease mineral rights. This would allow you\nthe right to extract whatever you find under the surface of the land and sell it.\nWater rights are determined in two different ways in the United States. Generally speaking, states east of\nthe Mississippi River follow ariparian water rights doctrine, which means that those who live next to the\nwater have a right to use the water. The water is shared among the riparian owners. In a quite different\nscheme, most western states use the concept of prior appropriation, which grants rights to those who used\nthose rights \xe2\x80\x9cfirst in time.\xe2\x80\x9d Moreover, under this concept, the use must be beneficial, but the owner of the\nright need not be an adjacent landowner. This policy has led to some unnatural uses of land in western\nstates, where water rights are highly valued due to the scarcity. For example, we see flourishing farmlands\nin extremely arid climates because the owners of the water rights want to make sure that they retain their\nprior appropriation rights to the water by putting it to beneficial use (e.g., crop irrigation). If water is not\nput to beneficial use under a prior appropriation doctrine, then those rights can be lost. Prior\nappropriation is basically a \xe2\x80\x9cuse it or lose it\xe2\x80\x9d doctrine. Moreover, adjacent landowners in prior\nappropriation states may have no right whatsoever to use the water that runs through their land. Indeed,\nsuch an outcome is very common.\nEasements and covenants are nonpossessory interests in real property. An easement is created expressly\nor impliedly, and it generally gives people the right to use another\xe2\x80\x99s land for a particular purpose. For\nexample, an easement for utility companies to enter onto the land of others is common. This allows the\nutility companies to maintain poles, power lines, cable lines, and so on. Other examples include a\nlandlocked property having an easement across another piece of property for the purpose of a driveway,\nor an easement granted to the public to walk along the property of another to gain access to the shoreline.\nA covenant is a voluntary restriction on the use of land. Common covenants are homeowners associations\xe2\x80\x99\nrules, which restrict the rights of the owners to use their land in certain ways, often for aesthetic purposes.\nFor instance, such covenants might require houses subject to the covenant to be painted only in certain\npreapproved colors, or they might contain prohibitions against building swimming pools.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n262\n\n\x0cSome covenants and easements run with the land, which means that the restrictions will apply to\nsubsequent owners of the real property. Whether a covenant or easement runs with the land depends on\nthe type of interest granted.\n\nLandlord-Tenant Relationships\nA leasehold interest may be created in real property. For example, if you rent an apartment, house, or\ndormitory room from campus, you are a tenant with a leasehold interest. In such a relationship, you are\nthe tenant and the property owner is the landlord. A leasehold is simply a possessory interest with certain\nrights and duties, which are typically specified in the lease agreement. For example, a tenant has the right\nto exclusive possession of the real property and the duty to follow the rules of occupancy set out by the\nlandlord, and a landlord in a residential lease agreement has the right to be paid rent and the duty to\nensure that the premises are habitable. If one party does not perform under the lease as required, the\nother party may seek legal remedy. For example, if a tenant does not pay rent, then a landlord may\nlawfully evict the tenant from the premises, even if the term of the lease has not run. Like other interests\nin real property, leases generally must be in writing to be enforceable against the defendant.\nDifferent types of tenancies may be created. The most common tenancies are probably tenancies for years\nand periodic tenancies. Tenancy for years is simply a tenancy that lasts for a particular, specified period of\ntime. When you rent an apartment, you might sign a lease for nine months to reflect the school year. That\nwould be a tenancy for years, even though the term of the lease is less than one year. A periodic tenancy,\non the other hand, is a tenancy that simply runs for a particular period of time and then automatically\nrenews if it is not terminated by the landlord or the tenant. For instance, a one-year lease may become a\nperiodic tenancy if neither party terminates. Imagine that you had a one-year lease but you did not move\nout at the end of the year, and the landlord continued to accept rent payments and took no action to\nterminate the lease. A new lease\xe2\x80\x94for a one-year period of time\xe2\x80\x94would be created. Less common types of\ntenancies are tenancy at will, which is a tenancy for no particular fixed period of time and subject to\ntermination at will by either the landlord or the tenant, and tenancy at sufferance, which is a tenancy that\noccurs when a tenant remains on the property after the right of possession has ended and without the\nlandlord\xe2\x80\x99s consent.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n263\n\n\x0cTenancies may be created for residential purposes or commercial purposes. Commercial leases typically\nlast for longer periods of time than residential leases. For example, it is not uncommon to hear about\ncommercial leases that last five, ten, twenty-five, or even ninety-nine years. Many of the same\nresponsibilities and duties exist with commercial leases, but there are some important differences. For\nexample, a commercial tenant may demand that the landlord refuse to rent to a competitor of the tenant\nwithin the same building. For example, if a golf shop locates in a strip mall, it may require as a term in the\nlease that the landlord refrain from renting other retail space to a competitor golf shop within the same\nstrip mall.\nLease interests are assignable unless those rights are expressly restricted by the lease agreement. This\nmeans that the rights conveyed by the lease, which is a contract, may be transferred to another party\nby assignment, unless an express restriction on assignment exists within the lease. You may have seen\nrestrictions on assignment in your own residential lease in the form of a no-subletting clause. Commercial\nleases routinely contain a restriction on assignment without permission from the landlord.\nJust as the owner of real property may sell any or all of his or her interests, any ownership interest in real\nproperty may also be leased. For example, someone who owns the subsurface rights of land may lease the\nright to drill for oil or gas to another.\n\nKEY TAKEAWAYS\nReal property may be acquired by purchase, inheritance, gift, or adverse possession. Owners of property\nmust know the breadth and limits of their ownership interests to understand their rights to profits derived\nfrom the land and their liability resulting from use of their land. Interests in land may be absolute,\nconditional, or for a period of time. Additionally, co-owners may have different rights, depending on their\nkind of ownership. The scope of interest in land may include surface and the buildings attached to it, while\nother interests may be severed and conveyed separately, such as subsurface rights and water rights.\nEasements and covenants in real property convey nonpossessory interests. Leasehold interests are\npossessory, nonownership interests.\n\nEXERCISES\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n264\n\n\x0c1.\n\nDo you agree that a land\xe2\x80\x99s value is only its profits? If not, what makes land valuable? Does it have an\n\xe2\x80\x9cinherent\xe2\x80\x9d value, which has nothing to do with human profit?\n\n2.\n\nConsider this contemporary take on the tort of nuisance. Some Gulf Coast landowners filed a nuisance suit\nagainst power companies for emitting carbon, arguing that the carbon led to global warming, which then\nled to increased sea levels, which then led to hurricane Katrina\xe2\x80\x99s unusual ferocity and strength. The district\ncourt dismissed the case, but a three-judge panel on the Fifth Circuit reversed, saying the landowners had\nstanding to proceed and that the claim was justiciable. Do you think that this is a valid nuisance claim?\nWhy or why not?\n\n3.\n\nDo you think that adverse possession should be abolished? Why or why not? If you discovered a squatter\non your land, what should you do to protect your title?\n\n4.\n\nWhat type of due diligence can be performed to ensure that property does not contain a buried toxic\nwaste dump?\n5.\n\nClassify the following as trespasser, licensee, or invitee to determine the duty owed by a\nlandowner:\na.\n\nThe mailman\n\nb.\n\nA customer in Wal-Mart\n\nc.\n\nA person who cuts across your land to reach the other side, without your permission\nThink of a situation in which you would grant a life estate to someone in property that you own. How\n\ndoes that situation differ from renting property to a tenant?\nFind a story in the newspaper about liability resulting from the ownership of real property. Do you\nthink that landowner should be liable in the case that you located? Why or why not?\nWhat benefits can you see for both the landlord and the tenant for extremely long leases? What are\nthe risks?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n265\n\n\x0c8.3 Concluding Thoughts\nAn understanding of the nature of property is imperative, because at the heart of many transactions\nis the acquisition, rights to possession or use, or sale of personal or real property. Clearly, these\ntransactions are central to many businesses and the livelihoods of the people involved in business.\nWhen thinking about acquiring property, it is important to know not only whether the property is\n\xe2\x80\x9cright\xe2\x80\x9d for your or for your business but also about the rights and duties associated with acquiring it,\nthe protections afforded to you by law as the owner of it, and how to transfer it to another party at\nthe time of sale, lease, or licensing the right to use it. Additionally, liability often attaches to property,\nand limiting one\xe2\x80\x99s liability is at the heart of what your study of law should encourage you to do.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n266\n\n\x0cChapter 9\n\nIntellectual Property\nLEARNING OBJECTIVES\nNo matter what industry a company operates in, or its size, a company\xe2\x80\x99s intellectual property is often\nmore valuable than its physical assets. While factories and inventory can be rebuilt after a loss, losing\ncontrol of intellectual property can be ruinous for companies. After reading this chapter, you should be\nable to apply intellectual property concepts to answer the following questions:\n1.\n\nWhy is it important for the law to protect intellectual property?\n\n2.\n\nUnder what authority does Congress regulate intellectual property?\n\n3.\n\nHow can intellectual property be protected?\n\n4.\n\nWhat are the differences between the major forms of intellectual property protection?\n\n5.\n\nWhat are some current ethical issues that arise under intellectual property law?\n\nThe Apple iPhone 4 is the latest model of Apple\xe2\x80\x99s do-it-all cell phone. Since its introduction in 2007,\nthe iPhone has redefined the \xe2\x80\x9csmart phone\xe2\x80\x9d segment of the wireless phone industry and left its\ncompetitors scrambling to catch up. Its sleek lines, gorgeous full-color display, built-in GPS\nnavigation and camera, visual voice mail, and Web surfing capability (either over Wi-Fi or 3G phone\nnetworks) made it an instant hit, with thousands of consumers lining up for hours to have their\nchance to buy one. Its revolutionary business model, where thousands of software programmers\ncould write small programs called \xe2\x80\x9capps\xe2\x80\x9d and sell them on the App Store through Apple\xe2\x80\x99s iTunes\nsoftware, created a win-win-win business model for everyone who touched the iPhone. For software\nprogrammers, it was a win because small, untested, and first-time programmers could \xe2\x80\x9cstrike it rich\xe2\x80\x9d\nby selling thousands of their apps directly to consumers without having to find a software publisher\nfirst. For Apple, it was a win because thousands of talented programmers, not on Apple\xe2\x80\x99s payroll,\nwere developing content for their product and enhancing its appeal. Apple also wins because it\ncollects a percentage fee from every app sold on its iTunes store. And finally, consumers win because\nthey have access to all sorts of creative programs to help them do more on their iPhones than simply\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n267\n\n\x0cmake a phone call. The business has been a tremendous success for both Apple and AT&T, the\nexclusive service provider of iPhones in the United States.\nThere are quite a few companies in the industry that aren\xe2\x80\x99t doing as well, from Nokia to Motorola to\nSony Ericsson. If they wanted to see how Apple makes the iPhone, all they\xe2\x80\x99d have to do is buy one\nand then take it apart to see its components (a process known as reverse engineering). Or they could\nlook at the reverse engineering conducted by iSuppli, an independent market intelligence firm.\n\nHyperlink: iPhone Teardown Analysis\nYou can see how iSuppli broke down the components in an iPhone 4 by reading this press release:\nhttp://www.isuppli.com/Teardowns-Manufacturing-and-Pricing/News/Pages/iPhone-4-Carries-Bill-ofMaterials-of-187-51-According-to-iSuppli.aspx\n\niSuppli found out that the bill of material (BOM), or the breakdown of each component Apple\npurchased to assemble into an iPhone, is roughly $187.51. The most expensive components are a $27\n16GB flash memory module from Samsung, a $28.50 display module that includes the iPhone\xe2\x80\x99s\nglossy 3.5-inch screen, and a $10 touch screen assembly that includes the touch-sensitive glass on\ntop of the screen.\nApple makes a lot of money selling iPhones. Although the $199 retail price of the 16GB iPhone 4\nsuggests that Apple makes only about $12 profit per phone, in reality the \xe2\x80\x9ccost\xe2\x80\x9d of the iPhone is much\nhigher than $199, since each phone is sold with a two-year contract with AT&T service. Industry\nanalysts estimate that AT&T pays Apple approximately $300 for each iPhone sold with an AT&T\nplan, in return for Apple agreeing not sell the iPhone through any other phone network. [1] The result\nfor Apple is staggering profitability, with a $1.21 billion profit reported in the first three months of\n2009, much of which driven by iPhone sales. [2] This chart (Figure 9.1 "Estimated Revenues of the\nTop Cell Phone Manufacturers") shows, to scale, how outsized Apple\xe2\x80\x99s profits are compared to those\nof the rest of the industry. Apple\xe2\x80\x99s profit margin, at an estimated 40 percent, is nearly double that of\nits nearest competitor, Research in Motion, maker of the BlackBerry. [3]\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n268\n\n\x0cFigure 9.1 Estimated Revenues of the Top Cell Phone Manufacturers\n\nSource: Courtesy of iSmashPhone, http://www.ismashphone.com/2009/08/a-visualized-look-atthe-estimated-revenues-of-the-top-cell-phone-manufacturers.html.\nIf you were a competitor in the cell phone industry, you\xe2\x80\x99d be sorely tempted to try to duplicate\nApple\xe2\x80\x99s success. After all, if it only costs $187.51 to make an iPhone, and you could sell it for a $320\nprofit, why not just make something that looks a lot like an iPhone? Behold the Air Phone No. 4\n(Figure 9.2 "Air Phone 4"). Released in 2010, the Air Phone is made by a little-known Chinese\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n269\n\n\x0cmanufacturer and looks virtually identical to the iPhone 4. It lacks many of the features of the iPhone\n4 and does not run on the iPhone\xe2\x80\x99s software platform, but at approximately $150 in online stores, it\nis proving to be a popular alternative to the iPhone.\nFigure 9.2 Air Phone 4\n\nThe reason that companies like Motorola and Nokia don\xe2\x80\x99t simply use the bill of material generated\nby iSuppli to make their own iPhones, of course, is that it\xe2\x80\x99s illegal. The BOM only lists the component\ncosts to Apple; it does not capture the amount of money Apple spent in developing the product\nthrough the R&D process. The years of software and hardware development that Apple undertook to\ncreate the iPhone involve labor, just as building a skyscraper involves labor. In Apple\xe2\x80\x99s case, the\nproduct of its labor is not a skyscraper or other tangible property\xe2\x80\x94it is intangible property known\nbroadly as intellectual property, or IP. The law protects Apple\xe2\x80\x99s IP just as it protects tangible things\nfrom being stolen, so any attempt by a competitor to make an iPhone clone would fail even if the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n270\n\n\x0ctechnical ability to do so exists. To be legally sold in the United States, the Air Phone must be\ndifferent enough from the iPhone that it doesn\xe2\x80\x99t actually infringe, or step on, any of Apple\xe2\x80\x99s\nintellectual property rights in the iPhone.\nIn this chapter, we\xe2\x80\x99ll discuss how the law protects IP. We\xe2\x80\x99ll begin by examining how IP has been a\npart of the country\xe2\x80\x99s foundation from its very beginning. We\xe2\x80\x99ll then discuss the four major types of IP\nprotected by the law: patents, trade secrets, trademarks, and copyright. By the end of this chapter,\nyou\xe2\x80\x99ll understand the value that IP plays in a modern economy, the challenges that companies face in\ndoing business in countries that don\xe2\x80\x99t value IP, and the devastating impact that IP infringement\n(including the downloading of music and movies by college students) has on copyright content\nholders. You\xe2\x80\x99ll also be able to distinguish among the various types of IP protection and how they are\nsimilar to, and differ from, each other.\n\nKey Takeaways\nCompanies (such as Apple) invest tremendous resources in developing exciting and innovative new\nproducts and services. Reverse engineering means that it would be easy for competitors to quickly figure\nout how these new products are manufactured, and then copy them. Intellectual property law prevents\nthis from happening and in doing so provides incentive for individuals and companies to create and\ninnovate.\n\n[1] M. G. Siegler, \xe2\x80\x9cAT&T iPhone Deal Extended to 2010. Did Apple Mortgage Its Future for a Subsidy?\xe2\x80\x9d Social Beat,\nAugust 1, 2008, http://digital.venturebeat.com/2008/08/01/att-iphone-deal-extended-to-2010-did-applemortgage-its-future-for-a-subsidy (accessed September 27, 2010).\n[2] Jim Dalrymple, \xe2\x80\x9cStrong iPhone and iPod Sales Drive Apple Profits to $1.21 Billion,\xe2\x80\x9dMacworld, April 22,\n2009,http://www.macworld.com/article/140162/2009/04/appleearnings.html (accessed September 27, 2010).\n[3] \xe2\x80\x9cA Visualized Look at the Estimated Revenues of the Top Cell Phone Manufacturers,\xe2\x80\x9diSmashPhone, August 11,\n2009, http://www.ismashphone.com/2009/08/a-visualized-look-at-the-estimated-revenues-of-the-top-cell-phonemanufacturers.html (accessed September 27, 2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n271\n\n\x0c9.1 Constitutional Roots\nLEARNING OBJECTIVES\n1.\n\nUnderstand the constitutional roots for providing legal protection to intellectual property.\n\n2.\n\nExplore the tension between content producers and the public good, and how Congress resolves this\ntension.\n\nAnyone alive when the U.S. Constitution was adopted would be surprised at the size and scope of the\nU.S. federal government today. What would not surprise them, however, is the existence of the\nU.S. Patent and Trademark Office (USPTO), since the establishment of a system to protect patents is\n\none of those few congressional powers enumerated in Article I, Section 8 of the Constitution. That\nclause, known as the Copyright Clause, says that Congress may \xe2\x80\x9cpromote the Progress of Science and\nuseful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their\nrespective Writings and Discoveries.\xe2\x80\x9d Keep the key words of this clause in mind, as we\xe2\x80\x99ll come back\nto them later: \xe2\x80\x9cpromote progress,\xe2\x80\x9d \xe2\x80\x9climited times,\xe2\x80\x9d and \xe2\x80\x9cexclusive.\xe2\x80\x9d\n\nHyperlink: Patent and Trademark Database\nThe USPTO Web site is a treasure trove of information as it includes a searchable database for trademarks\nand patents. See if you can search these databases for well-known trademarks or patents.\nhttp://www.uspto.gov\n\nAlthough the Constitution addresses only copyrights and patents, modern intellectual property (IP)\nlaw also includes trademarks (probably left out of the Constitution because of the relative\nunimportance of corporations and branding at the time) and trade secrets (a relatively new form of\nIP protection). Unlike other controversial portions of the Constitution, such as state rights and the\nrole of the judiciary, the value of laws that protected authors and inventors was well accepted in 1787,\nwhen inventions of new machines were shaping up to be part of the fabric of the new country.\nIndeed, the attendees at the Constitutional Convention took a break from their work to watch the\nfirst steamship in the Delaware River. One of the first patents granted was to Abraham Lincoln, who\ndrew on his experience as a young man making his way from Indiana to New Orleans along the Ohio\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n272\n\n\x0cand Mississippi rivers on a flatboat to devise a system to lift and drop boats over shallow water\nwithout dropping off their cargo. A scale model of his invention is on display at the Smithsonian\n(Figure 9.3 "President Lincoln\xe2\x80\x99s Patent"). Lincoln, who many historians described as mechanically\ninclined and fascinated by engineering, felt that the patent system added \xe2\x80\x9cfuel of interest to the fire\nof genius.\xe2\x80\x9d\nFigure 9.3 President Lincoln\xe2\x80\x99s Patent\n\nSource: Photo courtesy of the Smithsonian National Museum of American History,\nhttp://americanhistory.si.edu/collections/object.cfm?key=35&objkey=19.\n\nEssentially, the Copyright Clause permits (even commands) the federal government to protect\ncertain products of the mind, just as much as it protects personal land or money. If someone\ntrespasses on your property, you can call the police and have them removed or you can sue them in\ncourt for damages. In either case, the full force and power of government is involved. The same thing\ncan be said about IP. On the other hand, you know from your economics classes that, in general, our\ncapitalist economy frowns on monopolies. We believe that monopolies are immune from competitive\npressures and can therefore charge exorbitant prices without any regard to the quality of their\nproduct. Efficiency suffers when monopolies are allowed to exist, and ultimately the consumer loses\nin choice and price. If you think about it, though, the Copyright Clause essentially allows the\ngovernment to create a special kind of monopoly around IP. Take, for example, a pharmaceutical\ncompany that invents a certain kind of drug and applies for a patent on that drug. If the government\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n273\n\n\x0cgrants the patent, then the company can charge as much as it wants (some drugs can cost tens of\nthousands of dollars per year for consumers) without any regard for competitors, since competitors\nare shut out of that drug market by virtue of the patent. If any competitor dares to copy the drug to\ncompete against the inventing company, the full force and weight of the government will be brought\ndown on the competitor. Violations of patent law carry extremely stiff penalties.\nHow can we say that monopolies are bad, and yet grant Constitutional protection to monopolies on\nIP? The answer lies in the genius of the Copyright Clause itself. As in all monopolies, there are two\nsides: the producer and the consumer. The producer always wants the monopoly to last as long as\npossible, while the consumer wants the monopoly to end as quickly as possible. The Copyright Clause\nstrikes a compromise between the producer and the consumer in two ways.\nFirst, the Clause states that Congress can grant the monopoly only to \xe2\x80\x9cpromote the progress of\nScience and Useful Arts.\xe2\x80\x9d In other words, the monopoly exists for a specific purpose. Note that\n\xe2\x80\x9cmaking Beyonc\xc3\xa9 rich\xe2\x80\x9d or \xe2\x80\x9callowing Pfizer to make billions of dollars\xe2\x80\x9d is not the purpose. Rather, the\npurpose is progress. Granting monopolies can encourage progress by providing a financial incentive\nto producers. Singers, songwriters, inventors, drug companies, manufacturers\xe2\x80\x94they all invent and\ninnovate in the hope of making money. If they knew that the law wouldn\xe2\x80\x99t protect what they came up\nwith, they\xe2\x80\x99d either not invent at all or they\xe2\x80\x99d simply do it for themselves and their families, without\nsharing the fruits of their labor with the rest of society.\nSecond, the clause states whatever monopoly Congress grants has to be for a \xe2\x80\x9climited time.\xe2\x80\x9d In other\nwords, at some point the monopoly will end. When the monopoly ends, science is once again\nprogressed because then society can freely copy and improve upon the producer\xe2\x80\x99s products. Society\nbenefits greatly from the expiration of these IP monopolies. Important drugs such as aspirin and\npenicillin, for example, can now be purchased for pennies and are accessible to the entire human\npopulation. Grand literary works, such as Shakespeare\xe2\x80\x99s Hamlet or Beethoven\xe2\x80\x99s Fifth Symphony, can\nbe performed and enjoyed by anyone at any time without seeking permission or paying any fees or\nroyalties. These inventions and works are in the public domain, to be enjoyed by all of us.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n274\n\n\x0cThe Copyright Clause does not state how long the monopoly can last; it leaves that task to Congress.\nCongress must make the decision based on what\xe2\x80\x99s best to promote progress. Remember, though, that\nproducers want monopolies to last as long as possible. For example, consider how long copyrights\nlast. Since 1976 copyrights have lasted for fifty years after the death of the author. After that,\ncopyrighted works fall into the public domain (such as works by Shakespeare or Beethoven). In 1998,\nhowever, Congress began considering adding an extra twenty years to that term, for a total of seventy\nyears after the author\xe2\x80\x99s death. In the early part of the twentieth century, the United States\nexperienced a cultural renaissance that accompanied the Industrial Revolution. The invention of the\nphonograph and cameras allowed the creative genius of Walt Disney, George Gershwin, and Charlie\nChaplin (to name a few) to flourish. Under the 1976 copyright law, though, some of these early works\n(including early versions of Winnie the Pooh) were about to fall into the public domain by 1998. The\nUnited States was also under some pressure from international trading partners to increase the\ncopyright term.\n\nVideo Clip: United Airlines Commercial\nAs a result of these pressures, U.S. Representative Sonny Bono (himself a popular artist together\nwith his former wife Cher) introduced the Copyright Term Extension Act to add twenty years to\ncopyrights. During hearings on this bill, Congress heard testimony from Jack Valenti, then president\nof the Motion Picture Association of America, an industry group that represents film studios and\ncorporations. When asked how long he thought copyrights should last, he answered \xe2\x80\x9cForever minus\na day.\xe2\x80\x9d Although Sonny Bono\xe2\x80\x99s bill passed, whether or not \xe2\x80\x9cforever minus a day\xe2\x80\x9d will eventually\nbecome the law as Congress seeks to strike the right balance between protection and access and\nwhether it satisfies the Constitution\xe2\x80\x99s demand that the monopoly last for a \xe2\x80\x9climited\xe2\x80\x9d time remain\nunresolved questions.\n\nKEY TAKEAWAYS\nThe Constitution commands Congress to provide monopoly protection for intellectual property, but only\nfor purposes of progressing science and useful arts, and only for a limited time. Content producers will\nalways want legal protection to last as long as possible to maximize profits, while the public good benefits\nwhen content falls into the public domain. Congress is under intense pressure to resolve this tension.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n275\n\n\x0cEXERCISES\n1.\n\nWhy do you think the Founding Fathers decided to empower Congress to protect intellectual property, but\nonly for a limited time?\n\n2.\n\nHow likely do you think it is that Congress may extend the term for copyright protection again in the\nfuture? Why?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n276\n\n\x0c9.2 Patents\nLEARNING OBJECTIVES\n1.\n\nUnderstand what a patent is, as well as the different types of patents that exist.\n\n2.\n\nLearn the criteria required for an item to be patentable.\n\n3.\n\nExplore controversial issues surrounding patents.\n\n4.\n\nExamine patent infringement and its consequences.\n\n5.\n\nUnderstand boundaries and limitations on patent rights.\n\nImagine that you invented the Apple iPhone 4. If you invent a patentable item that is useful, new,\nand nonobvious, and if you are capable of describing it in clear and definite terms, you may wish to\nprotect your invention by obtaining a patent. A patent grants property rights to the inventor for a\nspecified period of time, with a utility patent and a plant patent expiring twenty years following the\noriginal patent application and a design patent expiring fourteen years afterward. A patentee owns a\npatent.\nHowever, if you invented the Apple iPhone 4 while employed to perform creative and inventive work,\nthen any patents obtained with respect to your work would be assigned to your employer. Many\ninventors and designers work for employers in creative and inventive capacities. This arrangement\nallows innovative ideas to be adequately funded in trade for the property rights resulting from\npatents granted to those inventions.\nThree patent types exist. Utility patents may be granted for machines, processes, articles of\nmanufacture, compositions of matter, or for improvements to any of those items. The Apple iPhone 4\ncertainly is the subject of utility patents. A design patent may be granted for ornamental designs for\nan article of manufacture. A plant patent covers inventions or discoveries of asexually reproduced\nplants (e.g., plants produced through methods such as grafting).\nNot all items are patentable. For instance, an idea alone (without a definite description) cannot be\npatented. So even if you dreamed up the idea of something that looked and functioned exactly like\nthe Apple iPhone 4, you would not have been eligible for a patent on your idea alone. Likewise,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n277\n\n\x0cphysical phenomena, the laws of nature, abstract ideas, and artistic works cannot be patented. Note,\nhowever, that artistic works can be copyright protected. Additionally, otherwise patentable subjects\nthat are not useful, or items that are offensive to public morality, are not patentable.\nSo what does it mean to have a patent? Just like real property ownership, a patent confers the right\nto exclude others. If you owned a parcel of real property, your ownership interest would allow you to\nexclude others from your land. The rule of law would protect your right to exclude against the\nintrusions of others, which is the very essence of ownership. Likewise, a patent confers the legal right\nto exclude others from making, using, or selling the patented product. This is consistent with the\nCopyright Clause of the U.S. Constitution, which grants inventors the \xe2\x80\x9cexclusive Right to\ntheir\xe2\x80\xa6Discoveries.\xe2\x80\x9d For others to legally make, use, or sell the patented product, they would have to\nbe granted permission by the patentee. This is often accomplished through a licensing agreement, in\nwhich the patentee authorizes others to sell, make, or use the product.\nFor instance, some genetically modified agricultural products are the subjects of utility patents.\nMonsanto Company patented Genuity Bollgard II Cotton, designed to resist worm damage, which can\nbe a devastating problem for cotton farmers. This product reduces the need for farmers to spray\ninsecticide. Patentees, such as Monsanto Company, hold many patents on agricultural products such\nas cotton, soybeans, canola, and corn. In the United States these patents typically protect new plant\nbreeds as well as parts of the plants. In contrast, some countries, such as Canada, do not permit the\npatenting of life forms. In countries where the patenting of whole life forms is prohibited, the patents\ntypically protect the genetically modified parts of the life form, such as the genes and the cells, as\nwell as the process for inserting the genes into the cells.\nDo genetically modified plants meet the threshold requirements to be the subject of a patent?\nRemember that to be a patentable item, the invention must be useful, new, and nonobvious.\nGenetically modified plants are useful because they possess some particular quality for which they\nwere designed. For example, Genuity Bollgard II Cottonresists many types of damaging worms while\nreducing the need for farmers to use insecticide, and so this invention can be said to be useful.\nLikewise, some patented genetically modified agricultural products are resistant to herbicides, such\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n278\n\n\x0cas Monsanto Company\xe2\x80\x99s Roundup Ready line of agricultural products. Roundup Ready products are\nresistant to an herbicide known as glyphosate, which is the main active ingredient in the herbicide\nline marketed by the Monsanto Company under the Roundup brand. These are also useful\ninventions, because farmers that plant those patented herbicide-resistant products do not have to\nwait to plant their crops until their fields are cleared of weeds. They can plant their crops before they\nspray herbicides because the genetically modified crops will resist the herbicide and continue to\ngrow. This allows the farmers to put their land to use for longer periods of time and with more\nconfidence that they can kill weeds without damaging their crops. They can do so using inexpensive\nmethods such as by spraying herbicides, rather than hand-weeding, which is very labor intensive.\nGenetically modified plants are new and entitled to be patented when no one else has applied for a\npatent for that particular invention. If, for example, some other company had invented the same\nproduct that eventually became known as Genuity Bollgard II Cotton before the Monsanto Company\nhad invented that product, then the Monsanto Company would not have been permitted to patent\nthat product, even if it had independently invented that product with no knowledge of the other\ninvention. In this way, we can see that patents are granted in the United States by the \xe2\x80\x9cfirst to invent\xe2\x80\x9d\nrule. Many other countries follow the \xe2\x80\x9cfirst to file\xe2\x80\x9d rule, which means that the first applicant to file\nfor a patent on a particular invention is eligible for the patent, regardless of who first invented it.\nThere are legal movements to amend the U.S. Patent Act to change from \xe2\x80\x9cfirst to invent\xe2\x80\x9d to \xe2\x80\x9cfirst to\nfile,\xe2\x80\x9d but no amendment has yet been passed.\nGenetically modified plants are nonobvious inventions if they are different from what has been used\nbefore, so that someone with ordinary skill in genetically modified plant technology would not find\nthe new invention to be obvious. For example, if the \xe2\x80\x9cnew\xe2\x80\x9d invention only changed the color of one\ntiny cell in the entire plant, that would probably not be a patentable invention.\nYou might be wondering how a patent can be granted over a living thing, like a plant. As mentioned\nearlier in this section, in the United States living things are patentable. Living things became the\nlegal subjects of patents when, in 1980, the U.S. Supreme Court held that a bacterium designed by its\ninventor to break down crude oil components was the legitimate object of a patent. [1] Indeed, as the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n279\n\n\x0cSupreme Court noted in that case, congressional intent regarding the U.S. Patent Act was that\n\xe2\x80\x9canything under the sun that is made by man\xe2\x80\x9d is patentable. Since then, we have seen many living\norganisms patented. For example, the OncoMouse was among the first patented mammals. The\nOncoMouse is useful in medical research for its extreme propensity to develop cancer.\nThe patentability of life forms is a contentious issue. While the usefulness of such inventions is\nproven (or else they would not be patentable inventions), ethical questions abound. For example,\nwhen considering the OncoMouse, legitimate questions include whether intentionally creating life to\nexperience pain, sickness, and medical procedures is ethical. Moreover, many people find the idea of\n\xe2\x80\x9ccreating\xe2\x80\x9d life in a laboratory morally repugnant, as well as owning the products of that creation.\nMany fear a slippery slope: Today a mouse; tomorrow, a human? Of course, humans are not\npatentable subjects today, but the slippery slope argument often arises in such discussions. With\nrespect to genetically modified agricultural products, many people question the wisdom of placing\ncontrol and ownership over items essential to life\xe2\x80\x94like staple crop seeds\xe2\x80\x94into the hands of few,\nespecially when money must be traded for the rights to use those products. This issue is particularly\ncomplicated given the fact that genetically modified agricultural products may cross-pollinate with\nnongenetically modified agricultural products, resulting in progeny that contains the genes or cells\nthat are patented. When this happens, courts routinely recognize that the patentee has the rights to\nthose progeny by virtue of their patent ownership and that the unwitting possessor of those progeny\nhas, in fact, committed patent infringement by being in possession of those patented products\nwithout permission.\nAnother controversial issue surrounds the patents granted to pharmaceutical drugs. Large drug\ncompanies rely on patent law to protect their massive investment in research and development into\nnew drugs, the vast majority of which never make it to market. For the few drugs that eventually find\ngovernment approval and commercial success, manufacturers seek to extract the highest possible\nprice during the period of patent monopoly. For example, the introduction of antiretroviral drugs has\ngreatly extended the lives of HIV/AIDS patients, but the drugs cost between $10,000 and $12,000\nper year in the United States. In many developing countries in Asia and Africa, the drugs would make\na dramatic impact on human life. Some governments have therefore declared national health\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n280\n\n\x0cemergencies, a procedure under international treaties that permits those governments to force drug\ncompanies to license the formula to generic drugmakers (this is called compulsory licensing). Cipla, a\ngeneric drug manufacturer in India, manufactures the same antiretrovirals for about $350 a year, or\nless than one dollar a day.\nThe U.S. Patent and Trademark Office (USPTO) grants property rights to patentees within the\nUnited States, its territories and possessions. Patent law is complicated, and attorneys who wish\nto prosecute patents (file and interact with the USPTO) must have an engineering or science\nbackground and pass a separate patent bar exam. When an application is filed, the USPTO assigns a\npatent examiner to decide whether the patent application should be approved. While the application\nis pending, the applicant is permitted to use the term \xe2\x80\x9cpatent pending\xe2\x80\x9d in marketing the product to\nwarn others that a patent claim has been filed. Even after a patent has been issued by the USPTO,\nhowever, the patent is merely \xe2\x80\x9cpresumed\xe2\x80\x9d to be valid. If someone challenges a patent in a lawsuit,\nfinal validity rests with the U.S. federal courts. For decades, the U.S. Supreme Court routinely\nignored patent appeals, allowing lower courts to develop patent law. In recent years, under Chief\nJustice John Roberts, the Supreme Court has dramatically increased its acceptance of patent\ndisputes, perhaps as a sign that the Court believes too many patents have been issued.\nIn the last decade there has been an over 400 percent increase in the number of patents filed,\nresulting in a multiyear delay in processing applications. An increase in the number\nof business method patents contributed to this dramatic increase in patent applications. A business\nmethod patent seeks to monopolize a new way of conducting a business process. Figure 9.5 "Patent\nFiling for One-Click Web Ordering", for example, describes a method of e-commerce by which a\ncustomer can order an item and pay for it immediately with just one click of a mouse button.\nThis one-click patent was granted to Amazon.com, much to the chagrin of other online retailers such\nas Barnes & Noble, who were prohibited from using a similar checkout mechanism. Amazon licensed\nthe patent to Apple so that it could feature one-click on its Web site.\nFigure 9.5 Patent Filing for One-Click Web Ordering\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n281\n\n\x0cSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n282\n\n\x0cSource: Courtesy of Free Software Magazine,\nhttp://www.freesoftwaremagazine.com/files/www.freesoftwaremagazine.com/nodes/1250/1A.jp\ng.\nOutside the United States, a patent granted by the USPTO does not protect the inventor\xe2\x80\x99s interest in\nthat property. Other steps must be taken by the inventor to protect those rights internationally. If\nsomeone possesses the patented object without permission from the patentee, then the possessor can\nbe said to have infringed on the patent owner\xe2\x80\x99s rights. Patent infringement is an actionable claim. A\nsuccessful action may result in an injunction, treble damages, costs, and attorney\xe2\x80\x99s fees. One defense\nto a patent infringement claim is to challenge the validity of the patent.\n\nHyperlink: Wal-Mart Tries to Produce Shoes\nNike recently sued Wal-Mart stores for selling a shoe that Nike claims infringes on its patents. The shoe\nsold by Wal-Mart uses technology similar to Nike\xe2\x80\x99s Shox technology. Look at Nike\xe2\x80\x99s complaint here:\nhttp://online.wsj.com/public/resources/documents/nikepatentsuit.pdf\nDo you think that Nike has a good claim? What should Wal-Mart\xe2\x80\x99s defense be?\n\nIn recent years several companies that do nothing but sue other companies for patent infringement\nhave emerged. These patent holding companies, sometimes called patent trolls by critics, specialize in\npurchasing patents from companies that are no longer interested in owning them and then finding\npotential infringers. One such company, NTP, sued Research in Motion (RIM), the maker of the\nBlackBerry device, for a key technology used to deliver the BlackBerry\xe2\x80\x99s push e-mail feature. Faced\nwith a potential shutdown of the service, RIM decided to settle the case for more than six hundred\nmillion dollars.\n\nEXERCISES\n1.\n\nDo you think that life forms should be the subjects of patents? Does your answer change depending on\nwhether we are talking about bacteria, plants, animals, or humans? What are the most persuasive\narguments in favor of, and against, allowing the patentability of higher life forms?\n\n2.\n\nHow do patent rights encourage innovation?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n283\n\n\x0c3.\n\nIf patents are protected monopolies, why do you think patent applications are a matter of public record?\n\n4.\n\nDo you agree with compulsory licensing of lifesaving medications in response to national health\nemergencies? What are the consequences of compulsory licensing to the patentee? To the people in need\nof these medications in wealthy countries? To the people in need of these medications in poor countries?\n\n[1] Diamond v. Chakrabarty, 447 U.S. 303 (1980).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n284\n\n\x0c9.3 Trade Secrets\nLEARNING OBJECTIVES\n1.\n\nUnderstand what a trade secret is.\n\n2.\n\nLearn the differences between trade secret and patent protection.\n\n3.\n\nLearn how trade secrets may be lawfully discovered.\n\n4.\n\nExplore the concept of misappropriation and the legal consequences.\n\nFigure 9.6 Dr. Pepper Bottle\n\nSource: http://en.wikipedia.org/wiki/File:Dr_Pepper_bottle.JPG.\n\nImagine that you are in an antique store and find a nineteenth-century ledger book for sale,\noriginally from the W. B. Morrison & Co. Old Corner Drug Store in Waco, Texas. Among the recipes\nfor hair restorers and cough syrups, something in particular catches your eye\xe2\x80\x94a recipe entitled D\nPeppers Pepsin Bitters. What if you also knew that Dr. Pepper was first created and served in that\n\nvery drugstore? What if you offered to pay two hundred dollars for the old ledger book, even though\nif it did contain the recipe for Dr. Pepper, it would be worth far more? After all, according to the\ncompany that manufactures Dr. Pepper, only three people know the recipe to that very closely\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n285\n\n\x0cguarded trade secret. Something very similar to this happened to Bill Waters. He found the ledger\nbook in an antique store, and he paid two hundred dollars for it. However, at the time, he did not\nknow that the book might date back to the exact time and place from which the popular soda was\ncreated. In fact, he did not even notice the recipe until later, and it took him several more days to\nrecognize the possibility that it might be an early version of Dr. Pepper.\nUnlike patents, a trade secret can last forever. That is, it can last forever if the owner of the secret can,\nwell, keep it a secret. If someone uses lawful means to uncover the secret, then the secret is no longer\nprotected by the secret\xe2\x80\x99s owners. Does this include reverse engineering? Yes. Reverse engineering is\nan absolutely legal means of discovering a trade secret. What about ferreting out secrets from an\nemployer\xe2\x80\x99s safekeeping, while employed and under a binding confidentiality agreement? No. That is\nan actionable claim for misappropriation, and the secret\xe2\x80\x99s owners can pursue damages.\nTrade secrets are unlike patents in another important way. With a patent, the inventor must\nspecifically disclose the details of the invention when applying for a patent. This means that the\ninventor has not protected the secret of the invention. However, in exchange for this disclosure, a\npatent owner has a legal monopoly over the property for a specified period of time. So even if others\ndiscover the secret of the invention (not a difficult task since patent applications are public record),\nthey are prohibited from making, using, or selling it without the patentee\xe2\x80\x99s permission. After the\npatent expires, then the patentee no longer has a property right to exclude others.\nSo what is a trade secret? It is, in short, secret information. This information may include a process,\nformula, pattern, program, device, method, technique, or compilation. For many companies, lists of\nsuppliers, costs, margins, and customers are all trade secrets. Soft drink recipes, KFC\xe2\x80\x99s eleven spices,\nthe donut mix sent to Krispy Kreme franchisees, the Big Mac\xe2\x80\x99s special sauce, and even the\ncombination of wood that is used in the burning process to make Budweiser beer are all trade\nsecrets. Additionally, the information derives actual or potential economic value from being a secret\nthat is not readily discoverable by others, and the information is the subject of efforts to keep it a\nsecret. While most states have adopted the Uniform Trade Secrets Act (UTSA), not all have, so the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n286\n\n\x0cdefinition of trade secret can vary by jurisdiction. Unlike patents, trademarks, and copyrights, there\nis no federal law protecting trade secrets.\nA claim for misappropriation may be brought when a trade secret has been wrongfully obtained, such\nas through corporate espionage or bribery. Generally, according to the UTSA, misappropriation\noccurs if the secret was acquired by improper means, or if the secret was disclosed or used without\npermission from the secret\xe2\x80\x99s owner. Damages may include actual loss and unjust enrichment not\ncaptured by actual loss. Additionally, in cases of willful or malicious misappropriation, double\ndamages may be awarded, as well as attorney\xe2\x80\x99s fees.\nSo what if you are never lucky enough to discover a multimillion-dollar secret recipe hidden away in\nan antique shop? As long as the recipe is not patented, you can try to reverse engineer it. If you\nsucceed, you can use it immediately. However, if you are working for an employer in a creative\ncapacity, working with others to develop the secret, and if you have agreed not to use trade secrets,\nthen the right to the trade secret will belong to your employer, at least in most jurisdictions. Ask\nPeter Taborsky, an undergraduate student at South Florida University in 1988. According to\nTaborsky, while working in the university\xe2\x80\x99s chemical engineering lab, he began conducting\nexperiments on his own. He discovered a highly effective method for treating sewage. The university\ndemanded that he hand over his notebooks that contained the secrets of this invention. Taborsky\nrefused and filed for a patent for his invention, which he received. However, the university pressed\ncriminal charges for stealing trade secrets. Taborsky lost his case and found himself in a maximumsecurity facility working on a chain gang.\nSo does Bill Waters need to worry about Dr. Pepper\xe2\x80\x99s owners suing him for misappropriation or\npressing criminal charges for stealing trade secrets? No. He lawfully obtained the ledger book by\npurchasing it in the open market. Additionally, according to a company spokesman, the ingredient\nlist under D Peppers Pepsin Bitters is most likely an old remedy for a stomachache rather than any\nversion of the recipe for Dr. Pepper. Even if Mr. Waters had accidentally stumbled on the exact Dr.\nPepper recipe, he would have a good argument that the company did not take steps to keep the secret\na secret. If it had, he could argue, the company never would have allowed the recipe out of its sight.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n287\n\n\x0cKEY TAKEAWAYS\nTrade secrets last forever if the owner of the secret keeps the secret. However, if someone else discovers\nthe secret through a lawful method, then the owner of the secret has no right to exclude others from\nusing the secret. Unlawfully obtaining a trade secret is called misappropriation, which is an actionable\nclaim. The Uniform Trade Secret Act has been adopted by most (but not all) states, so different\njurisdictions have different rules of law concerning trade secrets.\n\nEXERCISES\n1.\n\nIf you owned a trade secret, what methods would you employ to protect it?\n\n2.\n\nIf you invented something that was patentable or the subject of a trade secret, what types of issues would\nyou consider when deciding whether or not to apply for a patent?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n288\n\n\x0c9.4 Trademarks\nLEARNING OBJECTIVES\n1.\n\nUnderstand what a trademark is.\n\n2.\n\nLearn what can and cannot be trademarked.\n\n3.\n\nExplore how companies protect trademarks from dilution and genericide.\n\n4.\n\nExamine how the Internet poses new challenges to trademark owners.\n\n5.\n\nExplore the tension between trademark protection and free speech.\n\nFigure 9.7McDonald\xe2\x80\x99s, One of the Most Recognized Trademarks in the World\n\nSource: http://commons.wikimedia.org/wiki/File:RiemArcaden.McD.JPG.\n\nLook at Figure 9.7 "McDonald\xe2\x80\x99s, One of the Most Recognized Trademarks in the World". It\xe2\x80\x99s\nobviously a McDonald\xe2\x80\x99s restaurant, but can you tell where this restaurant is? Is it in a mall or\nairport? Is it in Trenton, Toronto, or Tokyo (or, as it turns out, Messestadt Riem in Germany)?\nWithout additional information, it may be impossible to tell. And yet, no matter where you are in the\nworld, if you enter this McDonald\xe2\x80\x99s restaurant, there are certain standards that you expect. You\nwould expect to find a Big Mac on the menu, perhaps Chicken McNuggets and french fries too. You\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n289\n\n\x0cwould expect those menu items to taste the same as they do in your local McDonald\xe2\x80\x99s. Perhaps you\xe2\x80\x99d\nexpect a certain level of service from the employees, a certain value proposition for your money, a\ncertain look from the uniform and fixtures, or perhaps a clean restroom. If you walked into this\nMcDonald\xe2\x80\x99s restaurant and found out that it was in fact not McDonald\xe2\x80\x99s, you might be confused. The\nultimate goal of trademark law is to prevent this consumer confusion. To prevent any other\nrestaurant from using the name McDonald\xe2\x80\x99s, or from using a logo that looks like a stylized \xe2\x80\x9cM,\xe2\x80\x9d\nMcDonald\xe2\x80\x99s can trademark both its name and logo (and a lot of other elements of its brand as well).\nIn this section, we\xe2\x80\x99ll examine how trademark law accomplishes this goal.\nA trademark is any kind of name, logo, motto, device, sound, color, or look that identifies the origin\nof a particular good or service. Something begins to look like a trademark when a\nconsumer identifies it with a particular origin. For example, someone buying a Diet Coke knows that\nhe or she is getting a carbonated beverage from the Coca-Cola Company. If he or she bought a Diet\nCola, on the other hand, there\xe2\x80\x99s no association in the mind with any particular company, so it could\nbe from Coca-Cola, Pepsi, or any number of other companies. The key is that consumer identification\nwith a specific origin. If a consumer thinks of a class of goods rather than one specific origin, then it\xe2\x80\x99s\nnot a trademark. So, for example, when a consumer hears \xe2\x80\x9caspirin,\xe2\x80\x9d he or she thinks of a class of\ngoods with no particular origin because aspirin is not a trademark. But if a consumer hears \xe2\x80\x9cBayer,\xe2\x80\x9d\nhe or she thinks of a specific aspirin from a specific source, making \xe2\x80\x9cBayer\xe2\x80\x9d a trademark.\n\nHyperlink\nhttp://www.uspto.gov/go/kids/kidsound.html\nCan sounds be trademarked? Yes! Some sounds are instantly recognizable, such as AOL\xe2\x80\x99s \xe2\x80\x9cYou\xe2\x80\x99ve Got\nMail\xe2\x80\x9d and Twentieth Century Fox\xe2\x80\x99s movie opening scene. Click the link to explore other trademarked\nsounds.\n\nA federal law, the Lanham Act, protects trademarks. Unlike copyrights and patents, trademarks can\nlast forever and are not subject to the Constitution\xe2\x80\x99s \xe2\x80\x9climited time\xe2\x80\x9d restriction. Since the objective of\ntrademark law is to prevent consumer confusion, the public good is best served by allowing\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n290\n\n\x0ccompanies to maintain their trademarks as long as consumers associate a trademark with a specific\norigin. The moment they no longer make that association, however, the trademark ceases to exist.\nIf you are considering marketing as a career, you will become intimately familiar with the concepts\nrelated to branding and the value of branding. At its core, marketing involves the science of relating\nto consumers, telling them an authentic story about your product and service, and satisfying their\nwants and needs. Having a brand is essential to carrying out this objective, and it can lead to startling\nprofits. The Apple and iPhone brands, for example, are very strong and yield billions of dollars in\nprofits for Apple. Luxury brands are particularly aware of this phenomenon, as often their brand\nalone can justify pricing far above a similar good. Gucci, such as this store in Hong Kong (Figure 9.8\n"Gucci Store in Hong Kong"), trades on the value of its brand to command premium prices (and\nmargins) in the marketplace. Brands such as Rolex, Hermes, Rolls-Royce, and Bentley have similar\nbusiness models. These brands are all trademarks\xe2\x80\x94indeed, all brands are either registered\ntrademarks or are trademark-able because they share the common feature of consumer\nidentification. Be careful, though. \xe2\x80\x9cTrademark\xe2\x80\x9d and \xe2\x80\x9cbrand\xe2\x80\x9d are not interchangeable terms because\nnot all trademarks are brands.\nFigure 9.8 Gucci Store in Hong Kong\n\nTrademark law is especially important for luxury brands such as Gucci.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n291\n\n\x0cSource: Photo courtesy of Maizeam,\nhttp://commons.wikimedia.org/wiki/File:HK_TST_Canton_Road_GUCCI_Shop.JPG.\n\nSo what can be a trademark? Obviously, words can be trademarked. When it comes to trademarks,\ndistinctiveness is good. Therefore, an invented word is the best type of trademark. In 1997, for\nexample, when Stanford grad students Larry Page and Sergey Brin were brainstorming names for\ntheir new Internet search engine, they settled on the word \xe2\x80\x9cGoogle,\xe2\x80\x9d a play on \xe2\x80\x9cgoogol,\xe2\x80\x9d which means\n1 followed by 100 zeroes. They felt the name reflected their goal to organize the staggering amount of\ninformation available on the Internet. On the other hand, regular words can also become\ntrademarks, as long as consumers identify them with a particular source. Amazon, for example, is the\nname of the world\xe2\x80\x99s longest river, but it\xe2\x80\x99s also the name of an online retailer. Since consumers now\nidentify Amazon.com as an online retailer, the name can be trademarked. Another example is the\nphrase \xe2\x80\x9cYou\xe2\x80\x99re Fired\xe2\x80\x9d when used in a television program. The phrase was made popular by\nbillionaire Donald Trump and has such lasting recognition now that it\xe2\x80\x99s unlikely any other television\nshow could use that phrase as a central part of its theme.\nConsider what would happen if you tried to trademark your name. If your name happens to be Sam\nSmith, you\xe2\x80\x99d probably have a pretty hard time getting a trademark for your name. If, however, you\ncalled your business Sam Smith anyway, and started growing your business so that eventually, over\ntime, consumers began to identify \xe2\x80\x9cSam Smith\xe2\x80\x9d as your business, then your name has acquired\nsecondary meaning and can be trademarked. Thus, Sam Adams is a trademark for a beer, Ben &\nJerry\xe2\x80\x99s is a trademark for ice cream, and Ford is a trademark for a motor vehicle.\n\nHyperlink:\nhttp://www.npr.org/templates/story/story.php?storyId=19227066\nCan a sportscaster trademark the phrase \xe2\x80\x9cAre you ready to rumble\xe2\x80\x9d? Can Paris Hilton trademark the\nphrase \xe2\x80\x9cThat\xe2\x80\x99s hot\xe2\x80\x9d? As long as the public associates these phrases with a distinctive origin, the answer is\nyes. Listen to this National Public Radio broadcast for more examples.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n292\n\n\x0cNote that when you get a trademark, it\xe2\x80\x99s typically granted for a specific category of goods. The same\nname can sometimes be used for multiple categories of goods. The name Delta, for example, is a\ntrademark for both an airline and a brand of faucets. Since there is little chance that a consumer will\nbe confused by an airline or faucet brand, trademark law allows these dual registrations. On the\nother hand, some brands are so strong that they would probably stop registration even for a\ncompletely different category of goods. McDonald\xe2\x80\x99s is a good example of this. The McDonald\xe2\x80\x99s\ntrademark is one of the strongest in the world, meaning that it is instantly recognizable. In 1988, for\nexample, hotel chain Quality Inns decided to launch a new line of budget motels called \xe2\x80\x9cMcSleep.\xe2\x80\x9d\nMcDonald\xe2\x80\x99s sued, claiming trademark infringement. McDonald\xe2\x80\x99s claimed that consumers might be\nconfused and believe that McDonald\xe2\x80\x99s owned the hotel chain. A federal judge agreed and ordered\nQuality Inns to change the name of the chain, which it did, to Sleep Inns.\nTrademarks go beyond simply a company\xe2\x80\x99s name or its logo. A color can be trademarked if it\xe2\x80\x99s strong\nenough to create consumer identification. Pink, for example, is trademarked when used for building\ninsulation by Owens Corning. All other insulation manufacturers must use different colors. Sounds\ncan be trademarked too, such as MGM Studios\xe2\x80\x99 \xe2\x80\x9clion\xe2\x80\x99s roar.\xe2\x80\x9d Even a certain \xe2\x80\x9clook\xe2\x80\x9d can be\ntrademarked if a consumer identifies it with a certain origin. Thus, the distinctive colors, materials,\ntextures, and signage of a Starbucks or T.G.I. Friday\xe2\x80\x99s are considered trade dress and cannot be\ncopied. A bottle shape can be considered trade dress, too, such as the shape of a nail polish bottle\n(Figure 9.9 "OPI\xe2\x80\x99s Nail Polish Bottle"). OPI, a nail polish manufacturer, has registered this bottle\nshape with the U.S. Patent and Trademark Office (USPTO) and is suing other manufacturers that use\na similarly designed bottle. Interestingly, courts have been reluctant to grant certain smells\ntrademark protection, even though it can be argued that certain fragrances such as Old Spice or CK\nOne are distinctive. Imagine the chaos that would ensue if one company claimed trademark\nprotection for vanilla or strawberry scents\xe2\x80\x94consumers would ultimately be robbed of choice if that\nwere to happen.\nA trademark is not limited to a name or logo used to sell goods. If a company provides a service (as\nopposed to selling goods), it too can receive trademark protection. In this case it\xe2\x80\x99s called\na service mark. Facebook, for example, is a service mark. A trademark can also be used to\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n293\n\n\x0cdemonstrate certification meeting certain standards, such as the Good Housekeeping Seal of\nApproval. If you study operations management, you\xe2\x80\x99ll learn about the International Organization for\nStandardization (ISO) and its various standards for quality management (ISO 9000) or\nenvironmental quality (ISO 14000). The Forest Stewardship Council (FSC) allows its logo to be used\non paper products that come from sustainable forests, while certain foods can be labeled \xe2\x80\x9cOrganic\xe2\x80\x9d\nor \xe2\x80\x9cFair Trade\xe2\x80\x9d if they meet certain standards as established by governmental or nongovernmental\norganizations. Each of these marks is an example of a certification mark. Finally, a mark can\nrepresent membership in an organization, such as the National Football League, Girl Scouts of\nAmerica, Chartered Financial Analyst, or Realtor (Figure 9.10 "\xe2\x80\x9cRealtor\xe2\x80\x9d Certification Mark"). Each\nof these is known as a collective mark. The rules that apply to trademarks apply equally to service\nmarks, collective marks, and certification marks.\nFigure 9.9 OPI\xe2\x80\x99s Nail Polish Bottle\n\nA bottle\xe2\x80\x99s shape can be trademarked if it is distinctive enough.\n\nSource: Photo courtesy Jessica Ta,http://www.flickr.com/photos/blogggles/4288368487.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n294\n\n\x0cIf a color or sound can be trademarked, is there anything that cannot be trademarked? The Lanham\nAct excludes a few categories from trademark registration, mainly for public policy purposes.\nObviously, trademarks will not be granted if they are similar or identical to a trademark already\ngranted. If you\xe2\x80\x99re starting a new company, it\xe2\x80\x99s a good idea to make sure that not only is a domain\nname available for your company\xe2\x80\x99s name, but that the name isn\xe2\x80\x99t already trademarked by someone\nelse. Trademarks also cannot contain the U.S. flag, any government symbol (such as the White\nHouse or Capitol buildings), or anything immoral. Trademarks cannot be merely descriptive. (Thus\nevery restaurant is allowed to offer a \xe2\x80\x9cKid\xe2\x80\x99s Meal,\xe2\x80\x9d but only McDonald\xe2\x80\x99s can offer a \xe2\x80\x9cHappy Meal.\xe2\x80\x9d)\nFigure 9.10 \xe2\x80\x9cRealtor\xe2\x80\x9d Certification Mark\n\nSource:http://upload.wikimedia.org/wikipedia/en/1/16/Realtor_logo.jpg.\n\nWhether or not a region can be trademarked (a geographic indicator, or GI) is the subject of some\ncontroversy, especially with our trading partners. \xe2\x80\x9cMaine Lobster,\xe2\x80\x9d \xe2\x80\x9cNapa Valley Wine,\xe2\x80\x9d or \xe2\x80\x9cFlorida\nOrange Juice,\xe2\x80\x9d for example, may indicate to some consumers the origin of a particular lobster or\nbottle of wine or orange juice, and thus may be of commercial value to distinguish the product from\ncompetitors from other regions. For the time being, these foods must come from Maine, California,\nor Florida to avoid liability under consumer protection statutes for fraud (lying) about their origin.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n295\n\n\x0cWhat happens, though, if consumers lose the association with the region? For years, sparkling wine\nmanufacturers in Champagne, France, have fought to prevent this from happening by requiring that\nonly sparkling wine made in the Champagne region be called \xe2\x80\x9cchampagne.\xe2\x80\x9d Now, food producers\n(especially in the European Union) are seeking similar protection under international trademark law\nfor Feta, Parmesan, Gorgonzola, Asiago, and hundreds of other names.\nA trademark is valid as long as consumers believe that the mark is associated with a specific producer\nor origin. If the mark refers to a class of goods instead, then the trademark can no longer exist. This\nprocess is called genericide. Many words today once started as trademarks: furnace, aspirin,\nescalator, thermos, asphalt, zipper, softsoap, cellophane, lite beer, Q-tip, and yo-yo are all examples\nof trademarks that are now generic and have therefore lost legal protection. To prevent genericide\nfrom occurring, trademark owners must take active steps, often costing millions of dollars, to\neducate consumers on the importance of using their trademarks properly and to prosecute\ninfringers. For example, when you hear the word \xe2\x80\x9cKleenex,\xe2\x80\x9d do you think of a brand of tissue owned\nby Kimberly-Clark, or do you think of tissues generally? Does \xe2\x80\x9cRollerblade\xe2\x80\x9d refer to a brand of in-line\nskates, or to all in-line skates? In Southern states, does \xe2\x80\x9cCoke\xe2\x80\x9d refer to a Coca-Cola, or to soft drinks\ngenerally? When you run a \xe2\x80\x9cXerox\xe2\x80\x9d photocopy, is it on a Xerox photocopier or some other machine?\nThese trademarks, all currently active and worth billions of dollars to their owners, are in danger of\nbecoming generic in the United States. If that happens, the companies will lose control of the marks\nand the public (and competitors) will be free to use those words just as they use \xe2\x80\x9caspirin\xe2\x80\x9d and \xe2\x80\x9cyo-yo\xe2\x80\x9d\ntoday. Xerox has taken many steps to educate the public about its trademark, including running\nprint advertisements in business periodicals. In one of these ads, the text says, \xe2\x80\x9cWhen you use\n\xe2\x80\x98Xerox\xe2\x80\x99 the way you use \xe2\x80\x98aspirin,\xe2\x80\x99 we get a headache.\xe2\x80\x9d\nTrademark infringement occurs when someone uses someone else\xe2\x80\x99s mark, either completely or to a\nsubstantial degree, when marketing goods or services, without the permission of the mark\xe2\x80\x99s owner.\nObviously, making your own pair of jeans and slapping a \xe2\x80\x9cLevi\xe2\x80\x99s\xe2\x80\x9d label on it, or making your own\nhandbag and sewing a \xe2\x80\x9cCoach\xe2\x80\x9d label on it, constitutes trademark infringement. When Apple first\nreleased the iPhone, to its embarrassment it found out that \xe2\x80\x9ciPhone\xe2\x80\x9d was already a registered\ntrademark belonging to Cisco, another company, for a phone used for placing phone calls over the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n296\n\n\x0cInternet. To avoid trademark infringement liability, Apple had to pay Cisco an undisclosed sum to\npurchase the trademark. Ford found itself in a similar situation when it released a supercar called the\n\xe2\x80\x9cFord GT.\xe2\x80\x9d Ford made a similar racing car in the 1960s called the \xe2\x80\x9cGT 40\xe2\x80\x9d but lost control of the\ntrademark after production ceased. Unable to reach agreement with the current trademark owners,\nFord settled for releasing the new car as simply the \xe2\x80\x9cGT.\xe2\x80\x9d\nThe law also permits trademark owners to sue infringers who use their marks to a substantial degree.\nFor example, when Samsung announced its new smart phone, the Black Jack, the makers of the\nBlackBerry device sued for trademark infringement. When a software company released a product to\neliminate unwanted e-mails called \xe2\x80\x9cSpam Arrest,\xe2\x80\x9d it was sued by Hormel, makers of Spam canned\nluncheon meat. When a small coffee shop in Syracuse, New York, opened as \xe2\x80\x9cFederal Espresso,\xe2\x80\x9d the\nshipping company FedEx filed a trademark infringement claim.\nEven if a trademark owner doesn\xe2\x80\x99t believe a similar use of its mark would lead to any consumer\nconfusion, it can protect its trademark through a concept called dilution. Such was the case when an\nadult novelty store in Kentucky opened as \xe2\x80\x9cVictor\xe2\x80\x99s Secret\xe2\x80\x9d (the owner\xe2\x80\x99s name was Victor). The\ntrademark owners of \xe2\x80\x9cVictoria\xe2\x80\x99s Secret\xe2\x80\x9d filed a dilution suit in response. Traditionally, trademarks\nare intended to prevent consumer confusion. Dilution permits a trademark owner to stop usage of a\nsimilar word or phrase even if consumers aren\xe2\x80\x99t confused. Under dilution concepts, the trademark\nowner only needs to show that its mark will be diluted or tarnished in some way.\nDilution is controversial in trademark law. When Congress passed the first dilution law in 1995, the\nFederal Trademark Dilution Act, many felt that Congress had gone too far in protecting trademarks,\nto the detriment of the public and small businesses. For one thing, the Act only protected \xe2\x80\x9cfamous\xe2\x80\x9d\ntrademarks. It also failed to clearly define \xe2\x80\x9cdilution,\xe2\x80\x9d and what was required for trademark owners to\nwin a lawsuit. Finally, when the Victor\xe2\x80\x99s Secret case reached the Supreme Court, [1] the Supreme\nCourt issued some clarification. The Court ruled that to win a dilution case, a trademark owner had\nto show that it had suffered actual economic damage from the dilution, not merely the \xe2\x80\x9clikelihood\xe2\x80\x9d of\ndilution. This is a high standard for trademark owners to meet, because it means that they (1) have to\nwait for the diluting mark to hit the market and be used in commerce and (2) must be able to prove\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n297\n\n\x0cthat they suffered economic damage from the diluting mark. Unhappy with the Court\xe2\x80\x99s decision,\ncorporations lobbied Congress to pass the Trademark Revision Dilution Act of 2006, which\noverturns the Moseley case. Now, trademark owners of famous trademarks only need to show a\nlikelihood of dilution before filing a dilution lawsuit.\nCompanies or persons accused of trademark infringement have several defenses to rely on. The most\nobvious is arguing that no infringement has occurred because the two marks are sufficiently different\nthat consumers won\xe2\x80\x99t be misled. For example, in 2002 Jeep sued General Motors for infringing on\nwhat Jeep called its trademark grill. GM\xe2\x80\x99s Hummer division released the H2 that year, with a similar\nseven-bar grill. A district court held that there was no trademark infringement because the grills\nwere too dissimilar to cause consumer confusion. Look at the Hummer H2 grill (Figure 9.11\n"Hummer H2 Grill") and the Jeep grill (Figure 9.12 "Jeep Grill"). Do you think there is a chance of\nconsumer confusion?\nFigure 9.11 Hummer H2 Grill\n\nSource: Photo courtesy of Ramchandran Maharajapuram,http://www.flickr.com/photos/me_ram/3157719487.\n\nFigure 9.12 Jeep Grill\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n298\n\n\x0cSource: Photo courtesy of 3obryans,http://www.flickr.com/photos/3obryans/1017233.\n\nAnother defense is fair use. The Lanham Act prohibits the use of someone else\xe2\x80\x99s trademark when\nselling goods. It\xe2\x80\x99s not uncommon to see various items such as laptop computers, telephones, soda\ncans, or other foods with their labels covered by stickers or blurred out on television shows and\nmovies because of the trademark law. On the other hand, what if a company wanted to mention a\ncompetitor\xe2\x80\x99s product to draw a comparison with its own product? This is called comparative\nadvertising, and it\xe2\x80\x99s considered fair use. Honda, therefore, is free to claim that its \xe2\x80\x9cHonda Accord is\nbetter than the Ford Taurus\xe2\x80\x9d in its advertising even though Ford and Taurus are both trademarks\nowned by Ford Motor Company.\nThe First Amendment also recognizes the use of parody, comedy, or satire as fair use. Comedy skits\non television that make fun of, or use, company logos are an example of this fair use. Canadian\nnonprofit Adbusters, for example, claims to be an organization seeking to advance \xe2\x80\x9ca new social\nactivist movement in the information age.\xe2\x80\x9d Part of its work involves making fun of corporations and\nconsumer spending, sponsoring \xe2\x80\x9cBuy Nothing Day\xe2\x80\x9d as an antidote to the annual holiday spending\nseason. Making fun of corporations also involves spoofing their commercial messages, as the ad\nin Figure 9.13 "A Parody of the Well-Known Absolut Vodka Print Ads" illustrates. Although the ad\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n299\n\n\x0cundoubtedly infringes on a trademark, it is considered fair use because of the social commentary and\nsatire behind its message.\nFigure 9.13 A Parody of the Well-Known Absolut Vodka Print Ads\n\nSource: Photo courtesy of Adbusters,https://www.adbusters.org/gallery/spoofads/alcohol/absolutaa.\n\nAn interesting aspect of trademark infringement arises through the use of domain names on the\nInternet. The practice of cybersquatting (or domain name squatting)arises when a company registers a\ndomain name containing a famous trademark in hopes of selling that trademark to its rightful owner\nfor a large profit. The practice arose in the early days of the Internet, when domain name registration\ntook place on a first-come, first-served basis. There is nothing wrong with registering a domain name\nfor a generic word such as \xe2\x80\x9cshoes.com,\xe2\x80\x9d but incorporating a registered trademark into the domain\nname, for purposes of selling it later, is considered cybersquatting. This practice was made illegal in\n1999 with the passage of the Anticybersquatting Consumer Protection Act. It is only illegal, however, if\nthe domain name is registered to make a profit through later sale. It is not illegal if someone registers\nthe domain name in \xe2\x80\x9cgood faith.\xe2\x80\x9d A good example is the domain name registered by Canadian\nteenager Mike Rowe in 2003. An avid computer user, he registered \xe2\x80\x9cmikerowesoft.com\xe2\x80\x9d as a domain\nname. Software giant Microsoft launched legal proceedings against him, claiming violation of the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n300\n\n\x0ccybersquatting statute and trademark infringement. Rowe\xe2\x80\x99s defense was that the Web site merely\nreflected his name and his interest in computer programming and software and was being used for\nthat purpose. After heavy negative publicity, Rowe and Microsoft settled the case with Microsoft\ntaking control of the domain. Another example surrounds the Nissan.com domain. Uzi Nissan, a\ncomputer storeowner, had owned the domain for years before Nissan Motors attempted to gain\nownership of the domain. Since the domain was registered in good faith, no cybersquatting has\noccurred. The First Amendment is also a defense to cybersquatting. Web sites run by consumer\nactivists who seek to criticize or parody companies, such as \xe2\x80\x9cfordreallysucks.com\xe2\x80\x9d or\n\xe2\x80\x9cfordlemon.com\xe2\x80\x9d or \xe2\x80\x9cpeopleofwalmart.com\xe2\x80\x9d are not cybersquatting in spite of their use of\ntrademarks.\n\nKEY TAKEAWAYS\nTrademarks are anything that identifies the unique origin or goods or services. Trademarks are granted\nunder federal law by the U.S Patent and Trademark Office and can last forever. When a trademark is no\nlonger associated with a specific origin, it becomes generic and loses legal protection. Trademark owners\ncan take legal action against infringement and dilution of their marks. Fair use of trademarks includes\ncomparative advertising and parody. Trademark protection extends to the Internet, where mark owners\ncan prevent bad faith domain name squatting.\n\nEXERCISES\n1.\n\nGo to the U.S. Patent and Trademark Office at http://www.uspto.gov. Search the trademark database for\nthe phrase \xe2\x80\x9cLet\xe2\x80\x99s Roll.\xe2\x80\x9d Do you think that companies should be able to trademark phrases? Can you find\nother examples?\n\n2.\n\n\xe2\x80\x9cNetbook\xe2\x80\x9d is an example of a term the USPTO recently rejected as being generic, even though it was at\none point a registered trademark. Can you think of other recent examples of genericized trademarks?\n\n3.\n\nDo you think that the rules of cybersquatting should extend beyond Internet domain names to other uses\nsuch as Facebook or Twitter account names? Why or why not?\n\n[1] Moseley v. Secret Catalogue, 537 U.S. 418 (2003)[0].[0]\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n301\n\n\x0c9.5 Copyright\nLEARNING OBJECTIVES\n1.\n\nUnderstand what a copyright is.\n\n2.\n\nExplore the requirements for copyright protection.\n\n3.\n\nLearn how copyright owners can license their works for use by others.\n\n4.\n\nUnderstand copyright infringement and the fair use defense.\n\n5.\n\nUnderstand the Digital Millennium Copyright Act.\n\nThe final form of intellectual property (IP) protection is copyright. Like patents and trademarks,\nfederal law protects copyright. Whereas trade secrets protect confidential company information,\npatents protect processes and inventions, and trademarks protect brands and identity, copyright is\ndesigned to protect creativity. It is one of the two types of IP specifically mentioned in the Copyright\nClause of the U.S. Constitution. Of course, back then the only works copyrighted would have been\nsongs, art, or works in writing. Today, copyright extends to any form of creative expression,\nincluding digital forms.\nIf asked to write down four numbers from one to fifty in random sequence, most of us would write\nfour different numbers. The process of picking those numbers requires creativity, so the sequence of\nthe four numbers you write down is copyrighted. Note that the numbers themselves aren\xe2\x80\x99t\ncopyrighted, of course. It\xe2\x80\x99s just the unique sequence that you choose, the expression of your\ncreativity, that is copyrighted. Since computer software is a compilation of binary code expressed in 1\nand 0, all software is copyrighted. On the other hand, sequential page numbers or listings in a phone\ndirectory show no creativity and are therefore not copyrightable. Similarly, if a group of students\nwere given a camera and each was asked to photograph the same subject, each student would come\nup with a different photograph. Each student would frame the subject differently, and that is an\nexpression of creativity. Finally, consider the notes that you take in class for this course. A group of\nstudents could read the same textbook and listen to the same lecture, and come up with different sets\nof notes. Each work is unique and demonstrates creativity, so each is copyrighted.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n302\n\n\x0cA work must be original (not copied) and fixed in a durable medium to be copyrighted. Therefore, if\nyou sing an original song in the shower in the morning and your roommate hears it and records it,\nthe copyright to the song belongs to your roommate, not you. This requirement exists because it\nwould be impossible to prove, without a durable medium, who is the original author of a work. Ideas,\nby themselves, cannot be copyrighted. If you had an idea for a novel about a boy wizard who goes to a\nboarding school with his friends and battles evil monsters while growing up, that would not be\ncopyrighted. If you wrote a novel featuring such a story line, however, you would run the risk of\nviolating the copyrighted Harry Potter works. A similar dispute arose in 2006 after the blockbuster\nsuccess of Dan Brown\xe2\x80\x99s novel, \xe2\x80\x9cThe Da Vinci Code.\xe2\x80\x9d Two authors, Michael Baigent and Richard\nLeigh, claimed the novel infringed on their copyrighted book, \xe2\x80\x9cHoly Blood Holy Grail.\xe2\x80\x9d In their book,\nthe authors theorized that Jesus survived his crucifixion, married Mary Magdalene, and had\nchildren. The British judge hearing the case dismissed the claims, holding that the theory was \xe2\x80\x9ctoo\ngeneral or too low a level of abstraction to be capable of protection by copyright law.\xe2\x80\x9d [1]\nA copyrighted work is automatically copyrighted upon its creation. Unlike patents and trademarks,\nwhich must go through an expensive and rigorous application and approval process with the\ngovernment, authors do not need to send their work to the government for approval. Although it\xe2\x80\x99s a\ngood idea to write \xe2\x80\x9cCopyright\xe2\x80\x9d or place a \xc2\xa9 symbol on the work, it\xe2\x80\x99s not legally required.\nCopyright protection lasts for seventy years after the death of the author. If there is more than one\nauthor, the copyright expires seventy years after the death of the last surviving author. If a company,\nsuch as a publisher, owns a copyrighted work, the copyright expires ninety-five years from the date of\npublication, or one hundred twenty years from the date of creation, whichever comes first. After\ncopyright expires, the work falls into the public domain. The works of Shakespeare, Bach, and\nBeethoven, for example, are in the public domain. They may be freely recorded, performed, or\nmodified without permission. If you were to record yourself reciting Shakespeare\xe2\x80\x99s \xe2\x80\x9cTo be or not to\nbe\xe2\x80\x9d speech from Hamlet, however, that recording is copyrighted even though the underlying work\n(Hamlet) is in the public domain as a new creative expression. Classical music recordings are\nsimilarly copyrighted under the same concept.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n303\n\n\x0cThe owner of a copyright may allow members of the public to view or use a copyrighted work, for free\nor for a fee. This use is contained in a copyright license, sometimes called\nan End User License Agreement (EULA) for software. A license is essentially permission from the\ncopyright holder to violate the copyright, within the terms of the license. When you purchase a\nphysical book or CD or DVD, for example, the copyright license allows you to view the movie, listen\nto the music, or read the book, in private. The license does not allow you to show the movie in class\nto a broad audience, or to record the music into your computer and then modify it, or to run\nphotocopies of the book to give away or sell. These rights of reproduction, exhibition, and sale are\nnot part of the license you received and are reserved by the copyright holder. Of course, you may\npurchase those rights if you wish, but they will probably cost a lot more than the price of the book or\ndisc. Some organizations advocate the creation of a common license that authors can easily refer to if\nthey wish to distribute their work easily. The General Public License (GPL) for software\nand Creative Commons (CC) license for text and media are well-known examples. One right that you\ndo have, however, in spite of any language in the license, is the right of first sale. Essentially this\nmeans that as the owner of the physical work, you can do with it as you please, including resell the\noriginal work.\nLicenses in the digital arena can be very restrictive if you purchase digital media. Copyright holders\nmay use schemes such as Digital Rights Management (DRM) to limit your ownership rights in digital\nmedia. DRM limits the number of copies and devices a digital file can be transferred to, and in some\ncases even permits the copyright holder to delete the purchased work. Amazon.com recently deleted\ndigital George Orwell books from owners who had purchased the works for their Kindle reading\ndevices (Figure 9.14 "Amazon\xe2\x80\x99s Kindle E-reader"), without any prior notification. This would have\nbeen impossible if the books were in a physical form. Although Amazon.com was within its rights to\ndo so, the public outcry that followed made Amazon.com promise to not engage in such behavior\nagain in the future.\nFigure 9.14 Amazon\xe2\x80\x99s Kindle E-reader\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n304\n\n\x0cSource: Photo courtesy of Larry Page,http://www.flickr.com/photos/igboo/3879913438.\n\nCopyright infringement occurs when someone uses a copyrighted work without permission or\nviolates the terms of a copyright license. For example, if a classmate takes your class notes without\nyour permission and makes photocopies of them, the classmate has infringed on your copyright. It\xe2\x80\x99s\nalso copyright infringement if you take someone else\xe2\x80\x99s work and simply repackage it as your own.\nThis happened recently to Harry Potter author J. K. Rowling. Her books created a huge fan\nfollowing, and many fans gather online to discuss the Potter series. One such site is the Harry Potter\nLexicon, run by Steve Vander Ark, a former school librarian. The site serves as an encyclopedia to the\nHarry Potter world, with reference notes on characters, places, spells, and other details. When\nVander Ark announced plans to publish the contents of the Lexicon in a book format, J. K. Rowling\nsued, claiming copyright infringement. The judge agreed and ordered the Lexicon rewritten so that it\nuses less material from the copyrighted work.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n305\n\n\x0cCopyright infringement also occurs when you assist someone in violating a copyright, or create a\ndevice that assists in violating a copyright. Thus, Web sites such as the former Napster and Grokster,\nwhich existed solely for the purpose of facilitating illegal downloading of music, were held to be\ninfringers even though the Web sites themselves didn\xe2\x80\x99t violate any copyrights. Similarly, if you make\ndigital media available for download for others, you are not engaged in illegal downloading but still\nliable for contributory copyright infringement. The recording industry, which is battling for its very\nsurvival in a new file-sharing world, pursues these cases aggressively. In June 2009, a court in\nMinnesota ordered Jammie Thomas to pay $80,000 per song for making twenty-four songs\navailable for download, for a total fine of $1.92 million. In September 2009, the industry won a\n$675,000 verdict against a college student in Massachusetts for file sharing thirty songs. Devices that\ncan be used for purposes other than violating copyrights (such as photocopiers, video/DVD burners,\nand peer-to-peer networks used for sharing research) are not considered infringing devices.\nCopyright law makes a distinction between \xe2\x80\x9cfair\xe2\x80\x9d use and \xe2\x80\x9cinfringing\xe2\x80\x9d use of a copyrighted work. A\nfair use includes copying a work for purposes of commentary, criticism, news reporting, teaching, or\nresearch. Just because a work is used in a news article or in a classroom, however, does not make its\nuse fair. The law provides four factors that courts must consider in determining whether or not the\nuse is fair. First, the court must consider the purpose and character of the use. Is it for educational\npurpose, or for making a profit? Second, the court must consider the nature of the copyrighted work.\nIs the work part of the \xe2\x80\x9ccore\xe2\x80\x9d of the intended protection that copyright provides? Third, the court\nmust consider the amount and substantiality of the portion used. This is an important factor\xe2\x80\x94it\xe2\x80\x99s\none thing for your professor to copy an excerpt from a journal or book for distribution in class\n(probably fair) and another to copy the entire journal or book (probably infringing). Finally, the\ncourt must consider the effect of the use on the potential market for the copyrighted work. If the use\nis considered fair, what would it do to the market for the copyrighted work? For example, if copying\nan entire textbook is fair, it would probably eliminate the market for new textbooks.\nIn an attempt to tackle the problem of copyright infringement on the Internet, Congress passed\nthe Digital Millennium Copyright Act (DMCA) in 1998. One portion of the law helps Internet service\nproviders by expressly stating that those providers can\xe2\x80\x99t be sued for copyright infringement if others\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n306\n\n\x0cuse their networks for infringing uses. Another portion of the law helps Web sites by stating that if a\nWeb site user uploads infringing material and the Web site complies with a copyright holder\xe2\x80\x99s\nrequest to remove the material, the Web site won\xe2\x80\x99t be liable for infringement. For example, if you\nupload a portion of a copyrighted song, movie, or television show to YouTube, you may find that\nYouTube has removed your clip at the request of the copyright holder. Finally, the DMCA makes it\nillegal to attempt to disable a copy protection device. DVD and Blu-ray Discs, for example, are copy\nprotected to prevent them from being copied easily. Anyone who writes software (even if the\nsoftware is distributed for free) that disables this copy protection device is violating the DMCA. In\nrecent years the DMCA has been used by companies to prevent competitors from making\nreplacement inkjet cartridges, replacement garage door openers, and other replacement parts on the\ngrounds that the replacements circumvent a copy protection device.\n\nKEY TAKEAWAYS\nCopyright protects any creative work fixed in a tangible medium. Copyright protection is automatic\nwithout any prior government approval and generally lasts for seventy years past the death of the author.\nCopyright owners can license others to use their works while retaining full rights of ownership. Digital\nworks are fully protected by copyright and may be encrypted with digital rights management schemes.\nCopyright infringement, both direct and contributory, is a serious civil violation that can result in heavy\nmonetary penalties. Fair use is a defense to copyright infringement. The Digital Millennium Copyright Act\nprohibits any attempts to circumvent a copy protection device or scheme.\n\nEXERCISES\n1.\n\nHow long do you think copyrights should last?\n\n2.\n\nDo you think the use of copyrighted works in parody is fair use? Consider works by Weird Al Yankovic, or\nMel Brooks movies, for example.\n\n3.\n\nDo you think there is any difference between downloading a song on a peer-to-peer network versus\nwalking into a store and putting a CD into your jacket and walking out without paying for it? What are\nthose differences? Should the law treat those two acts differently?\n\n4.\n\nIs downloading music justifiable because recording artists and companies make a lot of money? Can you\nthink of other industries where this reasoning applies as well?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n307\n\n\x0c[1] Baigent v. Random House Group, http://www.scribd.com/doc/2473519/da-vinci-code-ruling-baigent-v-rhg0406 (accessed October 2, 2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n308\n\n\x0c9.6 Concluding Thoughts\nThe framers of the Constitution recognized the value of intellectual property (IP) by drafting the\nCopyright Clause into Article I, Section 8 as part of Congress\xe2\x80\x99s duty to pass laws. As IP law evolved, laws\nthat govern trade secrets, patents, trademarks, and copyright have emerged to protect different forms of\nIP. These legal protections provide a solid foundation for businesses, entrepreneurs, and artists to create\nuseful, innovative, and inspiring works for society. Our lives are enriched by machines to make tasks\neasier, medicines to heal us, and songs and movies to inspire and entertain us. Without the financial\nincentives provided by IP law, innovation would grind to a halt and the U.S. economy would become\nunrecognizable.\nOn the other hand, the Constitution is explicit about the primary purpose of providing IP monopolies: to\nadvance the progress of science and useful arts. This advance can take place when IP owners create IP, but\nit can also take place when the IP falls into the public domain at the end of its \xe2\x80\x9climited time.\xe2\x80\x9d Many legal\nscholars now believe that Congress has gone too far in pleasing copyright holders, mainly large\ncorporations with billions of dollars in profits at stake. In a case discussed in Chapter 7 "Torts" involving\nSamsung\xe2\x80\x99s use of a robot that looked like Vanna White, Judge Alex Kozinski from the Ninth Circuit Court\nof Appeals (Figure 9.15 "Judge Alex Kozinski") noted that sometimes the law does go too far in protecting\nIP:\nSomething very dangerous is going on here. Private property, including intellectual property, is\nessential to our way of life. It provides an incentive for investment and innovation; it stimulates\nthe flourishing of our culture; it protects the moral entitlements of people to the fruits of their\nlabors. But reducing too much to private property can be bad medicine. Private land, for\ninstance, is far more useful if separated from other private land by public streets, roads and\nhighways. Public parks, utility rights-of-way and sewers reduce the amount of land in private\nhands, but vastly enhance the value of the property that remains.\nSo too it is with intellectual property. Overprotecting intellectual property is as harmful as\nunderprotecting it. Creativity is impossible without a rich public domain. Nothing today, likely\nnothing since we tamed fire, is genuinely new: Culture, like science and technology, grows by\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n309\n\n\x0caccretion, each new creator building on the works of those who came before. Overprotection\nstifles the very creative forces it\xe2\x80\x99s supposed to nurture.\n\n[1]\n\nFigure 9.15 Judge Alex Kozinski\n\nSource: Photo courtesy of the Ninth Circuit Court of Appeals, http://www.ce9.uscourts.gov/chief_judge_bio.html.\n\nJudge Kozinski thinks that overprotecting intellectual property is as harmful as underprotecting it. Do you\nagree? The challenge for policymakers and courts is to find the balance between the rights of IP holders,\nwho would always like more protection, and the rights of the public, which are enhanced when material\nfalls into the public domain. Corporations, policymakers, and members of the public will all benefit from a\nreasoned debate over how to find this balance.\n\n[1] White v. Samsung Electronics, 989 F.2d 1512 (9th Cir. 1993).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n310\n\n\x0cChapter 10\n\nCriminal Law\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the nature of criminal law, why it is important to\nbusiness, and the potential consequences of committing criminal acts. You will become familiar with\nwhite-collar crimes, blue-collar crimes, and crimes committed by businesses. You will also learn about the\nconstitutional protections afforded to those accused of committing a crime, and the purpose of\npunishments for committing crimes. This chapter will explore corporate liability as well as individual\nliability for corporate actions. It also will examine strategies to minimize corporate criminal liability\nexposure or losses attributed to criminal activities. At the conclusion of this chapter, you should be able to\nanswer the following questions:\n1.\n\nWhy is crime relevant to business?\n\n2.\n\nHow does criminal law differ from civil law?\n\n3.\n\nWhat constitutional protections are afforded to those accused of committing a crime?\n\n4.\n\nWhat are some relevant defenses to crime?\n\n5.\n\nWhat are the consequences of committing a crime?\n\n6.\n\nWhat are the goals of punishment for committing a crime?\n\n7.\n\nWhich crimes must businesses be concerned about?\n\n8.\n\nWhat strategies exist for businesses to minimize exposure to criminal liability or to loss associated with\ncriminal activities?\n\nConsider the photo in Figure 10.1 "Businessperson in Trouble". It is probably not the usual image\nconjured by most business students who dream of success in the business world. Yet it becomes a sad\nreality for too many managers and executives who commit crimes in the context of their professional\nlives. How can the path from business success lead to a criminal conviction? Click on any credible\nnews source today, and you will find among the headlines a story in which this photo would fit.\nOf course, there are many reasons why something like this happens. People sometimes fall into the\n\xe2\x80\x9cwrong crowd\xe2\x80\x9d at work, and they do not know how to walk away. Sometimes corporate culture and\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n311\n\n\x0cleadership can contaminate a work environment, causing people to disregard ethical behavior or to\nflagrantly ignore the laws. If \xe2\x80\x9ceveryone is doing it,\xe2\x80\x9d then someone might believe that it\xe2\x80\x99s OK for him\nor her to do it, too. Being part of an organization has a way of making someone feel insulated and\n\xe2\x80\x9csafe\xe2\x80\x9d when committing wrongdoings. For example, some members of the Enron workforce seemed\nto be swept up in a culture of corporate greed, and they did not know how to walk away. Other people\nare opportunists, and their moral compass or ethics do not lead them away from temptation. Bernie\nMadoff may be a prime example of such an opportunist in today\xe2\x80\x99s news. Sometimes, criminal\nbehavior results from the emphasis of profit over ethical behavior. For example, we might think of\ncorporate environmental crimes, in which corporations decide not to follow regulatory requirements\nregarding hazardous waste disposal or storage. In the end, of course, the reasons for the criminal\nbehavior do not matter. When a crime is committed, others will be injured, and the wrongdoer will\nbe subject to criminal prosecution.\nEveryone must be diligent about crime. Crimes affect businesses both from the inside and from the\noutside. Even if individuals are honest in their dealings, that does not relieve them from the necessity\nto maintain a vigilant watch to protect not only their good name but also that of their business from\nthe criminal activities of others. Criminal activity \xe2\x80\x9cfrom the outside\xe2\x80\x9d can be costly to businesses. Loss\nthrough property damage, theft, shoplifting, corporate espionage, fraud, and arson are real threats.\nPerhaps more insidiously, threats \xe2\x80\x9cfrom the inside\xe2\x80\x9d also pose tremendous risk of loss. These\nactivities include crimes such as embezzlement, computer crimes, and fraud. Such \xe2\x80\x9cinside jobs\xe2\x80\x9d are\nperhaps more unsettling because the perpetrators are often trusted colleagues who would not\nordinarily fall under the suspicion of others. Moreover, a corporation must also protect itself from\nthe bad judgment or overzealous behavior of its employees. If an employee acting within the scope of\nemployment commits a crime from which the corporation itself will benefit, then the corporation can\nbe convicted of the crime, too. Of course, not all corporations that are convicted on criminal charges\nare hapless victims of an overzealous employee who commits crimes on their behalf. Other\nbusinesses are actively involved in crime, whether through a corporate culture run amok or through\noutright organized crime, such as money laundering.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n312\n\n\x0cLet\xe2\x80\x99s explore criminal law in the business world. Not only do we need to understand basic criminal\nlaw and the nature of crime in business to understand everyday headlines, but we also must ensure\nthat our own professional dealings and the people associated with our businesses are never the\nlegitimate focus of such stories. This chapter explores the differences between criminal law and civil\nlaw, the nature of criminal law, the constitutional protections afforded to those accused of\ncommitting a crime, relevant defenses, consequences of committing crimes, and the goals of\npunishment. It also examines specific crimes relevant to business, including white-collar crime, bluecollar crime that harms businesses, and crimes committed by businesses. Last, it examines different\nstrategies to minimize exposure to criminal liability.\n\nKey Takeaways\nCriminal law is relevant to business because crime presents real threats. When crimes are committed,\npeople are injured. Criminal behavior is punishable by law. Risks to business posed by crime arise from\nthe losses suffered from the criminal activities of those on the outside of the business organization, as well\nas those on the inside. Corporations themselves can be liable for crime when an employee working within\nthe scope of employment commits crime that benefits the corporation, or when the corporation itself\ncommits crime.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n313\n\n\x0c10.1 The Nature of Criminal Law, Constitutional Rights,\nDefenses, and Punishment\nLEARNING OBJECTIVES\n1.\n\nUnderstand what crime is.\n\n2.\n\nCompare and contrast the differences between criminal law and civil law.\n\n3.\n\nUnderstand the constitutional protections afforded to those accused of committing a crime.\n\n4.\n\nExamine some common defenses to crime.\n\n5.\n\nLearn about the consequences of committing a crime.\n\n6.\n\nExplore the goals or purposes of punishment for committing a crime.\n\nImagine a bookkeeper who works for a physicians group. This bookkeeper\xe2\x80\x99s job is to collect invoices\nthat are due and payable by the physicians group and to process the payments for those invoices. The\nbookkeeper realizes that the physicians themselves are very busy, and they seem to trust the\nbookkeeper with the task of figuring out what needs to be paid. She decides to create a fake company,\ngenerate bogus invoices for \xe2\x80\x9cservices rendered,\xe2\x80\x9d and send the invoices to the physicians group for\npayment. When she processes payment for those invoices, the fake company deposits the checks in\nits bank account\xe2\x80\x94a bank account she secretly owns. This is a fraudulent disbursement, and it is just\none of many ways in which crime occurs in the workplace. Check out Note 10.4 "Hyperlink: Thefts,\nSkimming, Fake Invoices, Oh My!" to examine several other common embezzlement schemes easily\nperpetrated by trusted employees.\n\nHyperlink: Thefts, Skimming, Fake Invoices, Oh My!\nhttp://www.acfe.com/resources/view.asp?ArticleID=1\nThink it couldn\xe2\x80\x99t happen to you? Check out common schemes perpetrated by trusted employees in this\narticle posted on the Association of Certified Fraud Examiners\xe2\x80\x99 Web site.\n\nWhen crime occurs in the workplace or in the context of business, the temptation might be to think\nthat no one is \xe2\x80\x9creally\xe2\x80\x9d injured. After all, insurance policies can cover some losses. Sometimes people\nthink that if the victims of embezzlement do not immediately notice the embezzlement, then they\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n314\n\n\x0cmust not \xe2\x80\x9cneed\xe2\x80\x9d the money anyhow, so no real crime has been committed. Of course, these excuses\nare just smoke screens. When an insurance company has to pay for a claim arising from a crime, the\ninsurance company is injured, as are the victim and society at large. Similarly, the fact that wealthy\npeople or businesses do not notice embezzlement immediately does not mean that they are not\nentitled to retain their property. Crime undermines confidence in social order and the expectations\nthat we all have about living in a civil society. No crime is victimless.\nA crime is a public injury. At the most basic level, criminal statutes reflect the rules that must be\nfollowed for a civil society to function. Crimes are an offense to civil society and its social order. In\nshort, crimes are an offense to the public, and someone who commits a crime has committed an\ninjury to the public.\nCriminal law differs from civil law in several important ways. See Figure 10.3 "Comparison between\nCriminal Law and Civil Law" for a comparison. For starters, since crimes are public injuries, they are\npunishable by the government. It is the government\xe2\x80\x99s responsibility to bring charges against\ncriminals. In fact, private citizens may not prosecute each other for crimes. When a crime has been\ncommitted\xe2\x80\x94for instance, if someone is the victim of fraud\xe2\x80\x94then the government collects the\nevidence and files charges against the defendant. When someone is charged with committing a\ncrime, he or she is charged by the government in an indictment. The victim of the crime is a witness\nfor the government but not for the prosecutor of the case. Note that our civil tort system allows a\nvictim to bring a civil suit against someone for injuries inflicted on the victim by someone else.\nIndeed, criminal laws and torts often have parallel causes of action. Sometimes these claims carry the\nsame or similar names. For instance, a victim of fraud may bring a civil action for fraud and may also\nbe a witness for the state during the criminal trial for fraud.\nFigure 10.3 Comparison between Criminal Law and Civil Law\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n315\n\n\x0cIn a criminal case, the defendant is presumed to be innocent unless and until he or she is proven\nguilty. This presumption of innocence means that the state must prove the case against the defendant\nbefore the government can impose punishment. If the state cannot prove its case, then the person\ncharged with the crime will be acquitted. This means that the defendant will be released, and he or\nshe may not be tried for that crime again. The burden of proof in a criminal case is the prosecution\xe2\x80\x99s\nburden, and the prosecution must prove its case beyond a reasonable doubt. This means that the\ndefendant does not have to prove anything, because the burden is on the government to prove its\ncase. Additionally, the evidence must be so compelling that there is no reasonable doubt as to the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n316\n\n\x0cdefendant\xe2\x80\x99s guilt. To be convicted of a crime, someone must possess the required criminal state of\nmind, or mens rea. Likewise, the person must have committed a criminal act, known as actus reus.\nCompare this to the standard of proof in a civil trial, which requires the plaintiff to prove the case\nonly by a preponderance of the evidence. This means that the evidence to support the plaintiff\xe2\x80\x99s case is\ngreater (or weightier) than the evidence that does not. It\xe2\x80\x99s useful to think of the criminal standard of\nproof\xe2\x80\x94beyond a reasonable doubt\xe2\x80\x94as something like 99 percent certainty, with 1 percent doubt.\nCompare this to preponderance of the evidence, which we might think of as 51 percent in favor of the\nplaintiff\xe2\x80\x99s case, but up to 49 percent doubt. This means that it is much more difficult to successfully\nprosecute a criminal defendant than it is to bring a successful civil claim. Since a criminal action and\na civil action may be brought against a defendant for the same incident, these differences in burdens\nof proof can result in verdicts that seem, at first glance, to contradict each other. Perhaps the most\nwell-known cases in recent history in which this very outcome happened were the O. J. Simpson\ntrials. Simpson was acquitted of murder in a criminal trial, but he was found liable for wrongful\ndeath in a subsequent civil action. Check out Note 10.14 "Hyperlink: Not Guilty Might Not Mean\nInnocent" for a similar result in the business context.\n\nHyperlink: Not Guilty Might Not Mean Innocent\nhttp://www.bloomberg.com/apps/news?pid=20601103&sid=a89tFKR4OevM\nRichard Scrushy of HealthSouth was acquitted of several criminal charges relating to accounting fraud but\nwas found civilly liable for billions. He was subsequently found guilty in a later criminal case for different\ncrimes committed.\n\nThis extra burden reflects the fact that the defendant in a criminal case stands to lose much more\nthan a defendant in a civil case. Even though it may seem like a very bad thing to lose one\xe2\x80\x99s assets in\na civil case, the loss of liberty is considered to be a more serious loss. Therefore, more protections are\nafforded to the criminal defendant than are afforded to defendants in a civil proceeding. Because so\nmuch is at stake in a criminal case, our due process requirements are very high for anyone who is a\ndefendant in criminal proceedings. Due process procedures are not specifically set out by the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n317\n\n\x0cConstitution, and they vary depending on the type of penalty that can be levied against someone. For\nexample, in a civil case, the due process requirements might simply be notice and an opportunity to\nbe heard. If the government intends to revoke a professional license, then the defendant might\nreceive notice by way of a letter, and the opportunity to be heard might exist by way of written\nappeal. In a criminal case, however, the due process requirements are higher. This is because a\ncriminal case carries the potential for the most serious penalties.\n\nConstitutional Rights Relevant to Criminal Proceedings\nA person accused of a crime has several rights, which are guaranteed by the U.S. Constitution. Many\ncrimes are state law issues. However, many provisions of the U.S. Constitution\xe2\x80\x99s Bill of Rights, which\ncontains the rights of concern to criminal defendants, have been incorporated as applicable to the states.\nThis is known as the incorporation doctrine.\nThe Sixth Amendment guarantees that criminal defendants are entitled to an attorney during any phase of\na criminal proceeding where there is a possibility of incarceration. This means that if a defendant cannot\nafford an attorney, then one is appointed for him or her at the state\xe2\x80\x99s expense.\nThe Fifth Amendment guarantees the right to avoid self-incrimination. This right means that the\ngovernment cannot torture someone accused of committing a crime. Obviously, someone under the\nphysical and psychological pain of torture will admit to anything, and this might be a strong incentive to\nallow torture if the government wanted someone to confess to a crime. However, the Fifth Amendment\nguarantees that people can choose to remain silent. No one is compelled to testify against himself or\nherself to make self-incriminating statements.\nThe Eighth Amendment prohibits cruel and unusual punishment. We do not employ many techniques\nthat were once used to punish people who committed crimes. For instance, we do not draw and quarter\npeople, which was a practice in England during the Middle Ages. Recently, however, the question of the\nuse of torture by the United States against aliens on foreign soil has been a hot topic. Many people believe\nthat our Eighth Amendment protections should be extended to everyone held by U.S. authorities, whether\nthey are on U.S. soil or not.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n318\n\n\x0cThe Fourth Amendment provides a prohibition against illegal searches and seizures. This means that if\nevidence were obtained in violation of the Fourth Amendment, then it cannot be used against the\ndefendant in a court of law. For Fourth Amendment requirements to be met, the government must first\nobtain a search warrant to search a particular area for particular items if there is a reasonable expectation\nof privacy in the area to be searched. The search warrant is issued only on probable cause. Probable cause\narises when there is enough evidence, such as through corroborating evidence, to reasonably lead to the\nbelief that someone has committed a crime.\nIf a valid search warrant is issued, then the government may search in the area specified by the warrant\nfor the item that is the subject of the warrant. If a search occurs without a warrant, the search might still\nbe legal, however. This is because there are several exceptions to the requirements for a search warrant.\nThese include the plain view doctrine, exigent circumstances, consent, the automobile exception, lawful\narrest, and stop and frisk. The plain view doctrine means that no warrant is required to conduct a search\nor to seize evidence if it appears in the plain view of a government agent, like a police officer.\nExigent circumstances mean that no warrant is required in the event of an emergency. For instance, if\nsomeone is cruelly beating his dog, the state can remove the dog without a warrant to seize the dog. The\nexigent circumstances exception to the warrant requirement is used in hot pursuit cases. For example, if\nthe police are in hot pursuit of a suspect who flees into a house, the police can enter the house to continue\nthe pursuit without having to stop to first obtain a warrant to enter the house. Consent means that the\nperson who has the authority to grant consent for a search or seizure has granted the consent. This does\nnot necessarily have to be the owner of the location to be searched. For example, if your roommate\nconsents to a search of your living room, which is a common area shared by you and your roommate, then\nthat is valid consent, even if the police find something incriminating against you and you or your landlord\ndid not consent to the search. The automobile exception means that an automobile may be searched if it\nhas been lawfully stopped. When a police officer approaches a stopped car at night and shines a light into\nthe interior of the car, the car has been searched. No warrant is required. If the police officer spots\nsomething that is incriminating, it may be seized without a warrant. Additionally, no warrant is required\nto search someone who is subject to lawful arrest. This exception exists to protect the police officer. For\ninstance, if the police could not search someone who was just arrested, they would be in peril of injury\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n319\n\n\x0cfrom any weapon that the person in custody might have possession of. Similarly, if someone is stopped\nlawfully, that person may be frisked without a warrant. This is the stop and frisk exception to the warrant\nrequirement.\nIn the business context, it is also important to note that administrative agencies in certain limited\ncircumstances may conduct warrantless searches of closely regulated businesses, such as junkyards,\nwhere many stolen cars are disassembled for parts that can be sold.\n\nDefenses\nIf the government violates a defendant\xe2\x80\x99s constitutional rights when collecting evidence, then the evidence\ngathered in violation of those rights may be suppressed at trial. In other words, it may not be used against\nthe defendant in trial. This is because evidence obtained through an illegal search is \xe2\x80\x9cfruit of the\npoisonous tree.\xe2\x80\x9d The fruit of the poisonous tree doctrine is known as the exclusionary rule. You should\nknow, however, that lying to the defendant, or using forms of trickery and deceit, are not constitutional\nviolations.\nAnother common defense arises under the exclusionary rule regarding confessions. This is when the\ngovernment, while holding someone in a custodial interrogation, questions that person without first\nreading the Miranda warnings. If someone is subjected to a custodial interrogation, he or she must first be\nread the Miranda warnings, which you have probably heard in the movies. Though the U.S. Supreme\nCourt did not script the warnings specifically, the warnings are usually delivered in language close to this:\n\xe2\x80\x9cYou have the right to remain silent. Anything that you say can and will be used against you in a court of\nlaw. You have the right to an attorney. If you cannot afford an attorney, one will be provided to you by the\nstate. Do you understand your rights?\xe2\x80\x9d\nThe purpose of the Miranda warnings is to ensure that people understand that they have the right not to\nmake self-incriminating statements and that they have the right to have counsel. If someone wants to\ninvoke his or her rights, he or she has to do so unequivocally. \xe2\x80\x9cDon\xe2\x80\x99t I need a lawyer?\xe2\x80\x9d is not enough.\nThe Miranda warnings are not required unless someone is in custody and subject to interrogation.\nSomeone in custody is not free to leave. So if a police officer casually strikes up a conversation with you\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n320\n\n\x0cwhile you are shopping in the grocery store and you happen to confess to a crime, that confession will be\nadmissible as evidence against you even though you were not Mirandized. Why? Because you were not in\ncustody and you were free to leave at any time. Likewise, if the police are not interrogating a person, then\nany statement made can also be used against that person, even if he or she is not Mirandized. Someone is\nbeing interrogated when the statements or actions by the police (or other government agent) are likely to\ngive rise to a response.\nAnother defense provided by the U.S. Constitution is the prohibition against double jeopardy. The Fifth\nAmendment prohibits the government from prosecuting the same defendant for the same crime after he\nor she has already stood trial for it. This means that the government must do a very thorough job in\ncollecting evidence prior to bringing a charge against a defendant, because unless the trial results in a\nhung jury, the prosecution will get only that one chance to prosecute the defendant.\nOther defenses to crime are those involving lack of capacity, including insanity and infancy. Insanity is a\nlack of capacity defense, specifically applicable when the defendant lacks the capacity to understand that\nhis actions were wrong. Infancy is a defense that may be used by persons who have not yet reached the age\nof majority, typically eighteen years of age. Those to which the infancy defense applies are not \xe2\x80\x9coff the\nhook\xe2\x80\x9d for their criminal actions, however. Juvenile offenders may be sentenced to juvenile detention\ncenters for crimes they commit, with common goals including things like education and rehabilitation. In\ncertain circumstances, juvenile offenders can be tried as adults, too.\nLast, the state may not induce someone to commit a crime that he or she did not already have the\npropensity to commit. If the state does this, then the defendant will have the defense of entrapment.\n\nPunishment\nIf convicted in a criminal case, the defendant will be punished by the government, rather than by the\nvictim. Once a defendant is convicted of a crime, he or she is a criminal. Punishment for criminal offenses\ncan include fines, restitution, forfeiture, probation, civil disabilities, and a loss of liberty. Loss of liberty\nmeans that the convicted criminal may be forced to do community service, may be subject to house arrest,\nmay be incarcerated or, in some states that have the death penalty, may even lose his or her life.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n321\n\n\x0cLength of incarceration varies depending on whether the conviction was for amisdemeanor or a felony. A\nmisdemeanor is a less serious offense than a felony, as determined by the legislative body and reflected in\nthe relevant statutes. Even an infraction, such as a parking ticket, is a criminal offense, typically carrying a\npenalty of a fine. An infraction is considered less serious than a misdemeanor.\nWhen someone is convicted of violating a state criminal statute\xe2\x80\x94a felony, misdemeanor, or infraction\xe2\x80\x94\nthe penalty will be set by the statute. For instance, the statute might state that the punishment will be \xe2\x80\x9cup\nto $5,000\xe2\x80\x9d or \xe2\x80\x9cup to one year in jail.\xe2\x80\x9d Often, the possible punishments are given in a range, which allows\nthe judge leeway to take other matters into consideration when sentencing the offender. For example, if\nsomeone is convicted of a misdemeanor that carries a penalty of up to one year in jail, but that person is a\nfirst-time offender with no prior criminal history, the judge might impose a sentence of some lesser time\nin jail, such as thirty days, or no jail time whatsoever.\nHistorically, all judges had the leeway to use their judgment when sentencing convicted criminals.\nHowever, disparities in sentences gave rise to concern about unequal treatment for similar offenses. In\nthe 1980s the U.S. Sentencing Commission established the Federal Sentencing Guidelines, which were\nunderstood to be mandatory guidelines that federal judges were expected to use when sentencing\noffenders. The mandatory nature of these guidelines led some to observe that extremely harsh penalties\nwere mandated for relatively minor offenses, given certain circumstances. Today, however, the federal\nguidelines are only advisory, due to the U.S. Supreme Court\xe2\x80\x99s decision in United States v. Booker, which\nheld that a wide range of factors should be taken into consideration when sentencing offenders.\n\n[1]\n\nThis\n\nopinion restored to federal district court judges the power to exercise their judgment when sentencing\nfederal offenders. Several states, however, passed their own versions of sentencing guidelines, and state\ntrial court judges in those states must rely on those guidelines when sentencing state offenders. This has\nled to controversial \xe2\x80\x9cthree strikes\xe2\x80\x9d laws, which can also carry extremely harsh penalties\xe2\x80\x94such as\nincarceration for twenty-five years to life\xe2\x80\x94for relatively minor offenses.\nOften, the convicted criminal will be subject to various civil disabilities, depending on the state in which\nhe or she lives. For instance, a felon, which is a criminal that has been convicted of a felony, may be\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n322\n\n\x0cprohibited from possessing firearms, running for public office, sitting on a jury, holding a professional\nlicense, or voting. A felon may be subject to deportation if he or she is an illegal immigrant.\nBesides loss of liberty and civil disabilities, other forms of punishment exist. Some of these are also\nappropriate in civil cases. Punishment for crimes also includes a fine, which is a monetary penalty for\ncommitting an offense. Fines can also be levied in civil cases. Restitution, which is repayment for damage\ndone by the criminal act, is a common punishment for property damage crimes such as vandalism.\nRestitution can also be an appropriate remedy in civil law, particularly in contracts disputes. Forfeiture,\nwhich means involuntarily losing ownership of property, is also a punishment, and it is commonly used in\nillegal drug trafficking cases to seize property used during the commission of a crime. Check out Note\n10.39 "Hyperlink: Shopping, Anyone?", which is the U.S. Marshall\xe2\x80\x99s Assets Forfeiture page, to see\nforfeited property currently available for sale. Finally, probation is a common penalty for committing\ncrime. Probation is when the criminal is under the supervision of the court but is not confined. Typically,\nthe terms of the probation require the criminal to periodically report to a state agent, such as a probation\nofficer.\n\nHyperlink: Shopping, Anyone?\nhttp://www.usmarshals.gov/assets/assets.html\n\nPurpose of Punishment\nConviction of a crime carries criminal penalties, such as incarceration. But what is the purpose of\npunishment? We do not have a vigilante system, where victims may bring their own form of justice to an\noffender. If we had such a system we would have never-ending feuds, such as the infamous and longstanding nineteenth-century dispute between the Hatfields and McCoys from the borderlands of West\nVirginia and Kentucky.\nSeveral goals could be the focus of a criminal justice system. These could include retribution, punishment,\nrehabilitation, the protection of society, or deterrence from future acts of crime. Our criminal justice\nsystem\xe2\x80\x99s penalties ostensibly do not exist for the purpose of retribution. Rather, rehabilitation,\npunishment, the protection of society, and deterrence from committing future crimes are the oft-cited\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n323\n\n\x0cgoals. The Federal Bureau of Prisons captures some of these concepts in its mission statement.\n\n[2]\n\nSadly,\n\nrehabilitation programs are not always available or, when they are, they are not always considered\nappropriate\xe2\x80\x94or, when appropriate, they do not always work. Additionally, the goal of deterrence is not\nalways achieved, as reflected in high recidivism rates in the United States.\n\nPunishment of Business-Related Crime\nPunishments committed by \xe2\x80\x9cwhite-collar criminals\xe2\x80\x9d are the same as those committed by any\ncriminal. White-collar crime is a term used to describe nonviolent crimes committed by people in their\nprofessional capacity or by organizations. Individuals involved in white-collar crime are criminally liable\nfor their own actions.\nAdditionally, since a corporation is a legal person, then the corporation can be convicted of committing\ncrimes, too. Accordingly, corporations can be punished. However, not all constitutional protections\nafforded to individuals are available to corporations. For instance, a corporation does not have the right\nagainst self-incrimination.\nOne difficulty that arises is the question of how to punish a corporation for engaging in criminal activity.\nAfter all, as they say, a corporation does not have a soul to rehabilitate or a body to incarcerate.\n\n[3]\n\nThis is\n\nvery different from a human being, who will stand to lose his or her liberty or who might be subject to\nmandatory counseling.\nWe might argue that a criminal corporation should have its corporate charter revoked, which would be\nequivalent to a corporate death penalty. However, if that happened, a lot of innocent people who were not\ninvolved in the criminal activity would be harmed. For instance, employees would lose their jobs, and\nsuppliers and customers would lose the goods or services of the corporate criminal. Entire communities\ncould suffer the consequences of a few bad actors.\nOn the other hand, corporations must be punished to respect the goal of deterrence of future crimes. One\nway that corporations are deterred is by the imposition of hefty fines. It is not uncommon to base such\npenalties on some percentage of profits, or all profits derived from the ill-gotten gains of criminal activity.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n324\n\n\x0cCorporations that are criminals also lose much in the way of reputation. Of course, reputational damage\ncan be very difficult to repair.\n\nKEY TAKEAWAYS\nCrime is a public injury. Criminal law differs from civil law in important ways, including who brings the\nclaim, the burden of proof, due process, postconviction civil disabilities, and penalties. Those who are\naccused of committing a crime are afforded a high level of due process, including constitutional\nprotections against illegal searches and seizures, and self-incrimination; guarantee of an attorney; and\nprohibition against cruel and unusual punishment. Several common defenses to crimes exist. If convicted,\ncriminals can face loss of liberty, with sentencing structures based on statutory language and, in the\nfederal system, guided by the U.S. Federal Sentencing Guidelines. The goals of imposing penalties for\nviolating criminal laws include protecting society, punishing the offender, rehabilitating the offender, and\ndeterrence from future acts of crime. Corporations can also be convicted of crimes, though unique\nquestions relating to appropriate means of punishment arise in that context.\n\nEXERCISES\n1.\n\nImagine a woman who suffers from dementia and lives in an assisted living facility. One day, she wanders\ninto another resident\xe2\x80\x99s room and picks up an antique vase from the other resident\xe2\x80\x99s bureau. As she holds\nthe vase, she forgets that it belongs to someone else and walks out of the room with it. Later, she places it\non her own nightstand, where she admires it greatly. Has there been a crime here? Why or why not?\n\n2.\n\nConsider the case of O. J. Simpson, in which a criminal jury acquitted him of murder, but a civil court found\nhim liable for wrongful death. Both trials arose out of the same incident. Do you think that the burden of\nproof should be the same for a civil case as it is for a criminal case? Why?\n\n3.\n\nWhat should be the goal of penalties or punishments for criminal offenses? Compare and contrast how\nour criminal justice system would differ if the goal of punishment was each of the following: retribution,\nrehabilitation, protection of society, or deterrence from future acts of crime.\n\n4.\n\nConsider the difference between minimum security federal prison camps and medium or high-level\nsecurities facilities, described here:http://www.bop.gov/locations/institutions/index.jsp. Should whitecollar criminals receive the same punishment as those convicted of committing a violent crime? Why or\nwhy not?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n325\n\n\x0c5.\n\nBefore listening to the link in this assignment, write down your perceptions of \xe2\x80\x9cfederal prison camp.\xe2\x80\x9d\nThen, listen to an interview with a convicted white-collar criminal\nhere: http://discover.npr.org/features/feature.jhtml?wfId=1149174. Compare your initial perceptions\nwith what you have learned from this interview. How are they the same? How do they differ?\n\n6.\n\nHow should a corporation be punished for committing a crime? Find an example of a corporation that was\nconvicted of a crime. Do you believe that the punishment was appropriate? Discuss.\n\n7.\n\nWhat kinds of crimes do college students commit? While the vast majority of college students wouldn\xe2\x80\x99t\neven think of committing a violent crime, many students do engage in crimes they believe to be victimless,\nsuch as downloading movies or buying and selling prescription drugs like Adderall or Ritalin. Are these\ncrimes actually victimless?\n\n8.\n\nThe exclusionary rule was created by the Supreme Court as a means of punishing the police for violating a\ndefendant\xe2\x80\x99s constitutional rights. Some legal commentators, including several members of the Supreme\nCourt, believe the exclusionary rule should be abolished. Without it, how do you think society can ensure\nthe police will not violate a citizen\xe2\x80\x99s constitutional rights?\n\n[1] United States v. Booker, 543 U.S. 220 (2005).\n[2] Federal Bureau of Prisons, \xe2\x80\x9cMission and Vision of the Bureau of Prisons,\xe2\x80\x9d\nhttp://www.bop.gov/about/mission.jsp (accessed September 27, 2010).\n[3] Albert W. Alschuler, \xe2\x80\x9cTwo Ways to Think about the Punishment of Corporations,\xe2\x80\x9d American Criminal Law\nReview, Public Law and Legal Theory Series, No. 09-19, 2009, p.\n13,http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1491263 (accessed September 27, 2010).This is a\nparaphrase of a remark first uttered by Lord Chancellor Thurlow between 1778 and 1792: \xe2\x80\x9cNo soul to damn, no\nbody to kick.\xe2\x80\x9d\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n326\n\n\x0c10.2 Crime\nLEARNING OBJECTIVES\n1.\n\nExamine white-collar crimes.\n\n2.\n\nExamine blue-collar crimes that harm businesses.\n\n3.\n\nExamine the crimes committed by businesses.\n\nImagine that you work in a publicly traded corporation as an accountant. One day, your manager calls\nyou. You sense desperation in his voice as he whispers, \xe2\x80\x9cQuick! Shred the paper copies of the financial\nrecords!\xe2\x80\x9d Will you do it? After all, how can shredding paper be a crime? Not so fast. It may be a crime\nunder the Sarbanes-Oxley Act, specifically if you destroy documents before the statutory length of time\nrequired to hold them. After studying this section, you should be able to recognize when the answer to\nsuch questions should be a resounding \xe2\x80\x9cNo!\xe2\x80\x9d Indeed, after reading this section, you should be able to spot\ncriminal activity, which may lead to tough decisions, such as whether you should be a whistleblower or\nnot.\nThis section addresses crimes relevant to business concerns. A business must be concerned about criminal\nactivity from the inside, from the outside, and through its own actions.\n\nWhite-Collar Crime\nWhite-collar crime is a term used to describe nonviolent crimes committed by people in their professional\ncapacity, or by organizations. These crimes are committed for financial gain, often through deception.\nHistorically, this term derives from a reference to the \xe2\x80\x9cwhite collars\xe2\x80\x9d that managers, executives, or\nprofessionals who committed these crimes wore as their everyday attire, rather than the \xe2\x80\x9cblue collars\xe2\x80\x9d of\nthe factory workers and laborers. White-collar crimes are not typical street crimes, like burglary or\nrobbery, and they are not person crimes, like murder or rape. Rather, the term is used to describe crime\ncommitted in the professional work environment, for the purpose of obtaining a financial reward through\nthe use of deception. White-collar criminals frequently commit their crimes on the job, in broad daylight,\nwhile sitting at a desk.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n327\n\n\x0cBut what leads an otherwise successful businessperson or organization to commit a white-collar crime?\nAfter all, if someone is earning a good salary, or if a business is financially healthy, why would he or she\nchoose to violate the law? While names like Kenneth Lay of Enron and Bernie Ebbers of WorldCom are\nvirtually synonymous with corporate greed, lack of ethical decision making, and fraudulent behavior,\nthese examples do not provide satisfactory answers to this question. Indeed, businesses must be vigilant\nagainst white-collar crime, because there is no absolute way to identify those who might turn to criminal\nbehavior in the workplace. White-collar crime can involve fraud or larceny, organized crime, cybercrime,\nand environmental crime.\n\nFraud and Larceny\nWhite-collar crimes generally involve the use of deception to acquire money or property. This is the very\ndefinition of fraud. Many white-collar crimes are versions of fraud. Sometimes, white-collar crime\ninvolves outright larceny, which is the trespassory taking of property with the intent to deprive the owner\nof the property. In both types of white-collar crime, the criminal is trying to take property for his or her\nown financial gain.\nFraud is found in many contexts. For instance, many regulatory violations, like insider trading, are forms\nof fraud. Specifically, these are securities fraud. Securities fraud is when someone uses deception to\ncircumvent the regulations or statutes interpreted by the U.S. Securities and Exchange Commission (SEC)\nto acquire money or property. Goldman Sachs was recently charged by the SEC for securities fraud,\nbecause it allegedly misrepresented material facts to investors to gain financially. Check out Note 10.49\n"Hyperlink: SEC v. Goldman Sachs" to review the complaint.\n\nHyperlink: SEC v. Goldman Sachs\nOne of Goldman Sachs\xe2\x80\x99s employees, Fabrice Tourre, self-named the \xe2\x80\x9cFabulous Fab,\xe2\x80\x9d was also named as a\ndefendant in the complaint. Do you think that the Fabulous Fab should bear criminal liability for\nmisleading investors, even if he did mislead investors?\nhttp://www.sec.gov/litigation/complaints/2010/comp21489.pdf\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n328\n\n\x0cThe Fabulous Fab\xe2\x80\x99s testimony before Congress:\nhttp://www.cbsnews.com/video/watch/?id=6436867n&tag=related;photovideo\nHealth care fraud is also a common type of white-collar crime. A physician who submits false claims to\nhealth insurance companies to receive money is a common example. Check out Note 10.51 "Hyperlink:\nHealth Care Fraud\xe2\x80\x99s Epidemic" to see the U.S. Department of Justice\xe2\x80\x99s comments regarding health care\nfraud.\n\nHyperlink: Health Care Fraud\xe2\x80\x99s Epidemic\nhttp://www.fbi.gov/news/videos/mp4/heat062409.mp4/view\nThis link is a video of the U.S. Department of Justice\xe2\x80\x99s comments concerning recent indictments against\nseveral individuals accused of creating \xe2\x80\x9cstraw patients\xe2\x80\x9d to submit claims to Medicaid to receive money.\nYou can see how someone who creates fake patients to receive money has committed fraud, because he or\nshe is using deception (fake patients) to acquire money (Medicaid payments).\nInsurance fraud is the use of deception to receive insurance funds. For instance, if someone falsely reports\nthat her office was burglarized and her computer equipment was stolen, and asks her insurance company\nto cover the loss, then this constitutes insurance fraud. This is because the person is lying (using\ndeception) to acquire an insurance payment (acquiring money). A common context for insurance fraud is\narson. If someone intentionally burns down his office building because he wishes to collect under his fire\ninsurance policy, then he has committed insurance fraud by arson. Arson is the act of intentionally setting\nfire to property.\nFinancial institution fraud is fraud against banks and other similar institutions, such as credit unions. The\nIRS investigates financial institution fraud. Cases of financial institution fraud can involve people who\nfalsify tax documents, or profit and loss statements to gain funding from banks, as well as those who\ncommit money laundering. Check out Note 10.56 "Hyperlink: Financial Institution Fraud" for several\nfinancial institution fraud cases, most of which are excellent examples of white-collar crime.\n\nHyperlink: Financial Institution Fraud\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n329\n\n\x0chttp://www.irs.gov/compliance/enforcement/article/0,,id=213770,00.html\nConsider another type of fraud, where the deception is perhaps better hidden. Bernie Madoff committed\nmassive fraud in a scheme known as a Ponzi scheme. A Ponzi scheme is a pyramid scheme, where people\npay in. Those at the top of the pyramid may receive something that appears to be a return on their\ninvestment, but those at the bottom do not. This is because the funds paid in by those at the bottom are\nused to pay the people at the top. Those who operate Ponzi schemes generally solicit investors, and those\nwho invest in such schemes are expecting a legitimate return on investment (ROI). However, the master\nof the Ponzi scheme does not really invest the funds. He simply takes them, and keeps his early\n\xe2\x80\x9cinvestors\xe2\x80\x9d happy by bringing in new investors, whose money he gives to the old investors as their ROI.\nThis allows the Ponzi scheme to continue, because it appears from the outside that investors are receiving\na legitimate ROI. The problem is that the capital contributions eventually disappear, since they are never\ninvested but are simply used by the criminal for his own purposes, including covering his tracks for as\nlong as possible by paying investors with fake ROI payments as necessary. To continue, the pyramid must\nget bigger and bigger. That is because new investors must be attracted to keep the cash flow going.\nEventually, of course, pyramids will eventually collapse under their own unsustainable structure. Check\nout Note 10.58 "Hyperlink: The Mechanics of a Pyramid Scheme" for an illustration of a pyramid scheme\nfrom the SEC.\n\nHyperlink: The Mechanics of a Pyramid Scheme\nhttp://www.sec.gov/answers/pyramid.htm\nMadoff was a wealth manager who defrauded investors out of billions of dollars. How does someone get\naway with this? Interestingly, Harry Markopolos, a financial analyst, flagged Madoff\xe2\x80\x99s actions to the SEC\nas statistically impossible long before Madoff was caught. Check out Note 10.59 "Hyperlink: Too Good to\nBe True? Statistically Impossible Returns" to watch Mr. Markopolos explain this by using sports\nanalogies. This raises interesting legal questions regarding whether the SEC is proactive enough. The SEC\nactions are often reactive, responding to a situation after it happened.\n\nHyperlink: Too Good to Be True? Statistically Impossible Returns\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n330\n\n\x0chttp://www.cbsnews.com/video/watch/?id=4834874n&tag=related;photovideo\nInvestors aren\xe2\x80\x99t the only potential victims of white-collar crime. Owners of businesses are also potential\nvictims. For example, embezzlement is a common crime, and it occurs when someone takes property that\nwas in his or her possession lawfully and then converts it to his or her own use. As you can see, Bernie\nMadoff was an embezzler because he lawfully had possession of his clients\xe2\x80\x99 money, but then he wrongfully\nconverted those funds to his own use, rather than exercising his fiduciary duty to his clients.\nEmbezzlement differs from larceny, because larceny requires the trespassory taking of property with the\nintent to deprive the owner of the property. In other words, in a larceny, the thief is not supposed to have\npossession of the property to begin with. Someone who embezzles something, however, has the right to be\nin possession of the property to start with but then wrongfully converts it (steals it) for his or her own use.\nEmbezzlement strategies can involve forgery, which is counterfeiting someone else\xe2\x80\x99s signature or other\ndocument. It can also involve wire fraud if the embezzlement uses electronic communications.\n\n[1]\n\nRefer\n\nagain to Note 10.4 "Hyperlink: Thefts, Skimming, Fake Invoices, Oh My!" to learn about many different\nembezzlement schemes.\nCorporate espionage and misappropriation are crimes in which a competitor or would-be competitor has\nacted illegally to obtain trade secrets of another. The Economic Espionage Act is a federal statute that\ncriminalizes the theft of trade secrets. In a recent case of corporate espionage, Starwood Hotels sued\nHilton, claiming that Hilton, along with some of its executives, stole millions of dollars in confidential\ntrade secrets that were used to compete with Starwood\xe2\x80\x99s successful chain of hotels.\n\nOrganized Crime\nWhile the term \xe2\x80\x9corganized crime\xe2\x80\x9d often summons images of the mafia, that is not the only type of\norganized criminal activity in this country. Consider the recent case against Pfizer, which settled with the\nU.S. Department of Justice in 2009. Pfizer\xe2\x80\x99s subsidiaries, Pharmacia and Upjohn, had been selling\npharmaceuticals \xe2\x80\x9coff-label\xe2\x80\x9d in doses and for uses not approved by the Food and Drug Administration\n(FDA), and it had been providing kickbacks to physicians to prescribe those drugs. The subsidiaries\nagreed to plead guilty to misbranding with the intent to defraud or mislead. They paid a criminal fine of\nmore than one billion dollars and forfeited their profits from their illegal activities. Not only did they\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n331\n\n\x0cplead guilty to a criminal violation, but they also had to pay a hefty penalty for violating civil law,\nparticularly related to paying kickbacks to physicians.\n\n[2]\n\nKickbacks are incentive payments that are given\n\nto someone who makes decisions to encourage others to pay for something. The repercussions of this\nconviction are certainly felt by those who were without knowledge of these acts, such as the shareholders\nand many employees, not to mention the patients who were subjected to off-label marketing in the\ncontexts of what otherwise should have been trusting relationships with their physicians.\nThe Racketeer Influenced and Corrupt Organizations Act (RICO) is a federal statute that, if violated, can\nadd substantial prison time to a convicted criminal\xe2\x80\x99s sentence. Even if someone is not per se involved with\norganized crime, RICO charges can be brought against a defendant who has violated the statute. This\nstatute punishes those engaged in a pattern (at least two) of racketeering activities\xe2\x80\x94which include a wide\nrange of activities typically associated with organized crime\xe2\x80\x94over a ten-year period,\n\n[3]\n\nwhen funds from\n\nthose activities were used to maintain, operate, or acquire a legitimate business. Racketeering activities\ninclude crimes such as loan-sharking, bookmaking, money laundering, counterfeiting, smuggling,\nblackmailing, human trafficking, and other similar crimes. Although RICO was written to target\ntraditional organized crime, less than 10 percent of RICO cases filed have been against the mafia. RICO is\nnow used against insurance companies, stock brokerages, tobacco companies, banks, and other large\ncommercial enterprises. RICO also has a civil provision allowing a competitor to file RICO charges, which\ncome with triple damages if the suit is successful.\nBribery occurs when someone pays a government official to influence the official\xe2\x80\x99s decision or actions in\nhis or her official capacity for the benefit of the person paying the bribe.\nThe Foreign Corrupt Practices Act (FCPA)outlaws bribery by U.S. companies doing business in foreign\nlands, though grease payments are permitted. Grease payments are payments given to speed up a process\nthat will occur, rather than to influence a decision. However, companies should be very careful in relying\non the grease payment exception, since such payments are legal under the FCPA only if they are also legal\nunder the laws of the country where the grease payments take place, and there are very few jurisdictions\n(if any) where they are indeed legal. States also have statutes against bribery.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n332\n\n\x0cMoney laundering occurs when funds gained from illegal activities are processed through a seemingly\nlegitimate business to \xe2\x80\x9cclean\xe2\x80\x9d the source of those funds. For example, someone who received $10,000 for\ncriminal activities will need to \xe2\x80\x9cclean\xe2\x80\x9d the money to be able to use it legitimately. One way this can be\ndone is by setting up a business that handles a lot of cash, which appears to be a legitimate business. This\nbusiness can overstate its earnings by $10,000 over time by running the money through its books, thereby\n\xe2\x80\x9ccleaning\xe2\x80\x9d the funds. For example, if the business was a tavern, and the tavern grossed $12,000 per\nmonth, the ill-gotten $10,000 could be spread out over ten months by having the business claim that it\ngrossed $13,000 each month. In that way, the ten thousand would eventually be \xe2\x80\x9claundered\xe2\x80\x9d or \xe2\x80\x9ccleaned,\xe2\x80\x9d\nbecause it will appear to be money received by the legitimate business itself.\nIn that example, if someone found out about this money laundering operation and threatened to go to the\nauthorities unless a payment was given to him to keep quiet, then that would be a form of extortion\nknown as blackmail. Blackmail occurs when someone threatens to reveal a harmful truth, such as\ninvolvement in criminal activity, but agrees to remain silent if paid. Extortionis when someone obtains\nproperty through coercion. Another example of extortion is when a neighborhood gang extracts\n\xe2\x80\x9cprotection payments\xe2\x80\x9d from local businesses. Essentially, the gang requires payment from local\nbusinesses periodically, and if the business refuses to pay, then the gang injures the business or its owner\nin some way, such as through vandalism or battery.\nIn organized crime cases, there can be strong incentives for people not to do the right thing. Maybe they\nare afraid of punishment by the government. But they may also fear punishment from their organized\ncrime communities. In such cases, sometimes people do not tell the truth when they should. Someone\nwho lies under oath, even if he or she thinks there\xe2\x80\x99s a good reason to do so, has committed the crime\nof perjury. Additionally, such a person might be charged with obstruction of justice, which is acting in a\nmanner that creates obstacles to the administration of justice.\nAntitrust laws seek to prevent activities that reduce or eliminate economic competition. Agreements \xe2\x80\x9cin\nrestraint of trade\xe2\x80\x9d are prohibited.\n\n[4]\n\nThese crimes involve things like collusion, allocating markets, price-\n\nfixing, and bid-rigging. Criminal convictions have been obtained for bid-rigging contracts for milk for\nschool children, price-fixing for residential doors, and price-fixing for steel wool scouring pads.\n\nSaylor URL: http://www.saylor.org/books\n\n[5]\n\nCheck\n\nSaylor.org\n333\n\n\x0cout Note 10.76 "Video Clip: Who Said Antitrust Is Boring? Not Hollywood!" for the movie trailer of The\nInformant!, which is based on an actual antitrust case involving illegal price-fixing.\n\nVideo Clip: Who Said Antitrust Is Boring? Not Hollywood!\nCheck out the movie trailer for The Informant!, which portrays the criminal price-fixing activities of\nsenior executives at ADM Co., which is a major agribusiness. Which commodity was being price fixed?\nLysine! Here is part of the trailer:\nCongress has addressed antitrust activities through the passage of several major pieces of legislation,\nthough not all carry criminal penalties. Specifically, the Sherman Anti-Trust Act carries criminal penalties\nfor antitrust violations, but other antitrust laws do not.\n\nCybercrime\nCybercrimes are crimes that are committed virtually from a computer or over the Internet. These crimes\nare on the rise, and they include activities like hacking and identity theft. Cybercrime is a broad term that\nincludes many white-collar crimes. Cybercrime is ubiquitous these days, because virtually every desk has\na computer on it. These crimes can range from non-white-collar crimes (like possession of child\npornography) to traditional white-collar crime, involving the use of deception to acquire money.\nThe Computer Fraud and Abuse Act is a federal statute that carries punishments for compromising\ncomputers used in interstate commerce or communication. It punishes those who access a computer to\ncommit fraud, among other things. See Table 10.1 "Summary of Computer Fraud and Abuse Act\nCompromising Confidentiality Provisions"\n\n[6]\n\nfor a summary of the provisions that carry criminal\n\npunishments, as well as the statutory sentences.\nTable 10.1 Summary of Computer Fraud and Abuse Act Compromising Confidentiality Provisions\n\nOffense\n\nSection\n\nSentence (Years)*\n\nObtaining national security information\n\n(a)(1)\n\n10 (20)\n\nCompromising the confidentiality of a computer\n\n(a)(2)\n\n1 or 5\n\nTrespassing in a government computer\n\n(a)(3)\n\n1 (10)\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n334\n\n\x0cOffense\n\nSection\n\nSentence (Years)*\n\nAccessing a computer to defraud and obtain value (a)(4)\n\n5 (10)\n\nKnowing transmission and intentional damage\n\n(a)(5)(A)(i)\n\n10 (20 or life)\n\nIntentional access and reckless damage\n\n(a)(5)(A)(ii) 5 (20)\n\nIntentional access and damage\n\n(a)(5)(A)(iii) 1 (10)\n\nTrafficking in passwords\n\n(a)(6)\n\n1 (10)\n\nExtortion involving threats to damage computer\n\n(a)(7)\n\n5 (10)\n\n* The maximum prison sentences for second convictions are noted in parentheses.\n\nThe Unauthorized Access to Stored Communications Act is a federal statute to protect the confidentiality\nof e-mail and voicemail. However, this act does not have as broad of a sweep as it might appear from its\nname. Courts have held that home computers, business computers, and Internet service providers (ISPs)\nare not \xe2\x80\x9celectronic communications devices\xe2\x80\x9d that are covered by this act. So hacking into an e-mail\naccount provider\ncomputer.\n\n[9]\n\n[7]\n\nwould be prohibited by this act, but not hacking into a home computer\n\n[8]\n\nor a business\n\nDue to the narrow reading of the statute by the courts, few prosecutions have occurred under\n\nthis Act since its enactment.\n\n[10]\n\nIdentity theft is also now codified into federal statute as a federal criminal violation.\n\n[11]\n\nThis crime is\n\nrampant. Identity thieves obtain credit in an otherwise creditworthy person\xe2\x80\x99s name. The victim of these\ncrimes can spend hundreds of hours repairing the damage. This is one of the primary reasons why it is\nvery important not to reveal personal information on the Internet.\nFinally, spamming is now subject to federal regulations, the violations of which are now a federal crime by\nvirtue of the CAN-SPAM Act. This law serves as the vehicle to prosecute senders of large quantities of\nunsolicited e-mails if those e-mails do not meet the federal requirements.\n\n[12]\n\nMarketers, beware!\n\nEnvironmental Crimes\nEnvironmental crimes are actions that violate federal or state statutes relating to the environment, which\ncarry criminal sanctions. The Environmental Protection Agency enforces federal environmental statutes,\nincluding those that carry a criminal penalty. Many corporations have been convicted of environmental\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n335\n\n\x0ccrimes. For instance, corporations that illegally dump toxic substances into waterways, illegally harm\nendangered species or those species\xe2\x80\x99 habitats, or trade in illegal substances that have been banned due to\ntheir propensity to cause great harm to the environment are all engaged in environmental crimes. U.S.\nfederal environmental statutes that carry criminal penalties include the Clean Air Act; the Clean Water\nAct; the Resource Conservation and Recovery Act; the Comprehensive Environmental Response,\nCompensation, and Liability Act; and the Endangered Species Act. Additionally, state environmental law\nstatutes frequently carry criminal penalties as well.\nRecent examples of corporate convictions for environmental crimes can be found in Note 10.84\n"Hyperlink: Federal Environmental Criminal Convictions".\n\nHyperlink: Federal Environmental Criminal Convictions\nhttp://www.epa.gov/compliance/resources/cases/criminal/highlights/2010/index.html\nCheck out this link to explore recent environmental crime convictions. Corporate convictions are not\nuncommon. For example, the Tulip Corporation of New York was convicted for illegally storing lead\ncontaminated materials without a permit. Penalties included a $100,000 fine and a $25,000 to Buffalo\nNiagara Riverkeepers.\nIn another case, Mar-Cone Appliance Part Co. was convicted of purchasing and selling ozone depleting\nrefrigerant gas, which was illegally smuggled into the United States in violation of the Clean Air Act. The\nsentence included a five-year probation for the business, a half-million-dollar criminal fine, and a fourhundred-thousand-dollar payment to a nonprofit organization. The company distributed this illegal\nsubstance throughout the United States, which was an action condemned as undermining global\nenvironmental efforts to reduce ozone damage for personal gain.\n\nBlue-Collar Crime\nBlue-collar crime is a generic term used to describe crimes that are not white-collar crimes. In business,\nproperty crimes (rather than person crimes) are a primary concern. A property crime is a crime involving\ndamage to property, while a person crime is a crime involving the injury to a person\xe2\x80\x99s body. Larceny is a\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n336\n\n\x0cmajor concern for many businesses. White-collar criminals are not the only ones who commit larceny. In\nretail, for instance, primary loss prevention concerns include shoplifting. Shoplifting is a serious and\nprevalent crime. Additionally, in any type of business, employee theft is a serious problem.\nLast, vandalism is unauthorized property damage, and any business with a physical presence can become\nthe target of vandals.\n\nKEY TAKEAWAYS\nCrime is a very important consideration in the business world. White-collar crimes are particularly\ninsidious because white-collar criminals work from the inside, can be difficult to spot since they often hold\npositions of trust, and use deception as their primary tool. Blue-collar crimes also pose substantial risk of\nloss for businesses. Fraud, cybercrime, environmental crime, organized crime, and various forms of\nproperty crimes are all serious threats to businesses. Crime carries high personal costs not only to the\nindividuals involved in the misconduct but also to society at large, including the corporations and others\nwho depend on those corporations.\n\nEXERCISES\n1.\n\nConsider the video in Note 10.59 "Hyperlink: Too Good to Be True? Statistically Impossible\nReturns" concerning Harry Markopolos\xe2\x80\x99s use of statistical modeling to identify Bernie Madoff\xe2\x80\x99s Ponzi\nscheme. What role should statistical analysis and probability modeling have played in the regulatory\nenvironment that could have identified the Madoff Ponzi scheme disaster earlier?\n\n2.\n\nHow can businesses protect themselves from embezzlement? What are some specific strategies that could\nbe devised to ensure that bookkeepers or accountants do not skim money from the business?\n\n3.\n\nIf you caught an employee stealing one dollar\xe2\x80\x99s worth of office supplies, what would you do? What about\ntwenty five dollars\xe2\x80\x99 worth of supplies? One hundred dollars\xe2\x80\x99? One thousand? Should employees be trained\nnot to even take a pencil home? Would that type of training be worth the cost of the training itself?\n\n4.\n\nCheck out Note 10.76 "Video Clip: Who Said Antitrust Is Boring? Not Hollywood!" to review some of the\nconvictions against corporations. Are penalties payable to nonprofit environmental organizations\nappropriate penalties for corporate convictions for environmental crimes? Why or why not?\n\n[1] 18 U.S.C. \xc2\xa71343.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n337\n\n\x0c[2] FBI Press Release, \xe2\x80\x9cThe Case Against Pfizer: A Record $2.3 Billion Settlement,\xe2\x80\x9d September 2,\n2009, http://www.fbi.gov/page2/sept09/pfizer_settlement_090209.html(accessed September 27, 2010).\n[3] 18 U.S.C. \xc2\xa71961(5).\n[4] Sherman Act, 15 U.S.C. \xc2\xa71.\n[5] Anne K. Bingeman and Gary R. Spratling, \xe2\x80\x9cCriminal Antitrust Enforcement\xe2\x80\x9d (joint address, Criminal Antitrust\nLaw and Procedure Workshop, American Bar Association Section of Antitrust Law, Dallas, TX, February 23,\n1995),http://www.justice.gov/atr/public/speeches/0103.htm (accessed September 27, 2010).\n[6] Computer Crime and Intellectual Property Section, United States Department of Justice, \xe2\x80\x9cComputer Fraud and\nAbuse Act,\xe2\x80\x9dhttp://www.justice.gov/criminal/cybercrime/ccmanual/01ccma.html (accessed September 27, 2010).\n[7] FTC v. Netscape Communications Corp., 196 F.R.D. 559, 560 (N.D. Cal. 2000).\n[8] United States v. Steiger, 318 F.3d 1039, 1049 (11th Cir. 2003).\n[9] United States v. Steiger, 318 F.3d 1039, 1049 (11th Cir. 2003).\n[10] Computer Crime and Intellectual Property Section, United States Department of Justice, \xe2\x80\x9cOther Network\nCrime Statutes, Unlawful Access to Stored Communications, 18 U.S.C. \xc2\xa72701, 8. Historical\nNotes,\xe2\x80\x9dhttp://www.justice.gov/criminal/cybercrime/ccmanual/03ccma.html (accessed September 27, 2010).\n[11] 18 U.S.C. \xc2\xa71028(a)(7) and 18 U.S.C. \xc2\xa71028A.\n[12] 18 U.S.C. \xc2\xa71037.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n338\n\n\x0c10.3 Minimizing Corporate Criminal Liability and Losses\nAttributed to Crime\nLEARNING OBJECTIVES\n1.\n\nExplore strategies for businesses to minimize criminal liability.\n\n2.\n\nExamine whistleblower protections.\n\nBusinesses can engage in affirmative actions to reduce criminal liability. Likewise, individuals do not\nhave to sit by passively if they know that criminal activity is afoot. This section addresses specific\nstrategies and laws that can help combat crime in the business world.\nBusinesses should conduct annual training sessions, such as ethics training, to help ensure good\nworkplace ethics. They should develop company-wide codes of ethics, which serve as the\norganizational commitment to ethical behavior. This can go far toward developing a corporate\nculture that values ethical behavior and condemns unethical actions, by providing leadership that\nserves as positive role models for all employees. Some companies, such as Boeing, have instituted an\nethics hotline, which allows employees to anonymously report unethical behavior so that it can be\ninvestigated. Additionally, federal sentencing guidelines in place for organizations state that\norganizations that maintain a rigorous compliance program to detect and report violations of the\nlaw, and voluntarily disclose those violations when they occur, are eligible for significantly reduced\nsentences and fines.\nSometimes, of course, things still go wrong. A person who observes illegal behavior in the workplace\nmay choose not to participate in that illegal behavior. Such a person can even choose to become a\nwhistleblower. Whistleblowers are people who report the illegal activity of their employers or of their\norganization to authorities. Typically, the whistleblowers have observed some wrongdoing that may\nharm others, and they decide to \xe2\x80\x9cblow the whistle\xe2\x80\x9d to protect the potential victims or to simply stop\nthe wrongdoing.\nWhistleblowers face many challenges in the workplace, not the least of which is the stigma associated\nwith blowing the whistle. Paradoxically, even though the whistleblower may be preventing harm to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n339\n\n\x0cinnocent people, other employees may view the whistleblower as someone who has betrayed the\norganization. Because of this, whistleblowers are often placed in a terrible ethical dilemma, because\nwhile they may observe wrongdoing, they may not feel comfortable in reporting the illegal activity.\nThey may fear losing their job or not being able to find a new job. Prospects of losing one\xe2\x80\x99s status,\nfriends, or reputation can prevent many people from blowing the whistle, even though they may wish\nthe behavior to stop.\nWhistleblower protection laws prohibit retaliatory action against whistleblowers. Some statutes\ncontain whistleblower protection provisions. For example, the Sarbanes-Oxley Act contains\nwhistleblower protection, but the statute is not entirely devoted to whistleblower protection. The\nFalse Claims Act provides that anyone who blows the whistle on a federal contractor committing\nfraud on the government can personally receive a portion of any amount recovered, up to 25 percent.\nDespite these protections, many real-world whistleblowers have discovered that the laws are cold\ncomfort for the realities that face them after whistle is blown. Check out Note 10.93 "Hyperlink:\nWhistleblower Law Blog", which lists many of the statutes under which whistleblower protections are\noffered.\n\nHyperlink: Whistleblower Law Blog\nCheck out the links on the right side of the Web page below. These are categories of blog entries, but they\nalso represent a list of many federal whistleblower protections:\nhttp://employmentlawgroupblog.com\nCorporations can also avail themselves of safe harbor provisions in certain statutes. If they see criminal\nbehavior and realize that they may be implicated in the criminal behavior, they can report certain actions\nto authorities, which will allow them to receive a lesser penalty, or no penalty at all. Only a few criminal\nstatutes have safe harbor provisions, however.\n\nKEY TAKEAWAYS\nBusinesses can encourage ethical behavior in the workplace to help employees avoid illegal behavior\nthrough training seminars, ethical leadership, and codes of ethics. Whistleblower protection laws and\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n340\n\n\x0cprovisions prohibit retaliation against whistleblowers. However, whistleblowers often experience negative\nconsequences when they report the illegal activities of their organization to the authorities.\n\nEXERCISES\n1.\n\nFind a corporate code of ethics by searching for \xe2\x80\x9ccode of ethics\xe2\x80\x9d in your Internet browser. Is this a good\ncode of ethics? How could it be changed? Do you think the employees pay attention to it? How would you\nensure that your employees believed in and adopted your company\xe2\x80\x99s code of ethics? Should employees\nwho do not follow the code of ethics, but who do not break any laws or company polices, be terminated?\nWhy or why not?\n\n2.\n\nShould whistleblowing be encouraged by businesses? Why or why not?\n\n3.\n\nImagine a scenario in which you would choose to blow the whistle. How does that differ from a situation in\nwhich you would not blow the whistle?\n\n4.\n\nDevelop an outline of topics that you would present to employees to train them to be vigilant against\ncriminal behavior in your organization. How could you ensure that employees understood the training?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n341\n\n\x0c10.4 Concluding Thoughts\nCrime statistics in the United States illustrate the sobering reality that businesses must maintain\nvigilance against criminal activities. Threats arise from the inside\xe2\x80\x94from employees, officers,\ndirectors, and employees\xe2\x80\x94as well as from the outside, from professional or opportunistic criminals.\nIt makes good business sense to practice both offensive and defensive strategies to stave off these\nthreats. This can best be accomplished through proactive policies that encourage ethical behavior,\nencourage whistleblowing, and create disincentives for violating the law in the form of company\npolicies, training programs, and codes of ethics.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n342\n\n\x0cChapter 11\n\nBusiness Organizations\nLEARNING OBJECTIVES\nBusinesses must be organized in order to effectively conduct their operations. This organization can run\nfrom simple to complex and depends greatly on the needs of the business owners to structure their\nliability and taxes. In this chapter, you\xe2\x80\x99ll learn about the factors that go into organizing a business.\nSpecifically, you should be able to answer the following questions:\n1.\n\nWhat are the available entity choices when conducting business?\n\n2.\n\nWhat are the factors that determine entity selection?\n\n3.\n\nWhat are the traditional entity choices, and how are they different from each other?\n\nFigure 11.1 Apple\xe2\x80\x99s Headquarters in Cupertino, California\n\nSource: Photo courtesy of kalleboo,http://www.flickr.com/photos/kalleboo/3614939469/sizes/o.\n\nMany of you may be reading this chapter on a laptop or desktop designed and manufactured by\nApple Inc. You may own a phone from Apple, or perhaps a portable music device. The company\xe2\x80\x99s\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n343\n\n\x0cinnovation, product development process, marketing capabilities in creating new and unthought-of\nmarkets, and ability to financially reward its owners are well known. While you might enjoy Apple\nproducts as a consumer, have you ever thought about Apple as a corporation? Its corporate\nheadquarters in Cupertino, California (Figure 11.1 "Apple\xe2\x80\x99s Headquarters in Cupertino, California"),\nis the physical embodiment of this entity we call a corporation, but what does that mean? It might\nsurprise you to learn that this building, or rather the legal concept of the entity that occupies it, is\nmore like you than you realize. For example, just like you, this entity can own property. This entity\ncan enter into contracts to buy and sell goods. This entity can hire and fire employees. This entity can\nopen bank accounts and engage in complex financial transactions. This entity can sue others, and\ncan be sued in court. This entity even has constitutional rights, just like you. Unlike you, however,\nthis entity does not breathe, does not bleed, and in fact may be immortal. And most unlike you, this\nentity has no independent judgment of its own, no moral compass or conscience to tell it the\ndifference between right and wrong. In this chapter we\xe2\x80\x99ll explore corporate entities such as Apple\nInc. in detail. We\xe2\x80\x99ll examine why human beings choose to organize into corporate entities in the first\nplace, and why the law recognizes these entities for public policy purposes. We\xe2\x80\x99ll start by looking at\nthe factors that go into making a decision about entity choice, and then examine the available choices\nin detail.\nTry to recall the basic function of a business. At its most fundamental level, a business exists to make\na profit for its owners. In a capitalist market-driven economy, a business that fails to make a profit\nultimately ceases to exist, overtaken by creditors and competitors. The need to make a profit is one\ntruism that binds all businesses together, but beyond that, it\xe2\x80\x99s hard to draw generalizations about\nbusiness operations. The world of business is as varied as human experience itself, ranging from the\nneighborhood kids who shovel snow in the winter and sell lemonade in the summer, to the\nneighborhood pizza restaurant, to the small tool-and-die factory on the outskirts of town making\nmachine tools, to the multinational corporation with hundreds of thousands of employees scattered\nthroughout the globe. Some businesses make things in factories (manufacturers), other businesses\nsell things that other businesses make (retailers or franchisees), and still other businesses exist to\nhelp both the makers and sellers make and sell better (business consultants). Some businesses don\xe2\x80\x99t\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n344\n\n\x0cmake things at all, and instead profit by selling their services (think of an accounting or law firm, a\nhouse painting company, or a hotel) or by lending money at a higher rate of interest than it can\nborrow.\nWith this breadth and diversity, it\xe2\x80\x99s not surprising that there is no \xe2\x80\x9cone size fits all\xe2\x80\x9d approach to\nchoosing a business organization. When choosing what form of entity is best, business professionals\nmust consider several factors. First, they have to consider how much it costs to create the entity and\nhow hard it is to create. Some entities are easy to create, while others are more complicated and have\nongoing maintenance requirements that are important to consider. Second, they have to consider\nhow easy it is for the business to continue if the founder dies, decides to retire, or decides to enter a\nnew business altogether. Third, they have to consider how difficult it might be to raise money to grow\nor expand the business. Fourth, they have to consider what sort of managerial control they wish to\nkeep on the business, and whether they are willing to cede control to outsiders. Fifth, they have to\nconsider whether or not they wish to eventually expand ownership to members of the public. Sixth,\nthey must give some thought to tax planning to minimize the taxes paid on earnings and income.\nFinally, and most importantly, they have to consider whether or not they wish to protect their\npersonal assets from claims, a feature known as limited liability.\nIt\xe2\x80\x99s important to remember that choosing a business organization is different from what kind of\nbusiness you run. For example, some businesses are known as franchises because they operate under\na license agreement (contract) whereby they agree to follow certain standards set by the franchisor,\npurchase their goods from the franchisor, and maybe share either a royalty fee or percentage of\nprofits with the franchisor. Franchises are a very common type of business (especially in the food and\nservices industries), but there is no typical form of business for a franchise. Depending on the needs\nof the franchise owners, a franchise could be a sole proprietorship, a limited liability company (LLC),\nor a corporation. Similarly, we sometimes refer to \xe2\x80\x9cnonprofit organizations\xe2\x80\x9d such as universities or\ncharities as separate legal entities. Although they are nonprofit, some of these enterprises can be very\nlarge, with complex operations that spread across borders (for example, the Red Cross or Doctors\nWithout Borders). For tax purposes, nonprofits do not have to pay any taxes if they meet strict\nqualifications under IRS guidelines to become a \xe2\x80\x9c501(c)(3)\xe2\x80\x9d organization (named for the section of\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n345\n\n\x0cthe Internal Revenue Code that grants nonprofit status), but from a legal perspective, these entities\ncan also take on any number of forms, from sole proprietorships to corporations.\nIf you are ever in a position to start a new business venture, your focus is typically on growing\nrevenue and cutting costs so that you can maximize profit. You may not be very concerned with\nentity choice at the outset, since so many other considerations are competing for your attention.\nOnce an entity choice is made, however, it is difficult (but not impossible) to change to another\nselection. Since entity choice can have a profound effect on these considerations, it is important to\ngain a basic understanding of the available choices so that you, the business professional, can focus\non the business fundamentals rather than legal or accounting details.\n\nKey Takeaways\nBusiness organizations are an important part of a business\xe2\x80\x99s structure. Different organizations provide\ndifferent advantages and disadvantages in creation cost and simplicity, ongoing maintenance\nrequirements, dissolution and continuity, fundraising, managerial control, public ownership, tax\nplanning, and limited liability. The type of business being conducted (for-profit, nonprofit, franchise) has\nlittle to do with the business organization in which the business is conducted. Many business\norganizations take the form of separate legal entities, which the law recognizes as nearly like persons for\npurposes of legal rights.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n346\n\n\x0c11.1 Sole Proprietorships\nLEARNING OBJECTIVES\n1.\n\nUnderstand the importance of sole proprietorships in our economy.\n\n2.\n\nExplore the advantages presented by doing business as a sole proprietorship.\n\n3.\n\nAssess the disadvantages and dangers of doing business as a sole proprietorship.\n\nLily, a college sophomore, is home for the summer. Unable to find even part-time work in a tough\neconomy, she begins to help her parents by cleaning up their overgrown garden. After a few days of\nthis work, Lily discovers that she enjoys doing this and is good at it. The neighbors see the work Lily\nis doing, and they ask her to help their gardens too. Within a week, Lily has scheduled appointments\nand jobs throughout the neighborhood. Using the money she has earned, she places orders for\nadditional landscaping equipment and materials with a local retailer. Within a month, she is so busy\nthat she has to hire workers to do some of the more routine tasks, such as mulching and lawn\nmowing, for her. By the middle of summer, Lily has applied knowledge she picked up in her business\nclasses by developing a name for her business (Lily\xe2\x80\x99s Landscaping) and developing marketing\nmaterials such as a Facebook fan page, flyers to be posted at local stores, business cards, and a\nYouTube video showing her projects. By the end of the summer, Lily has earned a healthy profit for\nall her work and developed valuable know-how on how to run her business. She has to stop working\nwhen the weather gets cooler and she returns to school, but promises herself to restart the business\nnext summer.\nLily is a sole proprietor, the most common form of doing business in the United States. From a legal\nperspective, there is absolutely no difference between Lily and Lily\xe2\x80\x99s Landscaping\xe2\x80\x94they are one and\nthe same, and completely interchangeable with each other. If Lily\xe2\x80\x99s Landscaping makes a profit, that\nmoney belongs exclusively to Lily. If Lily\xe2\x80\x99s Landscaping needs to pay a bill to a supplier or creditor,\nand Lily\xe2\x80\x99s Landscaping doesn\xe2\x80\x99t have the money, then Lily has to pay the bill. When Lily\xe2\x80\x99s\nLandscaping enters into a contract to plant a new flower garden, it is actually Lily that is entering\ninto the contract. If Lily\xe2\x80\x99s Landscaping wants to open a bank account to accept customer payments or\nto pay bills, then Lily will actually own the account. When Lily\xe2\x80\x99s Landscaping enters into a contract\npromising to pay a worker to mow lawns or lay mulch, it is actually Lily that is entering into that\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n347\n\n\x0ccontract. Lily can even apply for a \xe2\x80\x9cdoing business as\xe2\x80\x9d or d.b.a. filing in her state, so that her business\ncan carry on under the fictitious name \xe2\x80\x9cLily\xe2\x80\x99s Landscaping.\xe2\x80\x9d Note, however, that legally Lily\xe2\x80\x99s\nLandscaping is still no different from Lily herself. Any fictitious name therefore cannot have any\nwords in it that suggest a separate entity, such as \xe2\x80\x9cCorp.\xe2\x80\x9d or \xe2\x80\x9cInc.\xe2\x80\x9d\n\nHyperlink: Doing Business As\nhttp://www.business.gov/register/business-name/dba.html\nThe legal name for a sole proprietorship is the owner\xe2\x80\x99s name. Some business owners are happy to use\ntheir own names for their business, but for marketing and branding reasons many business owners prefer\nto use a fictitious name. Using a fictitious name is permitted under state laws where the business operates,\nusing a filing known as a d.b.a. filing. Explore this Web site to find out how to file a d.b.a. filing in your\nstate.\n\nThere are many advantages to doing business as a sole proprietor, advantages that make this form of\ndoing business extremely popular. First, it\xe2\x80\x99s easy to create a sole proprietorship. In effect, there is no\ncreation cost or time, since there is nothing to create. The entrepreneur in charge of the business\nsimply starts doing business, charging money, and providing goods or services. Depending on the\nbusiness, some sole proprietors may need to obtain permits or licenses before they can begin\noperating. A pizza restaurant, for example, may need to obtain a food service license, while a bar or\ntavern may need to obtain a liquor license. A small grocery store may need a license to collect sales\ntax. Do not confuse these governmental permits with legal approval for a business organization; in a\nsole proprietorship, the license is granted to the individual owner.\nAnother key advantage to sole proprietorships is autonomy. Since the owner is the business, Lily can\ndecide for herself what she wants to do to Lily\xe2\x80\x99s Landscaping. She could set her own hours, grow as\nquickly or slowly as she wants, expand into new lines of businesses, take a vacation, or wind down\nthe business, all at her own whim and direction. That autonomy also comes with total ownership of\nthe business\xe2\x80\x99s finances. All the money that Lily\xe2\x80\x99s Landscaping takes in, even if it is in a separate bank\naccount, belongs to Lily, and she can do with that money whatever she wants.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n348\n\n\x0cThese advantages must be weighed against some very important disadvantages. First, since a sole\nproprietorship can have only one owner, it is impossible to bring in others to the business. Lily\ncannot bring in her college roommate to work on Web site design as a partner in the business, for\nexample. In addition, since the business and the owner are identical, it is impossible to pass on the\nbusiness from Lily. If Lily dies, the business dies with her. Of course, she can always sell or give away\nthe business assets (equipment, inventory, as well as intangible assets such as customer lists and\ngoodwill).\nRaising working capital can be a problem for sole proprietors, especially those early in their business\nventures. Many entrepreneurial ventures are built on great ideas but need capital to flourish and\ndevelop. If the entrepreneur lacks individual wealth, then he or she must seek those funds from other\nsources. For example, if Lily decides to expand her business and asks her wealthy uncle to invest\nmoney in Lily\xe2\x80\x99s Landscaping, there is no way for her uncle to participate as a profit-sharing owner in\nthe business. He can make a loan to her, or enter into a profit-sharing contract with her, but there is\nno way for him to own any part of Lily\xe2\x80\x99s Landscaping. Traditionally, most sole proprietors seek\nfunding from banks. Banks approach these loans just like any other personal loan to an individual,\nsuch as a car loan or mortgage. Down payment requirements may be high, and typically the banks\nrequire some form of personal collateral to guarantee the loan, even though the loan is to be used to\ngrow the business. Many sole proprietors resort to running their personal credit cards to the\nmaximum limit, or transferring balances between credit cards, in the early stage of their business.\n\nHyperlink: Small Businesses Squeezed as Banks Limit Lending\nhttp://www.npr.org/templates/story/story.php?storyId=113816657\nDuring the Great Recession, many banks faced a liquidity crisis as loans they made performed poorly.\nLending tightened, interest rates went up, credit lines went down, and standards became higher. The\neffect on many sole proprietors, including those featured in this National Public Radio story, has been\nvery challenging.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n349\n\n\x0cIn certain industries, entrepreneurs may be able to find financing through venture capital. Venture\ncapital firms combine funds from institutional investors and high net-worth individuals (known\nas angel investors) to identify promising start-ups, and to fund them in a private placement offering\nuntil the start-up has developed its technology to a commercially feasible stage. At that point the\nventure capital firm seeks an exit strategy, typically through offering sale of the business to the public\nin an initial public offering (IPO).\nTax planning can also be challenging for the sole proprietor. Since there is no legal distinction\nbetween the owner and the business, all the income generated by the business is treated as ordinary\npersonal income to the owner. The United States has several income tax rates depending on the type\nof income being taxed, and ordinary personal income typically suffers the highest rate of taxation.\nBeing able to plan effectively to take advantage of lower income tax rates is very difficult for the sole\nproprietor.\nFinally, sole proprietors suffer from one hugely unattractive feature: unlimited liability. Since there is\nno difference between the owner and the business, the owner is personally liable for all the business\xe2\x80\x99s\ndebts and obligations. For example, let\xe2\x80\x99s say that Lily\xe2\x80\x99s Landscaping runs into some financial trouble\nand is unable to generate planned revenue in a given month due to unexpectedly bad weather.\nCreditors of the business include landscaping supply stores, employees, and outside contractors such\nas the company that prints business cards and maintains the business Web site. Lily is personally\nliable to pay these bills, and if she doesn\xe2\x80\x99t she can be sued for breach of contract. Some proprietors\nare very successful and can generate many hundreds of thousands of dollars in profit every year.\nUnlimited liability puts all the personal assets of the sole proprietor reachable by creditors. Personal\nhomes, automobiles, boats, bank accounts, retirement accounts, and college funds\xe2\x80\x94all are within\nreach of creditors. With unlimited liability, all it takes is one successful personal injury lawsuit, not\ncovered by insurance or exceeding insurance limits, to wipe out years of hard work by an individual\nbusiness owner.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n350\n\n\x0cFor these reasons, while sole proprietors are still the most common way of doing business in the\nUnited States, they are in many ways the most unattractive. Thankfully, modern business law creates\nreal and viable alternatives for sole proprietors, as we\xe2\x80\x99ll discuss shortly.\n\nKEY TAKEAWAYS\nSole proprietorships are the most common way of doing business in the United States. Legally, there is no\ndifference or distinction between the owner and the business. The legal name of the business is the\nowner\xe2\x80\x99s name, but owners may carry on business operations under a fictitious name by filing a d.b.a.\nfiling. Sole proprietors enjoy ease of start-up, autonomy, and flexibility in managing their business\noperations. On the downside, they have to pay ordinary income tax on their business profits, cannot bring\nin partners, may have a hard time raising working capital, and have unlimited liability for business debts.\n\nEXERCISES\n1.\n\nMany household services professionals such as carpenters, plumbers, and electricians do business as sole\nproprietors. If they make a promise to their customers that their work (not the products themselves) will\nbe free from defects for a certain period of time (i.e., a warranty), and then subsequently sell their\nbusiness assets to another individual, is the buyer bound by the promises made by the seller? Why or why\nnot?\n\n2.\n\nD.b.a. statutes prohibit sole proprietors from using certain words such as \xe2\x80\x9ccompany,\xe2\x80\x9d \xe2\x80\x9cCorp.\xe2\x80\x9d or \xe2\x80\x9cInc.\xe2\x80\x9d in\ntheir fictitious names. Why do you think this rule exists?\n\n3.\n\nIf a sole proprietor dies suddenly, what do you think happens to the business run by the sole proprietor?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n351\n\n\x0c11.2 Partnerships\nLEARNING OBJECTIVES\n1.\n\nLearn about how general and limited partnerships are formed.\n\n2.\n\nExplore the major differences between general and limited partnerships.\n\n3.\n\nUnderstand major advantages and disadvantages to doing business as general or limited partnerships.\n\nLet\xe2\x80\x99s assume that after her first summer running Lily\xe2\x80\x99s Landscaping, Lily decides that it\xe2\x80\x99s time to\ntake her business to the next level. She has gathered a lot of expertise in running the operations in\nher business, from placing orders with suppliers to scheduling workers for client projects. She\nrealizes, however, that she\xe2\x80\x99s not very good at marketing or accounting, and that if her business is to\ngrow, she needs to bring someone on board who can create a strong brand and strategy for growth,\nas well as keep good records of her accounts so that she can plan for the future. Fortunately, her good\nfriend Adam is a double major in accounting and marketing, and after a series of discussions, Adam\nand Lily decide to run Lily\xe2\x80\x99s Landscaping together.\nLily and Adam have formed ageneral partnership. The moment they agreed to run Lily\xe2\x80\x99s Landscaping\ntogether, and to share in the profits and losses of the business together, the partnership was formed.\nAlthough they formed their partnership verbally, most general partnerships are formed formally,\nwith partners writing down their agreement in a special type of contract known as\nthe articles of partnership. The articles can set forth anything the partners wish to include about how\nthe partnership will be run. Normally, all general partners have an equal voice in management, but\nas a creation of contract, the partners can modify this if they wish. As in a sole proprietorship, there\nis no state involvement in creating a general partnership because there is no separation from the\nbusiness and the partners\xe2\x80\x94they are legally the same.\nGeneral partnerships are dissolved as easily as they are formed. Since the central feature of a general\npartnership is an agreement to share profits and losses, once that agreement ends, the general\npartnership ends with it. In a general partnership with more than two persons, the remaining\npartners can reconstitute the partnership if they wish, without the old partner. A common issue that\narises in this situation is how to value the withdrawing partner\xe2\x80\x99s share of the business. Articles of\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n352\n\n\x0cpartnership therefore typically include abuy/sell agreement, setting forth the agreement of the\npartners on how to account for a withdrawing partner\xe2\x80\x99s share, which the remaining partners then\nagree to pay to the withdrawing partner (or the spouse or heir if the partner dies).\n\nHyperlink: A Law Firm Partner Is Fired\nhttp://www.law.cornell.edu/nyctap/I96_0191.htm\nAfter a nearly twenty-year career, Evan Dawson was a partner at a major New York City law firm, White &\nCase. In 1988 the firm tried to persuade him to withdraw as a partner, but he refused. In July 1988 the\nother partners in the firm voted to dissolve the partnership and then immediately re-formed again,\nwithout Dawson as a partner. He had effectively been fired as a partner from a general partnership.\nDawson filed a suit against White & Case for an \xe2\x80\x9caccounting,\xe2\x80\x9d claiming that the \xe2\x80\x9cgoodwill\xe2\x80\x9d of the law firm\nshould be part of the valuation of the partnership. The common law in New York at the time was that\nprofessional partnerships like law firms have no goodwill. The reasoning behind the rule is that as\nprofessionals, law firm partners develop and cultivate their own goodwill with clients, and if a partner\nleaves the firm then the goodwill leaves with that partner. The New York Court of Appeals, in its opinion\non this case, held that unless the partnership agreement states otherwise, goodwill is indeed an asset of\nthe partnership and has to be distributed when the partnership is dissolved.\n\nA general partnership is taxed just like a sole proprietorship. The partnership is considered\na disregarded entity for tax purposes, so income \xe2\x80\x9cflows through\xe2\x80\x9d the business to the partners, who\nthen pay ordinary income tax on the business income. The partnership may file\nan information return, reporting total income and losses for the partnership, and how those profits\nand losses are allocated among the general partners. As is the case for sole proprietors, tax planning\nopportunities are limited for general partners.\nGeneral partnerships are also similar to sole proprietorships in unlimited liability. Every partner in\nthe partnership is jointly and severally liable for the partnership\xe2\x80\x99s debts and obligations. This is a very\nunattractive feature of general partnerships. One partner may be completely innocent of any\nwrongdoing and still be liable for another partner\xe2\x80\x99s malpractice or bad acts.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n353\n\n\x0cLet\xe2\x80\x99s assume that the general partnership formed by Lily and Adam flourishes and becomes\nprofitable. To grow the landscaping business, they want to bring in Lily\xe2\x80\x99s wealthy uncle as a partner.\nThe uncle, however, is worried about maintaining limited liability. In most states, they can form\nalimited partnership. A limited partnership has both general partners and limited partners. In this\ncase, Lily and Adam will remain as general partners in the business, but the uncle can become\na limited partner and enjoy limited liability. As a limited partner, the most he can lose is the amount\nof his investment into the business, nothing more. Limited partnerships have to be formed in\ncompliance with state law, and limited partners are generally prohibited from participating in dayto-day management of the business.\n\nKEY TAKEAWAYS\nA general partnership is formed when two or more persons agree to share profits and losses in a joint\nbusiness venture. A general partnership is not a separate legal entity, and partners are jointly and severally\nliable for the partnership\xe2\x80\x99s debts, including acts of malpractice by other partners. Income from a general\npartnership flows through to the partners, who pay tax at the ordinary personal income tax rate. In most\nstates general partners can also bring in limited partners, creating a limited partnership. Limited\npartnerships must be formed in compliance with state statutes. Limited partners enjoy limited liability but\ngenerally cannot participate in day-to-day management of the business.\n\nEXERCISES\n1.\n\nJohn approaches his friend Kevin and offers Kevin 50 percent of the profits from his new online venture if\nKevin designs the Web site for the venture. Kevin says nothing, and later that night begins work on the\nWeb site, which he then sends to John for his approval. Have John and Kevin formed a general\npartnership? Why or why not?\n\n2.\n\nDo you think it\xe2\x80\x99s ethical for a general partnership to fire a partner by dissolving the partnership and then\nre-forming without the dismissed partner? Why or why not?\n\n3.\n\nDo modern professional firms such as law firms or accounting firms face the same problems as White &\nCase did in Note 11.24 "Hyperlink: A Law Firm Partner Is Fired"? Why or why not?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n354\n\n\x0c11.3 Corporations\nLEARNING OBJECTIVES\n1.\n\nLearn about the advantages and disadvantages of corporations.\n\n2.\n\nStudy roles and duties of shareholders, directors, and officers in corporations.\n\n3.\n\nExplore issues surrounding corporate governance.\n\n4.\n\nUnderstand how corporations are taxed.\n\nFigure 11.4 Apple Cofounder Steve Jobs\n\nSource: Photo courtesy of acaben, http://www.flickr.com/photos/acaben/541334636/sizes/o.\n\nSo far in this chapter, we have explored sole proprietorships and partnerships, two common and\nrelatively painless ways for persons to conduct business operations. Both these forms of business\ncome with significant disadvantages, however, especially in the area of liability. The idea that\npersonal assets may be placed at risk by business debts and obligations is rightfully scary to most\npeople. Businesses therefore need a form of business organization that provides limited liability to\nowners and is also flexible and easy to manage. That is where the modern corporation comes in.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n355\n\n\x0cConsider, for example, tech entrepreneur and Apple cofounder Steve Jobs (Figure 11.4 "Apple\nCofounder Steve Jobs"). As a young man, he was a college dropout without much ability for\ncomputer engineering. If doing business as a sole proprietor was his only option, Apple would not\nexist today. However, Jobs met a talented computer engineer named Steve Wozniak, and the two\ndecided to pool their talents to form Apple Computer in1976. A year later, the company\nwas incorporated and in 1980 went public in an initial public offering (IPO). Incorporation allowed\nJobs much more flexibility in carrying out business operations than a mere sole proprietorship\ncould. It allowed him to bring in other individuals with distinct skills and capabilities, raise money in\nthe early stage of operations by promising shares in the new company, and eventually become very\nwealthy by selling stock, or securities, in the company.\n\nHyperlink: Great Things in Business\nhttp://cnettv.cnet.com/60-minutes-steve-jobs/9742-1_53-50004696.html\nSole proprietorships are limiting not just in a legal sense but also in a business sense. As Steve Jobs points\nout in this video, great things in business are never accomplished with just one person; they are\naccomplished with a team of people. While Jobs may have had the vision to found Apple Inc. and\nmaintains overall strategic leadership for the company, the products the company releases today are very\nmuch the result of the corporation, not any single individual.\n\nUnlike a sole proprietorship or general partnership, a corporation is a separate legal entity, separate\nand distinct from its owners. It can be created for a limited duration, or it can have perpetual\nexistence. Since it is a separate legal entity, a corporation has continuity regardless of its owners.\nEntrepreneurs who are now dead founded many modern companies, and their companies are still\nthriving. Similarly, in a publicly traded company, the identity of shareholders can change many times\nper hour, but the corporation as a separate entity is undisturbed by these changes and continues its\nbusiness operations.\nSince corporations have a separate legal existence and have many legal and constitutional rights,\nthey must be formed in compliance with corporate law. Corporate law is state law, and corporations\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n356\n\n\x0care incorporated by the states; there is no such thing as a \xe2\x80\x9cU.S. corporation.\xe2\x80\x9d Most corporations\nincorporate where their principal place of business is located, but not all do. Many companies choose\nto incorporate in the tiny state of Delaware even though they have no business presence there, not\neven an office cubicle. Delaware chancery courts have developed a reputation for fairly and quickly\napplying a very well-developed body of corporate law in Delaware. The courts also operate without a\njury, meaning that disputes heard in Delaware courts are usually predictable and transparent, with\nwell-written opinions explaining how the judges came to their conclusions.\n\nHyperlink: How to Incorporate in Your State\nhttp://www.business.gov/register/incorporation\nSince corporations are created, or chartered, under state law, business founders must apply to their\nrespective state agencies to start their companies. These agencies are typically located within the Secretary\nof State. Click the link to explore how to fill out the forms for your state to start a company. You may be\nsurprised at how quickly, easily, and inexpensively you can form your own company! Don\xe2\x80\x99t forget that\nyour company name must not be the same as another company\xe2\x80\x99s name. (Most states allow you to do a\nname search first to ensure that name is available.)\n\nTo start a corporation, the corporate founders must file the articles of incorporation with the state\nagency charged with managing business entities. These articles of incorporation may vary from state\nto state but typically include a common set of questions. First, the founders must state the name of\nthe company and whether the company is for-profit or nonprofit. The name has to be unique and\ndistinctive, and must typically include some form of the words \xe2\x80\x9cIncorporated,\xe2\x80\x9d \xe2\x80\x9cCompany,\xe2\x80\x9d\n\xe2\x80\x9cCorporation,\xe2\x80\x9d or \xe2\x80\x9cLimited.\xe2\x80\x9d The founders must state their identity, how long they wish the company\nto exist, and the company\xe2\x80\x99s purpose. Under older common law, shareholders could sue a company\nthat conducted business beyond the scope of its articles (these actions are called ultra vires), but most\nmodern statutes permit the articles to simply state the corporation can carry out \xe2\x80\x9cany lawful actions,\xe2\x80\x9d\neffectively rendering ultra vires lawsuits obsolete in the United States. The founders must also state\nhow many shares the corporation will issue initially, and the par value of those shares. (Of course, the\ncompany can issue more shares in the future or buy them back from shareholders.)\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n357\n\n\x0cUnlike sole proprietorships, corporations can be quite complicated to manage and typically require\nattorneys and accountants to maintain corporate books in good order. In addition to the foundation\nrequirements, corporate law requires ongoing annual maintenance of corporations. In addition to\nfiling fees due at the time of incorporation, there are typically annual license fees, franchise fees and\ntaxes, attorney fees, and fees related to maintaining minute books, corporate seals, stock certificates\nand registries, as well as out-of-state registration. A domestic corporation is entitled to operate in its\nstate of incorporation but must register as a foreign corporation to do business out of state. Imagine\nfiling as a foreign corporation in all fifty states, and you can see why maintaining corporations can\nbecome expensive and unwieldy.\n\nVideo Clip: Monstrous Obligations\nVideo Clip: The Pathology of Commerce\nOwners of companies are called shareholders. Corporations can have as few as one shareholder or as\nmany as millions of shareholders, and those shareholders can hold as few as one share or as many as\nmillions of shares. In aclosely held corporation, the number of shareholders tends to be small, while in\na publicly traded corporation, the body of shareholders tends to be large. In a publicly traded\ncorporation, the value of a share is determined by the laws of supply and demand, with various\nmarkets or exchanges providing trading space for buyers and sellers of certain shares to be traded.\nIt\xe2\x80\x99s important to note that shareholders own the share or stock in the company but have no legal\nright to the company\xe2\x80\x99s assets whatsoever. As a separate legal entity, the company owns the property.\nShareholders of a corporation enjoy limited liability. The most they can lose is the amount of their\ninvestment, whatever amount they paid for the shares of the company. If a company is unable to pay\nits debts or obligations, it may seek protection from creditors in bankruptcy court, in which case\nshareholders lose the value of their stock. Shareholders\xe2\x80\x99 personal assets, however, such as their own\nhomes or bank accounts, are not reachable by those creditors.\nShareholders can be human beings or can be other corporate entities, such as partnerships or\ncorporations. If one corporation owns all the stock of another corporation, the owner is said to be a\nparent company, while the company being owned is a wholly owned subsidiary. A parent company\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n358\n\n\x0cthat doesn\xe2\x80\x99t own all the stock of another company might call that other company an affiliate instead\nof a subsidiary. Many times, large corporations may form subsidiaries for specific purposes, so that\nthe parent company can have limited liability or advantageous tax treatment. For example, large\ncompanies may form subsidiaries to hold real property so that premises liability is limited to that real\nestate subsidiary only, shielding the parent company and its assets from tort lawsuits. Companies\nthat deal in a lot of intellectual property may form subsidiaries to hold their intellectual property,\nwhich is then licensed back to the parent company so that the parent company can deduct royalty\npayments for those licenses from its taxes. This type of sophisticated liability and tax planning makes\nthe corporate form very attractive for larger business in the United States.\nCorporate law is very flexible in the United States and can lead to creative solutions to business\nproblems. Take, for example, the case of General Motors Corporation. General Motors Corporation\nwas a well-known American company that built a global automotive empire that reached virtually\nevery corner of the world. In 2009 the General Motors Corporation faced an unprecedented threat\nfrom a collapsing auto market and a dramatic recession, and could no longer pay its suppliers and\nother creditors. The U.S. government agreed to inject funds into the operation but wanted the\ncompany to restructure its balance sheet at the same time so that those funds could one day be\nrepaid to taxpayers. The solution? Form a new company, General Motors Company, the \xe2\x80\x9cnew GM.\xe2\x80\x9d\nThe old GM was brought into bankruptcy court, where a judge permitted the wholesale cancellations\nof many key contracts with suppliers, dealers, and employees that were costing GM a lot of money.\nStock in the old GM became worthless. The old GM transferred all of GM\xe2\x80\x99s best assets to new GM,\nincluding the surviving brands of Cadillac, Chevrolet, Buick, and GMC; the plants and assets those\nbrands rely on; and the shares in domestic and foreign subsidiaries that new GM wanted to keep. Old\nGM (subsequently renamed as \xe2\x80\x9cMotors Liquidation Company\xe2\x80\x9d) kept all the liabilities that no one\nwanted, including obsolete assets such as shuttered plants, as well as unpaid claims from creditors.\nThe U.S. federal government became the majority shareholder of General Motors Company, and may\none day recoup its investment after shares of General Motors Company are sold to the public. To the\npublic, there is very little difference in the old and new GM. From a legal perspective, however, they\nare totally separate and distinct from each other.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n359\n\n\x0cOne exception to the rule of limited liability arises in certain cases mainly involving closely held\ncorporations. Many sole proprietors incorporate their businesses to gain limited liability but fail to\nrealize when they do so that they are creating a separate legal entity that must be respected as such.\nIf sole proprietors fail to respect the legal corporation with an arm\xe2\x80\x99s-length transaction, then creditors\ncan ask a court to pierce the corporate veil. If a court agrees, then limited liability disappears and\nthose creditors can reach the shareholder\xe2\x80\x99s personal assets. Essentially, creditors are arguing that the\ncorporate form is a sham to create limited liability and that the shareholder and the corporation are\nindistinguishable from each other, just like a sole proprietorship. For example, if a business owner\nincorporates the business and then opens a bank account in the business name, the funds in that\naccount must be used for business purposes only. If the business owner routinely \xe2\x80\x9cdips into\xe2\x80\x9d the\nbank account to fund personal expenses, then an argument for piercing the corporate veil can be\neasily made.\nNot all shareholders in a corporation are necessarily equal. U.S. corporate law allows for the creation\nof different types, or classes, of shareholders. Shareholders in different classes may be given\npreferential treatment when it comes to corporate actions such as paying dividends or voting at\nshareholder meetings. For example, founders of a corporation may reserve a special class of stock for\nthemselves with preemptive rights. These rights give the shareholders the right of first refusal if the\ncompany decides to issue more stock in the future, so that the shareholders maintain the same\npercentage ownership of the company and thus preventing dilution of their stock.\nA good example of different classes of shareholders is in Ford Motor Company stock. The global\nautomaker has hundreds of thousands of shareholders, but issues two types of stock: Class A for\nmembers of the public and Class B for members of the Ford family. By proportion, Class B stock is\nfar outnumbered by Class A stock, representing less than 10 percent of the total issued stock of the\ncompany. However, Class B stock is given 40 percent voting rights at any shareholder meeting,\neffectively allowing holders of Class B stock (the Ford family) to block any shareholder resolution\nthat requires two-thirds approval to pass. In other words, by creating two classes of shareholders, the\nFord family continues to have a strong and decisive voice on the future direction of the company\neven though it is a publicly traded company.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n360\n\n\x0cShareholder rights are generally outlined in a company\xe2\x80\x99s articles of incorporation or bylaws. Some of\nthese rights may include the right to obtain a dividend, but only if the board of directors approves\none. They may also include the right to vote in shareholder meetings, typically held annually. It is\ncommon in large companies with thousands of shareholders for shareholders to not attend these\nmeetings and instead cast their votes on shareholder resolutions through the use of a proxy.\n\nVideo Clip: Activist Shareholders at Wal-Mart\nUnder most state laws, including Delaware\xe2\x80\x99s business laws, shareholders are also given a unique\nright to sue a third party on behalf of the corporation. This is called\na shareholder derivative lawsuit (so called because the shareholder is suing on behalf of the\ncorporation, having \xe2\x80\x9cderived\xe2\x80\x9d that right by virtue of being a shareholder). In essence, a shareholder\nis alleging in a derivative lawsuit that the people who are ordinarily charged with acting in the\ncorporation\xe2\x80\x99s best interests (the officers and directors) are failing to do so, and therefore the\nshareholder must step in to protect the corporation. These lawsuits are very controversial because\nthey are typically litigated by plaintiffs\xe2\x80\x99 lawyers working on contingency fees and can be very\nexpensive for the corporation to litigate. Executives also disfavor them because oftentimes,\nshareholders sue the corporate officers or directors themselves for failing to act in the company\xe2\x80\x99s\nbest interest.\nOne of the most important functions for shareholders is to elect the board of directors for a\ncorporation. Shareholders always elect a director; there is no other way to become a director. The\nboard is responsible for making major decisions that affect a corporation, such as declaring and\npaying a corporate dividend to shareholders; authorizing major new decisions such as a new plant or\nfactory or entry into a new foreign market; appointing and removing corporate officers; determining\nemployee compensation, especially bonus and incentive plans; and issuing new shares\nand corporate bonds. Since the board doesn\xe2\x80\x99t meet that often, the board can delegate these tasks to\ncommittees, which then report to the board during board meetings.\nShareholders can elect anyone they want to a board of directors, up to the number of authorized\nboard members as set forth in the corporate documents. Most large corporations have board\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n361\n\n\x0cmembers drawn from both inside and outside the company. Outside board members can be drawn\nfrom other private companies (but not competitors), former government officials, or academe. It\xe2\x80\x99s\nnot unusual for the chief executive officer (CEO) of the company to also serve as chair of the board of\ndirectors, although the recent trend has been toward appointing different persons to these functions.\nMany shareholders now actively vie for at least one board seat to represent the interests of\nshareholders, and some corporations with large labor forces reserve a board seat for a union\nrepresentative.\nBoard members are given wide latitude to make business decisions that they believe are in the best\ninterest of the company. Under the business judgment rule, board members are generally immune\nfrom second-guessing for their decisions as long as they act in good faith and in the corporation\xe2\x80\x99s\nbest interests. Board members owe a fiduciary duty to the corporation and its shareholders, and\ntherefore are presumed to be using their best business judgment when making decisions for the\ncompany.\nShareholders in derivative litigation can overcome the business judgment rule, however. Another\nfallout from recent corporate scandals has been increased attention to board members and holding\nthem accountable for actually managing the corporation. For example, when WorldCom fell into\nbankruptcy as a result of profligate spending by its chief executive, board members were accused of\nnegligently allowing the CEO to plunder corporate funds. Corporations pay for insurance for board\nmembers (known as D&O insurance, for directors and officers), but in some cases D&O insurance\ndoesn\xe2\x80\x99t apply, leaving board members to pay directly out of their own pockets when they are sued. In\n2005 ten former outside directors for WorldCom agreed to pay $18 million out of their own pockets\nto settle shareholder lawsuits.\nOne critical function for boards of directors is to appoint corporate officers. These officers are also\nknown as \xe2\x80\x9cC-level\xe2\x80\x9d executives and typically hold titles such as chief executive officer, chief operating\nofficer, chief of staff, chief marketing officer, and so on. Officers are involved in everyday decision\nmaking for the company and implementing the board\xe2\x80\x99s strategy into action. As officers of the\ncompany, they have legal authority to sign contracts on behalf of the corporation, binding the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n362\n\n\x0ccorporation to legal obligations. Officers are employees of the company and work full-time for the\ncompany, but can be removed by the board, typically without cause.\nIn addition to being somewhat cumbersome to manage, corporations possess one very unattractive\nfeature for business owners: double taxation. Since corporations are separate legal entities, taxing\nauthorities consider them as taxable persons, just like ordinary human beings. A corporation doesn\xe2\x80\x99t\nhave a Social Security number, but it does have an Employer Identification Numbers (EIN), which\nserves the same purpose of identifying the company to tax authorities. As a separate legal entity,\ncorporations must pay federal, state, and local tax on net income (although the effective tax rate for\nmost U.S. corporations is much lower than the top 35 percent income tax rate). That same pile of\nprofit is then subject to tax again when it is returned to shareholders as a dividend, in the form of a\ndividend tax.\n\nOne way for closely held corporations (such as small family-run businesses) to avoid the double\ntaxation feature is to elect to be treated as an S corporation. An S corporation (the name comes from\nthe applicable subsection of the tax law) can choose to be taxed like a partnership or sole\nproprietorship. In other words, it is taxed only once, at the shareholder level when a dividend is\ndeclared, and not at the corporate level. Shareholders then pay personal income tax when they\nreceive their share of the corporate profits. An S corporation is formed and treated just like any other\ncorporation; the only difference is in tax treatment. S corporations provide the limited liability\nfeature of corporations but the single-level taxation benefits of sole proprietorships by not paying\nany corporate taxes. There are some important restrictions on S corporations, however. They cannot\nhave more than one hundred shareholders, all of whom must be U.S. citizens or resident aliens; can\nhave only one class of stock; and cannot be members of an affiliated group of companies. These\nrestrictions ensure that \xe2\x80\x9cS\xe2\x80\x9d tax treatment is reserved only for small businesses.\n\nKEY TAKEAWAYS\nA corporation is a separate legal entity. Owners of corporations are known as shareholders and can range\nfrom a few in closely held corporations to millions in publicly held corporations. Shareholders of\ncorporations have limited liability, but most are subject to double taxation of corporate profits. Certain\nsmall businesses can avoid double taxation by electing to be treated as S corporations under the tax laws.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n363\n\n\x0cState law charters corporations. Shareholders elect a board of directors, who in turn appoint corporate\nofficers to manage the company.\n\nEXERCISES\n1.\n\nHenry Ford (Ford Motor Company), Ray Croc (McDonald\xe2\x80\x99s), and Levi Strauss (Levi\xe2\x80\x99s) were all entrepreneurs\nwho decided to incorporate their businesses and in doing so created long-lasting legacies that outlive\nthem. Why do you think these entrepreneurs were motivated to incorporate when incorporation meant\ngiving up control of their companies?\n\n2.\n\nSome corporations are created for just a limited time. Can you think of any strategic reasons why founders\nwould create a corporation for just a limited time?\n\n3.\n\nRecently some companies have come under fire for moving their corporate headquarters out of the\ncountry to tax havens such as Bermuda or Barbados. Which duty do you believe is higher, the duty of\ncorporations to pay tax to government or the duty of corporations to pay dividends to shareholders?\nWhy?\n\n4.\n\nSome critics believe that the corporate tax code is a form of welfare, since many U.S. corporations make\nbillions of dollars and don\xe2\x80\x99t pay any tax. Do you believe this criticism is fair? Why or why not?\n\n5.\n\nIt is very easy to start a corporation in the United States. Take a look at how easy it is to start a corporation\nin China or India. Do you believe there is a link between ease of starting businesses and overall economic\nefficiency?\n\n6.\n\nDo you agree with filmmaker Achbar that a corporation might be psychopathic? What do you think the\nethical obligations of corporations are? Discuss.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n364\n\n\x0c11.4 Limited Liability Entities\nLEARNING OBJECTIVES\n1.\n\nLearn about the development of limited liability entities.\n\n2.\n\nExplore how limited liability entities are created.\n\n3.\n\nUnderstand why limited liability entities are now heavily favored.\n\nBy now you should understand how easy yet dangerous it is to do business as a sole proprietor, and\nwhy many business organizations are drawn to the corporation as a form for doing business. As\nflexible as the corporation is, however, it is probably best suited for larger businesses. Annual\nmeeting requirements, the need for directors and officers, and the unattractive taxation features\nmake corporations unwieldy and expensive for smaller businesses. A form of business organization\nthat provides the ease and simplicity of sole proprietorships, but the limited liability of corporations,\nwould be much better suited for a wide range of business operations.\nA limited liability company (LLC) is a good solution to this problem. LLCs are a \xe2\x80\x9chybrid\xe2\x80\x9d form of\nbusiness organization that offer the limited liability feature of corporations but the tax benefits of\npartnerships. Owners of LLCs are called members. Just like a sole proprietorship, it is possible to\ncreate an LLC with only one member. LLC members can be real persons or they can be other LLCs,\ncorporations, or partnerships. Compared to limited partnerships, LLC members can participate in\nday-to-day management of the business. Compared to S corporations, LLC members can be other\ncorporations or partnerships, are not restricted in number, and may be residents of other countries.\nTaxation of LLCs is very flexible. Essentially, every tax year the LLC can choose how it wishes to be\ntaxed. It may want to be taxed as a corporation, for example, and pay corporate income tax on net\nincome. Or it may choose instead to have income \xe2\x80\x9cflow through\xe2\x80\x9d the corporate form to the membershareholders, who then pay personal income tax just as in a partnership. Sophisticated tax planning\nbecomes possible with LLCs because tax treatment can vary by year.\nLLCs are formed by filing the articles of organization with the state agency charged with chartering\nbusiness entities, typically the Secretary of State. Starting an LLC is often easier than starting a\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n365\n\n\x0ccorporation. In fact, you might be startled at how easy it is to start an LLC; typical LLC statutes\nrequire only the name of the LLC and the contact information for the LLC\xe2\x80\x99s legal agent (in case\nsomeone decides to file a lawsuit against the LLC). In most states, forming an LLC can be done by\nany competent business professional without any legal assistance, for minimal time and cost. Unlike\ncorporations, there is no requirement for an LLC to issue stock certificates, maintain annual filings,\nelect a board of directors, hold shareholder meetings, appoint officers, or engage in any regular\nmaintenance of the entity. Most states require LLCs to have the letters \xe2\x80\x9cLLC\xe2\x80\x9d or words \xe2\x80\x9cLimited\nLiability Company\xe2\x80\x9d in the official business name. Of course, LLCs can also file d.b.a. filings to\nassume another name.\nAlthough the articles of organization are all that is necessary to start an LLC, it is advisable for the\nLLC members to enter into a written LLCoperating agreement. The operating agreement typically sets\nforth how the business will be managed and operated. It may also contain a buy/sell agreement just\nlike a partnership agreement. The operating agreement allows members to run their LLCs any way\nthey wish to, but it can also be a trap for the unwary. LLC law is relatively new compared to\ncorporation law, so the absence of an operating agreement can make it very difficult to resolve\ndisputes among members.\nLLCs are not without disadvantages. Since they are a separate legal entity from their members,\nmembers must take care to interact with LLCs at arm\xe2\x80\x99s length, because the risk of piercing the veil\nexists with LLCs as much as it does with corporations. Fundraising for an LLC can be as difficult as it\nis for a sole proprietorship, especially in the early stages of an LLC\xe2\x80\x99s business operations. Most\nlenders require LLC members to personally guarantee any loans the LLC may take out. Finally, LLCs\nare not the right form for taking a company public and selling stock. Fortunately, it is not difficult to\nconvert an LLC into a corporation, so many start-up business begin as LLCs and eventually convert\ninto corporations prior to their initial public offering (IPO).\nA related entity to the LLC is the limited liability partnership, or LLP. Be careful not to confuse\nlimited liability partnerships with limited partnerships. LLPs are just like LLCs but are designed for\nprofessionals who do business as partners. They allow the partnership to pass through income for tax\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n366\n\n\x0cpurposes, but retain limited liability for all partners. LLPs are especially popular with doctors,\narchitects, accountants, and lawyers. Most of the major accounting firms have now converted their\ncorporate forms into LLPs.\n\nKEY TAKEAWAYS\nThe limited liability company (LLC) represents a new trend toward business organization. It allows owners,\ncalled members, to have limited liability just like corporations. Unlike corporations, however, LLCs can\navoid double taxation by choosing to be taxed like a partnership or sole proprietorship. Unless a business\nwishes to become publicly traded on a stock exchange, the LLC is probably the most flexible, most\naffordable, and most compatible form for doing business today. The limited liability partnership (LLP) is\nsimilar to the LLC, except it is designed for professionals such as accountants or lawyers who do business\nas partners.\n\nEXERCISES\n1.\n\nMost small businesses in the United States are still run as sole proprietorships. Why do you think these\nbusinesses have not converted to the LLC form?\n\n2.\n\nTake a look at some of the brands and businesses you are most familiar with. How many of them do\nbusiness as an LLC?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n367\n\n\x0c11.5 Concluding Thoughts\nMost economists and public policy officials believe that the American economy is a key anchor to\nAmerican society and values. Private enterprise and the profit motive allow innovation and\nentrepreneurship to flourish, leading to prosperity and peace. Underlying the strength of American\nbusiness enterprises is a flexible and easy-to-manage legal system that allows business owners many\noptions in choosing how to organize their operations. The sole proprietorship, which provides\nautonomy and ease in creation, is a dangerous form to do business because of unlimited liability. The\ngeneral partnership allows business partners to do business together but similarly carries unlimited\nliability. The corporation provides limited liability for its owners but can be unwieldy and\ncumbersome to manage, with numerous technical requirements in creation and ongoing\nmanagement. Limited liability entities, such as the limited liability company and limited liability\npartnership, provide the most flexible choice for doing business, multiple options for tax planning,\nand limited liability for owners.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n368\n\n\x0cChapter 12\n\nEmployment Discrimination\nLEARNING OBJECTIVES\nGreat strides have been made in recent decades in eliminating the smears of discrimination from many\nfacets of society such as voting rights, property ownership, and education. In the workplace, however,\nsystematic discrimination continues to take its toll on many. This chapter explores workplace\ndiscrimination and examines the legal remedies available to those who believe they may be victims of\ndiscrimination. After reading this chapter, you should be able to answer the following questions:\n1.\n\nWhat are the various civil rights statutes that govern employment discrimination?\n\n2.\n\nWhat legal theories govern recovery discrimination lawsuits?\n\n3.\n\nHow can businesses steer clear of liability for discrimination?\n\nFigure 12.1 An Abercrombie & Fitch Billboard in New York City\n\nSource: Photo courtesy of FaceMePLS,http://www.flickr.com/photos/faceme/2536281153.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n369\n\n\x0cFigure 12.1 "An Abercrombie & Fitch Billboard in New York City" shows a billboard for Abercrombie\n& Fitch (or A&F, as it\xe2\x80\x99s sometimes known), a clothing retailer. The Columbus, Ohio\xe2\x80\x93based company\ngenerates nearly $2 billion in sales annually by selling clothes in retail locations throughout North\nAmerica, Europe, and Asia. As the billboard suggests, A&F\xe2\x80\x99s marketing concept (which it calls\n\xe2\x80\x9cCasual Luxury\xe2\x80\x9d) is based heavily on portraying a certain image. How would you characterize that\nimage? If you used adjectives like athletic, young, all-American, sexy, or attractive, you would be\ncorrectly identifying the company\xe2\x80\x99s strategy. The strategy works as it has helped the company\ngenerate hundreds of millions in profits for its shareholders.\nA&F relies on a message that boils down to convincing its young consumers that by wearing A&F\nclothing, they will also be young, athletic, and attractive. If consumers don\xe2\x80\x99t believe that message,\nthey will likely abandon the brand for another in this hugely competitive segment. To maintain the\nauthenticity of that marketing message, A&F rigorously hires only models that fit a certain image in\nprint and Web advertising. It extends this practice to store workers so that any time a customer\ninteracts with A&F, that brand image is reinforced.\nIs it illegal for A&F to hire only \xe2\x80\x9cattractive\xe2\x80\x9d people to work in its stores? The answer is no, just as it\xe2\x80\x99s\nnot illegal for Vogue magazine to hire only attractive models, or for a cosmetics company to hire only\nsalespeople with clear skin. Under the employment-at-will doctrine, workers in the United States are\nfree to work for whomever they want to (or not work at all), and employers are free to hire whomever\nthey want to, and fire them at will. The vast majority of workers in the United States are covered by\nthe at-will doctrine.\nIf you came in to work with green hair, you could be fired. If you came in to work with a visible body\npiercing or tattoo, you could be fired. If you get into an argument with your boss about whether\nbaseball or basketball is a better sport, you could get fired. Companies can fire workers for smoking\ncigarettes, even at home. Companies can fire employees who say anything disparaging or negative\nabout their bosses or the company, even on a private Facebook page. Narrow exceptions lie in the\nlaw, such as a company that enters into a written contract to hire a worker for a specified period of\ntime. (Even then, many employment contracts specify at-will status for the worker.) If A&F wishes to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n370\n\n\x0cengage in \xe2\x80\x9clooks-based\xe2\x80\x9d discrimination and refuses to hire workers who are overweight, ugly, or have\npimples, then it is free to do so under U.S. law.\nA problem arises, however, if \xe2\x80\x9call-American casual luxury\xe2\x80\x9d starts to suspiciously become another way\nto say \xe2\x80\x9call-white.\xe2\x80\x9d Many of A&F\xe2\x80\x99s competitors, such as Gap, A\xc3\xa9ropostale, American Eagle, and J.\nCrew, market their clothes on a similar \xe2\x80\x9call-American\xe2\x80\x9d theme, but their models and store workers\ntend to look more diverse than those at A&F. If A&F is using its \xe2\x80\x9cbeautiful people only\xe2\x80\x9d marketing to\nhide a more sinister plan to discriminate against racial minorities, then A&F is breaking the law.\n\nHyperlink: Abercrombie & Fitch Settles Discrimination Suit\nhttp://www.npr.org/templates/story/story.php?storyId=4174147\nIn 2004 several former workers at A&F as well as job applicants denied employment filed a lawsuit\nagainst A&F for racial discrimination. The company paid $50 million to settle the claim and hired a vice\npresident for diversity.\n\nDiscrimination, then, is not always illegal. A&F can discriminate against ugly people and Vogue can\ndiscriminate against fat people. When is discrimination illegal? Under what circumstances can\nemployers draw lines of classification within the general population? When does a person fall into\na protected class that the law recognizes? What must a disappointed worker be able to prove to\ndemonstrate illegal discrimination? In this chapter we\xe2\x80\x99ll explore these issues so that as future\nbusiness professionals, you\xe2\x80\x99ll have a sense of what you can and cannot do when it comes to hiring,\nmanaging, and firing employees.\n\nKey Takeaways\nWorkers in the United States are hired and fired at will, meaning they can be hired or fired for any reason\nand at any time. Workers in a protected class may be protected if they can demonstrate that they were\ndiscriminated against because they were members of a protected class.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n371\n\n\x0c12.1 Overview of Title VII of the Civil Rights Act of 1964\nLEARNING OBJECTIVES\n1.\n\nLearn about the history of the Civil Rights Act.\n\n2.\n\nUnderstand who has to comply with the Civil Rights Act.\n\n3.\n\nExplore what employment practices are protected by the Civil Rights Act.\n\n4.\n\nStudy the procedures involved with the Equal Employment Opportunity Commission.\n\nHyperlink: Kennedy Calls for Legislative Action on Civil Rights\nhttp://www.jfklibrary.org/Historical+Resources/Archives/Reference+Desk/Speeches/JFK/003POF03Ci\nvilRights06111963.htm\nOn June 11, 1963, President John F. Kennedy delivered a speech to the nation describing the peaceful\nresolution to a tense standoff in Alabama after a federal court ordered the admission of two black students\nto the University of Alabama. He used the occasion to rail against continued discrimination against\nAfrican Americans a century after the Civil War. \xe2\x80\x9cNext week I shall ask the Congress to act, to make a\ncommitment it has not fully made in this century to the proposition that race has no place in American life\nor law\xe2\x80\xa6I am asking Congress to enact legislation giving all Americans the right to be served in facilities\nwhich are open to the public\xe2\x80\x94hotels, restaurants, retail stores, and similar establishments. This seems to\nme to be an elementary right. Its denial is an arbitrary indignity that no American in 1963 should have to\nendure, but many do.\xe2\x80\x9d You can listen to the entire speech, and read the transcript of the speech, through\nthe hyperlink.\nFigure 12.2\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n372\n\n\x0cPresident John F. Kennedy made passage of the Civil Rights Act a key part of his presidency.\n\nSource: Photo courtesy of Abbie Rowe, National Park\nService,http://www.jfklibrary.org/Asset+Tree/Asset+Viewers/Image+Asset+Viewer.htm?guid={0AFA0FD79DBA-4467- B051-44A6DD69C48A}&type=Image.\n\nIn 1963 President Kennedy called for the passage of a sweeping civil rights bill in response to\nintransigent racial segregation. The bill was vehemently opposed by many in Congress, including\navowed segregationists who saw the bill as an intrusion on states\xe2\x80\x99 rights. Kennedy was assassinated\nbefore he could see the bill passed into law, but his successor President Johnson carried Kennedy\xe2\x80\x99s\nwish forward through aggressive lobbying of Congress to pass the bill. At its core, the bill was\ndesigned to integrate African Americans into the mainstream of American society. Today, the Civil\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n373\n\n\x0cRights Act of 1964 has broad significance for all racial minorities, religious organizations, and\nwomen.\nThe bill has several provisions, but the most important for businesses is known widely as \xe2\x80\x9cTitle VII.\xe2\x80\x9d\nIt applies to employers with more than fifteen employees. It eliminates job discrimination on the\nbasis of\n\xef\x82\xb7\n\nrace,\n\n\xef\x82\xb7\n\ncolor,\n\n\xef\x82\xb7\n\nreligion,\n\n\xef\x82\xb7\n\nsex,\n\n\xef\x82\xb7\n\nnational origin.\n\nAny act of discrimination on any of these bases is illegal. These acts may be a refusal to hire, a\ndischarge or termination, a temporary layoff or retrenchment, compensation, an opportunity for\nadvancement, or any other term or condition of employment. For example, employers are not\npermitted to maintain all-white or all-black work crews even if they can demonstrate that doing so is\ngood for business or morale. Title VII also prohibits acts of retaliation against anyone who complains\nabout, or participates in, any employment discrimination complaint. Employers need to be very\ncareful about this provision, because while the employer may be innocent of the first charge of\ndiscrimination, taking any subsequent action after an employee has complained can be a separate\ncharge of discrimination. Once an employee has made a complaint of discrimination, it is very\nimportant that the employer not alter any condition of his or her employment until the complaint\nhas been resolved.\nThe law does, however, allow discrimination on religion, sex, and national origin if there is\na bona fide occupational qualification (BFOQ)reasonably necessary for normal business operations.\nFor example, a Jewish synagogue may restrict hiring of rabbis to Jewish people only, and a Catholic\nchurch can restrict hiring priests to Catholic men only. A nursing home that caters exclusively to\nelderly women and is hiring personal assistants to help the patients with personal hygiene and\ndressing may restrict hiring to women only as a BFOQ. Victoria\xe2\x80\x99s Secret can legally discriminate\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n374\n\n\x0cagainst men in finding models to advertise and market their products. A movie producer can legally\ndiscriminate between men and women when casting for certain roles such as a woman to play Bella\nand a man to play Edward in the popular Twilight series. Since BFOQ discrimination extends to\nnational origin, a play producer casting for a role that specifically calls for a Filipino can legally\nrestrict hiring to Filipinos only. A gentlemen\xe2\x80\x99s club can hire women only as a BFOQ.\nManagers should be very careful in applying BFOQ discrimination. It is an exception that is very\nmuch based on individual cases and subject to strict interpretation. The BFOQ must be directly\nrelated to an essential job function to be \xe2\x80\x9cbona fide.\xe2\x80\x9d Customer preference is not a basis for BFOQ.\nFor example, a taxi company cannot refuse to hire women as taxi drivers even if the company claims\nthat customers overwhelmingly prefer male drivers, and airlines cannot refuse to hire men even if\nsurveys show customers prefer female flight attendants.\n\nHyperlink: Men and Hooters\nhttp://www.time.com/time/magazine/article/0,9171,987169,00.html\nThe Hooters restaurant chain hires scantily clad women exclusively as servers, refusing to hire men for\nthat role. Men are hired for other roles such as kitchen staff and hosts. In 1997 a group of men sued\nHooters for sex discrimination. Without admitting any wrongdoing, Hooters settled the claim. Hooters\nsays that its policy of hiring only women to act as servers is a bona fide occupational qualification. What\ndo you think?\nHooters has also been accused by women\xe2\x80\x99s groups of only hiring women who fit a certain profile that\ndiscriminates against anyone who management deems to be unattractive or overweight. Do you believe\nHooters should be able to take these factors into account when making hiring decisions?\n\nNote that race and color are not on the list of acceptable BFOQs. This means that in passing the law,\nCongress made a determination that there is no job in the United States where race or color is a bona\nfide occupational qualification. A country-and-western-themed restaurant, for example, may not hire\nonly white people as wait staff.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n375\n\n\x0cTitle VII creates only five protected classes. Various other federal and state laws, discussed\nin Chapter 12 "Employment Discrimination", Section 12.3 "Other Federal Antidiscrimination Laws",\ncreate other protected classes. Many other classes, such as weight, attractiveness, and height, are not\non the list of protected classes. Contrary to popular belief, there is also no federal law that protects\nagainst discrimination on the basis of sexual orientation. National restaurant chain Cracker Barrel,\nfor example, for many years maintained an open policy of not hiring homosexuals and dismissing\nany person who came out at work. It was only under pressure from shareholder activists that the\ncompany finally rescinded its discriminatory policy.\n\nHyperlink: The Employment Non-Discrimination Act\nhttp://www.npr.org/templates/story/story.php?storyId=113719460\nSince 2007 Congress has been debating the Employment Non-Discrimination Act (ENDA). The law would\nspecifically prohibit employment discrimination on the basis of sexual orientation. The House passed the\nbill in 2007, but it died in the Senate. In 2009 new attempts were made at passing the law, but strident\npartisanship once again ended chances of passage, as this NPR story explains. Do you believe this law\nshould be passed? If it passes, do you see an inconsistency with the Defense of Marriage Act, which\nprohibits federal recognition of same-sex marriage?\n\nNote too that Title VII does not prohibit all discrimination. Employers are free to consider factors\nsuch as experience, business acumen, personality characteristics, and even seniority, as long as those\nfactors are related to the job in question. Title VII requires employers to treat employees equally, but\nnot identically.\nTitle VII is a federal law, but it does not give victims of discrimination the immediate right to file a\nfederal lawsuit. Instead, Title VII created a federal agency,\nthe Equal Employment Opportunity Commission (EEOC) to enforce civil rights in the workplace. The\nEEOC publishes guidelines and interpretations for the private sector to assist businesses in deciding\nwhat employment practices are lawful or unlawful. The EEOC also investigates complaints filed by\nworkers who believe they are victims of unlawful discrimination. If the EEOC believes that unlawful\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n376\n\n\x0cdiscrimination has taken place, the EEOC can file charges against the employer. Even if the employee\nhas signed a predispute arbitration clause with the employer agreeing to send employment disputes\nto arbitration, the Supreme Court has ruled that the predispute arbitration clause does not extend to\nthe EEOC, which can still file a lawsuit on the employee\xe2\x80\x99s behalf in federal court. [1]\nFigure 12.3 Lilly Ledbetter\n\nA jury found Lilly Ledbetter was the victim of regular pay discrimination at Goodyear because of her gender.\n\nSource: Photo courtesy of aflcio, http://www.flickr.com/photos/labor2008/2928072316/sizes/o/in/photostream.\n\nEmployees must file Title VII charges with the EEOC first before going to court. If the EEOC\ninvestigates and decides not to pursue the case any further, the EEOC can issue a \xe2\x80\x9cright to sue\xe2\x80\x9d letter.\nWith that letter, the employee can then file a case in federal court within 90 days of the date of the\nletter. Any EEOC complaint must be filed within 180 days of the alleged discriminatory act taking\nplace. This deadline is generally extended to 300 days if there is a state agency that enforces a state\nlaw prohibiting discrimination on the same basis. If employees wait beyond 180 or 300 days, their\nclaims will be dismissed. The question of when the clock begins was the subject of much debate\nrecently when a female manager at Goodyear, Lilly Ledbetter (Figure 12.3 "Lilly Ledbetter"),\ndiscovered she had been paid unequally compared to males for many years. She filed a Title VII\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n377\n\n\x0clawsuit in federal court and won several million dollars in damages. At the Supreme Court, however,\na narrow 5\xe2\x80\x934 majority opinion authored by Justice Alito held that she had to file her claim within\n180 days of any decision to pay her unequally, which had happened many years ago. [2] She therefore\nlost her case and her damages award. In response, Congress passed\nthe Lily Ledbetter Fair Pay Act of 2009, which gives victims the right to file a complaint within 180\ndays of their last discriminatory paycheck.\nThe EEOC has the authority to award several remedies to victims of discrimination. These include\nthe award of back pay for any lost wages, the issuance of an injunction to stop the employer from\nmaking any continuing acts or policies of discrimination, ordering a terminated or demoted\nemployee reinstated to his or her prior position, and the award of compensatory damages for out-ofpocket costs resulting from the discrimination as well as emotional harm. Attorneys\xe2\x80\x99 fees may also be\nrecoverable. In cases of severe or reckless discrimination, punitive damages are also available.\nPunitive damages are capped by amendments to Title VII passed in 1991. These caps start at\n$50,000 for employers with less than one hundred employees and rise to $300,000 for employers\nwith more than five hundred employees.\nAnyone who files a Title VII claim in federal court must prove his or her claim using one of two\npossible theories. The first theory, known as disparate treatment, alleges that the defendant employer\nacted intentionally to discriminate against the victim because of the victim\xe2\x80\x99s membership in a\nprotected class. Winning a disparate treatment case is very hard because it essentially requires proof\nthat the defendant acted intentionally, such as a statement by the defendant that it is not hiring\nsomeone because of that person\xe2\x80\x99s race, an e-mail to the same effect, or some other sort of \xe2\x80\x9csmoking\ngun\xe2\x80\x9d evidence. If a defendant wants to discriminate against someone illegally in the workplace, it is\nvery unusual for it to say so explicitly since under the at-will doctrine, it is easy for an employer to\nfind a lawful reason to discriminate.\nUnder Supreme Court precedent, a plaintiff wishing to demonstrate disparate treatment has to first\nmake out a prima facie case of discrimination, which involves demonstrating that he or she is a\nmember of a protected class of workers. [3] He or she applied for a job that he or she is qualified for,\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n378\n\n\x0cand the employer chose someone else outside of the plaintiff\xe2\x80\x99s class. Once that demonstration has\nbeen made, the employer can rebut the presumption of discrimination by arguing that a legitimate,\nnondiscriminatory reason existed for taking the adverse action against the plaintiff. If the employer\ncan state such a legitimate reason, then the burden of proof shifts back to the employee again, who\nmust then prove by a preponderance of evidence that the employer\xe2\x80\x99s explanation is insufficient and\nonly a pretext for discrimination. This last step is very difficult for most victims of intentional\ndiscrimination.\nIf a victim is unable to find proof of disparate treatment, he or she may instead use a theory\ncalled disparate impact, where the discrimination is unintentional. Most Title VII cases fall into this\ncategory because it is so rare to find proof of the intentional discrimination required in disparate\ntreatment cases. In a disparate impact case, the victim alleges that the defendant has adopted some\nform of race-neutral policy or employment practice that, when applied, has a disproportionate\nimpact on certain protected classes. If a victim successfully demonstrates a disparate impact, then\nthe employer must articulate a nondiscriminatory business necessity for the policy or practice. The\nSupreme Court first articulated this theory in 1971 in a case involving a power company that\nimplemented an IQ test and high school diploma requirement for any position outside its labor\ndepartment, resulting in very few African Americans working at the power company other than in\nmanual labor. The Court held that the Civil Rights Act \xe2\x80\x9cproscribes not only overt discrimination, but\nalso practices that are fair in form, but discriminatory in operation. The touchstone is business\nnecessity.\xe2\x80\x9d [4] In that case, the Court found that the power company could not prove a business\nnecessity for having the IQ tests or high school diploma requirement, so those practices were ruled\nillegal.\nBusiness policies that raise suspicions for disparate impact include educational qualifications,\nwritten tests, intelligence or aptitude tests, height and weight requirements, credit checks, nepotism\nin hiring, and subjective procedures such as interviews. Businesses that have these sorts of policies\nneed to be very careful that the policies are directly related to and necessary for the job function\nunder consideration. In one recent case, the city of Chicago received more than twenty-six thousand\napplications for firefighters in 1995 for only several hundred positions. The city required all the\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n379\n\n\x0capplicants to take a test, and it used that test to categorize applicants as failing, qualified, or wellqualified. Faced with so many applicants, the city decided to hire only candidates who received a\nwell-qualified score. African Americans made up 45 percent of the qualified group, but only 11.5\npercent of the well-qualified group, so the decision had an adverse and disparate impact on a\nprotected class. More than ten years later and after an appeal all the way to the Supreme Court on\nthe question of timeliness of their lawsuit, the plaintiffs are still waiting for a trial on whether the city\nacted illegally. [5]\nProving a disparate impact case is not easy for victims of discrimination. It is not enough for the\nemployee to use statistics alone to point out that a job policy or practice has a disparate impact on\nthe victim\xe2\x80\x99s protected class. In addition, the 1991 amendments to the Civil Rights Act prohibited the\nuse of race norming in employment testing.\n\nKEY TAKEAWAYS\nThe 1964 Civil Rights Act is a major piece of legislation that affects virtually all employers in the United\nStates. Originally created to ensure the integration of African Americans into mainstream society, the law\nprohibits discrimination on the basis of race, color, religion, sex, and national origin. Some forms of\ndiscrimination on the basis of religion, sex, or national origin are permitted if they are bona fide\noccupational qualifications. Federal law does not prohibit discrimination on the basis of sexual orientation.\nThe Equal Employment Opportunity Commission investigates charges of illegal workplace discrimination.\nThese charges must be filed by workers within 180 days of the alleged discriminatory act taking place. If a\nworker believes intentional discrimination has taken place, he or she may pursue a theory of disparate\ntreatment in his or her lawsuit. If the discrimination is unintentional, the worker may pursue a theory of\ndisparate impact. Employment practices that have a disparate impact on members of a protected class are\npermissible, however, if they are job-related and qualify as a business necessity.\n\nEXERCISES\n1.\n\nMore than four decades after the passage of the 1964 Civil Rights Act, many libertarians and conservatives\ncontinue to believe that the law is a violation of states\xe2\x80\x99 rights. Do you agree? Why or why not?\n\n2.\n\nIn listening to President Kennedy\xe2\x80\x99s speech, do you believe that the promise held by the Civil Rights Act has\nbeen met? Why or why not?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n380\n\n\x0c3.\n\nBusinesses sometimes discriminate against their customers on the basis of sex. A bar may charge females\na reduced or waived cover charge in a \xe2\x80\x9cLadies Night\xe2\x80\x9d promotion, for example, to increase the female ratio\nin their audience. Hair salons routinely charge more for services to women, and even dry cleaners charge\nhigher prices for cleaning women\xe2\x80\x99s clothes. Do you believe these forms of discrimination should be illegal?\nWhy or why not?\n\n4.\n\nResearch demonstrates that taller, more athletic, and more attractive people earn more in the workplace\nthan shorter, less fit, or less attractive people. Do you believe this is unfair, and if so, do you believe the\nlaw should be amended to protect these classes?\n\n5.\n\nRace and color can never be BFOQs. Does that mean that an African American actor could play Abraham\nLincoln in a movie reenactment of Lincoln\xe2\x80\x99s life? Why or why not?\n\n[1] EEOC v. Waffle House, Inc., 534 U.S. 279 (2002).\n[2] Ledbetter v. Goodyear Tire & Rubber Co., 550 U.S. 618 (2007).\n[3] McDonnell Douglas v. Green, 411 U.S. 792 (1973).\n[4] Griggs v. Duke Power Co., 401 U.S. 424 (1971).\n[5] Lewis v. Chicago, 560 U.S. ___ (2010), http://www.law.cornell.edu/supct/html/08-974.ZS.html (accessed\nSeptember 27, 2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n381\n\n\x0c12.2 Enforcement of Title VII\nLEARNING OBJECTIVES\n1.\n\nExplore what the protections of the Civil Rights Act mean.\n\n2.\n\nUnderstand implications of the Civil Rights Act for employers and employment practices.\n\n3.\n\nExamine how businesses can protect themselves against claim of discrimination.\n\nMany times in the business world, it pays to be exceptional and different. Standing out from the\ncrowd allows an employee to be noticed for exceptional performance and can lead to faster and\ngreater advancement. In some other respects, however, standing out for being a racial or ethnic\nminority, or for being a woman, can be incredibly uncomfortable for employees. Learning to\ncelebrate differences appropriately remains a challenge for many human resource professionals.\nThe main purpose of Title VII was to integrate African Americans into the mainstream of society, so\nit\xe2\x80\x99s no surprise that charges of race-based discrimination continue to generate the highest number of\ncomplaints to the Equal Employment Opportunity Commission (EEOC). In 2009 the EEOC received\nnearly thirty-four thousand complaints of race-based discrimination in the workplace, representing\n36 percent of the total number of complaints filed. [1] Intentional discrimination against racial\nminorities is illegal, but as discussed earlier in this section, proving intentional discrimination is\nexceedingly difficult. That means the EEOC pays close attention to disparate impact cases in this\narea.\n\nHyperlink: Diversity Day at The Office\nhttp://www.nbc.com/The_Office/video/diversity-day/116137\nIn NBC\xe2\x80\x99s hit sitcom The Office, Michael Scott is the hapless and often clueless manager of a paper\ncompany\xe2\x80\x99s branch office in Pennsylvania. In this clip, he decides to celebrate Diversity Day by having the\nemployees engage in an exercise. He has written certain ethnicities and nationalities on index cards and\ntaped them to employees\xe2\x80\x99 foreheads. The employee does not know what his or her card says and is\nsupposed to figure it out through interactions with other employees. The results are a less-than-stellar\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n382\n\n\x0cbreakthrough in an understanding of diversity. Does your school or university celebrate in diversity\ncelebrations? Do you believe these celebrations are helpful or unhelpful in the workplace?\n\nFor example, an employer policy to examine the credit background of employees might be suspect.\nStatistically, African Americans have poorer credit than white Americans do, so this policy will\nnecessarily reduce the number of African Americans who can qualify for the position. While a credit\ncheck may be a business necessity for a job requiring a high level of trustworthiness, it is hardly\nnecessary for all positions. Similarly, sickle-cell anemia is a blood disease that primarily affects\nAfrican Americans. An employer policy that excludes persons with sickle-cell anemia must be job\nrelated and a business necessity to be legal. A \xe2\x80\x9cno-beard\xe2\x80\x9d employment policy may also be\nproblematic for African Americans. Many African American men suffer from a medical skin\ncondition that causes severe and painful bumps if they shave too closely, requiring them to keep a\nbeard. A no-beard policy will therefore have to be justified by business necessity. For example, a\nfirefighter may be required to be beard-free if a beard interferes with the proper functioning of an\noxygen mask, a critical piece of equipment when fighting fires. White persons can be victims of race\nor color discrimination as well. A tanning salon cannot refuse to hire a very light-skinned person of\nIrish descent, for example, if its refusal is based on color appearance of the job candidate.\nTo correct past mistakes in treatment of women and minorities, many companies go beyond being\nequal opportunity employers by adopting affirmative action programs. Companies are not required to\nundertake affirmative action programs, but many do. In some instances, they do so to qualify as a\nfederal contractor or subcontractor. Under Executive Order 11246, most federal contractors or\nsubcontractors must develop an annual affirmative action plan and take \xe2\x80\x9caffirmative steps\xe2\x80\x9d to\nrecruit, hire, and train females and minorities in the workforce. Even companies that do not seek to\nsell to the federal government may voluntarily undertake affirmative action programs, as long as\nthose programs are meant to correct an imbalance in the workforce, are temporary, and do not\nunnecessarily infringe on the rights of nonbeneficiaries.\nAffirmative action plans can be tricky to administer because white Americans can also be the victims\nof race discrimination or so-called reverse discrimination. The provisions of Title VII are meant to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n383\n\n\x0cprotect all Americans from race discrimination. One of the earliest cases of reverse discrimination\ntook place in 1981, when a white air traffic controller successfully sued the Federal Aviation\nAdministration (FAA), claiming the FAA had hired women and racial minorities over him. In one\nrecent case, the fire department in the city of New Haven conducted a management test to decide\nwhich firefighters to promote. When no black firefighters passed the test, the city decided to\ninvalidate the test. Nineteen firefighters who did pass the test (all white or Hispanic) filed suit,\nalleging the city\xe2\x80\x99s actions violated Title VII. The Supreme Court found in favor of the firefighters,\nholding that the city\xe2\x80\x99s fear of a discrimination lawsuit from minorities if it went forward with the test\nwas not enough justification to discriminate against the white firefighters. [2]\nA related form of discrimination is discrimination on the basis of national origin, which is also\nprohibited by Title VII. This involves treating workers unfavorably because of where they are from\n(specific country or region) or ethnicity. It is illegal to discriminate against a worker because of his or\nher foreign accent unless it seriously interferes with work performance. Workplace \xe2\x80\x9cEnglish-only\xe2\x80\x9d\nrules are also illegal unless they are required for the job being performed. While English-only rules\nmight be a business necessity for police officers, they would not be for late-night office cleaners.\n\nHyperlink: Sikhs Regain Right to Wear Turbans in U.S. Army\nhttp://www.npr.org/templates/story/story.php?storyId=125142736\nMembers of one of the world\xe2\x80\x99s oldest religions, Sikhism, do not cut their hair and wear their hair in a\nturban. Since 1984 this has been prohibited by the U.S. Army, which has standards for both hair and facial\nhair for recruits. In 2010 the army lifted this prohibition, resulting in the first Sikh Army officer, Captain\nTejdeep Singh Rattan (Figure 12.5 "Captain Tejdeep Singh Rattan, the First Sikh Army Officer"), in more\nthan twenty-five years, as this NPR story explains.\nFigure 12.5Captain Tejdeep Singh Rattan, the First Sikh Army Officer\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n384\n\n\x0cSource: Photo courtesy of the U.S. Army,http://www.flickr.com/photos/soldiersmediacenter/4464653659/sizes/o.\n\nTitle VII\xe2\x80\x99s prohibition on religious discrimination has raised some interesting workplace issues. The\nlaw makes it illegal to treat an employee unfavorably because of his or her religious beliefs.\nFurthermore, employees cannot be required to participate in any religious activity as a condition of\nemployment. It extends protection not just to major religions such as Buddhism, Christianity,\nHinduism, Islam, and Judaism but also to anyone who has sincerely held religious or moral beliefs.\nAdditionally, employers must reasonably accommodate an employee\xe2\x80\x99s religious beliefs or practices\nas long as it does not cause an undue hardship on the employer\xe2\x80\x99s operation of its business. Typically,\nthis would involve being flexible in schedule changes or leaves. A Muslim worker who asked for a few\nshort breaks a day to pray, for example, might be reasonable for an administrative assistant but not\nfor a police officer or air traffic controller. Issues of dress and appearance are often grounds for\ncharges of religious discrimination. For example, if a Muslim woman wished to wear a hijab, or\ntraditional headscarf, then she should be permitted to do so unless it places an undue hardship on\noperations. In 2010, UPS agreed to settle a case with the EEOC, paying $46,000 in damages for\nfiring a driver who refused to cut his hair or shave his beard, which the driver believes would violate\ntenets of his Rastafarian religion. [3]\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n385\n\n\x0cA very interesting recent development of workplace discrimination arises when a worker refuses to\ncarry out his or her job duties because of a sincerely held moral belief that doing so would promote\nimmoral activity. For example, after the Food and Drug Administration approved sale of the socalled morning after pill to prevent unwanted pregnancy, some pharmacists refused to fill\nprescriptions for the drug, claiming it was against their religious beliefs to do so. Another example\narose in Minnesota in 2006 when a bus driver refused to drive a bus carrying an advertisement for a\ngay-themed newspaper. Courts and legislatures continue to struggle with where to draw the line\nbetween respecting employees\xe2\x80\x99 religious beliefs and the rights of employers to insist their workers\nperform essential job functions.\nFinally, Title VII prohibits discrimination on the basis of sex. Interestingly, the inclusion of sex as a\nprotected class in Title VII was a legislative maneuver designed to kill the bill while it was being\ndebated in Congress. Howard Smith, a Democrat from Virginia, strongly opposed the 1964 Civil\nRights Act and thought that by adding the word \xe2\x80\x9csex\xe2\x80\x9d to the list of protected classes, the bill would\nbecome so poisonous that it would fail passage. In fact, the bill quickly passed, and it led former\nChief Justice Rehnquist to complain that courts were therefore \xe2\x80\x9cleft with little legislative history to\nguide us in interpreting the Act\xe2\x80\x99s prohibition against discrimination based on sex.\xe2\x80\x9d [4]\nFigure 12.7 An Advertisement for PSA Airlines\n\nSource:http://gulfnews.com/polopoly_fs/an-airline-advertisement-of-the-1960s1.564441!image/4155641854.jpg_gen/derivatives/box_475/4155641854.jpg.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n386\n\n\x0cThe prohibition on sex discrimination means that employers cannot categorize certain jobs as singlesex only unless a bona fide occupational qualification (BFOQ) applies. Customer preferences or\nmarket realities are not the basis for BFOQ. For example, a job that requires heavy lifting cannot be\ncategorized as male-only since a woman may qualify after passing a physical test. As society has\nchanged, much progress has been made in this area of equal employment opportunity. Airlines, for\nexample, used to routinely hire predominantly single young women as flight attendants (Figure 12.7\n"An Advertisement for PSA Airlines"). Male cabin crew could marry, but women could not. Those\ndistinctions have now been erased, partially because of Title VII, and partially because of societal\nattitudes.\nThe prohibition against sex discrimination also includes making stereotypical assumptions about\nwomen simply because they might be the primary caregiver to children at home. If there are two job\napplicants, for example, and both have young children at home, it would be illegal to give preference\nto the male candidate over the female candidate. Once a female employee has children, it would be\nillegal to assume that she is less committed to her job, or would like to work fewer hours. It\xe2\x80\x99s\nimportant to note that these protections extend to men as well. If an employer voluntarily provides\ntime off to new mothers, for example, it must extend identical benefits to new fathers.\nDiscrimination on the basis of sex can also take the form of workplace sexual harassment. Contrary\nto popular belief, there isn\xe2\x80\x99t an actual statute that makes sexual harassment illegal. Instead, sexual\nharassment is the product of judicial interpretation of what it means to discriminate on the basis of\nsex. Courts have generally recognized two forms of sexual harassment. The first, known as\nquid pro quo, involves asking for sexual favors in return for job opportunities or advancement. Courts\n\nreason that if a male worker asks a female worker for sex in return for favorable treatment, it is\nbecause that worker is female, and therefore a Title VII violation has occurred. If a supervisor fires a\nsubordinate for breaking up with him or her, then quid pro quo harassment has taken place.\nAnother type of sexual harassment is known as the hostile work environment. First recognized by the\nSupreme Court in 1986, a hostile work environment is one where hostile conditions in the workplace\nare severe and pervasive, unwelcome, and based on the victim\xe2\x80\x99s gender. [5] Courts are careful not to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n387\n\n\x0cimpose manners on workplaces, so an offhand remark or dirty joke is unlikely to be sexual\nharassment. To be considered sexual harassment, the harassment must be so severe or pervasive that\nit alters the conditions of the victim\xe2\x80\x99s employment. In one recent case, the EEOC collected $471,000\nfor thirteen female telemarketers from a firm providing basement waterproofing services. The\nharassment by male managers and coworkers at the firm included repeated requests for sex,\nfrequent groping, sexual jokes, and constant comments about the bodies of women\nemployees. [6] Similar cases involve workplace atmospheres where women are heckled with sexual\ncomments, propositioned for sex, made to listen to crude sexual comments or comments about their\nbodies, subject to pornography in the workplace, or invited to after-work outings to strip clubs.\nUnder traditional tort doctrines, employers can be held liable for an employee\xe2\x80\x99s sexual harassment of\nanother person. The Supreme Court has held that employers can overcome this liability by\ndemonstrating that they conduct workplace training about sexual harassment and have implemented\npolicies, including methods for employees to report suspected cases of harassment, and that they\ntake prompt action against any employee found to be engaging in sexual harassment. [7] The Supreme\nCourt has also held that men can be the victims of sexual harassment and that same-sex sexual\nharassment is also illegal under Title VII. [8] The hostile work environment theory is not limited to\ndiscrimination on the basis of sex; a hostile work environment can also be motivated by\ndiscrimination on the basis of race, color, national origin, religion, age, and disability.\n\nKEY TAKEAWAYS\nRacial discrimination charges are the most common form of complaint filed with the EEOC. Discrimination\non the basis of race or color prohibits employers from adopting any policy or practice that has a disparate\nimpact on persons because of their race or color. To be legal, job policies or practices that have a disparate\nimpact on protected classes must be related to the job function and qualify as a business necessity.\nDiscrimination on the basis of national origin (ethnicity, accent, or language) is illegal. Discrimination on\nthe basis of religion is also illegal. Employers must reasonably accommodate an employee\xe2\x80\x99s religious\nbeliefs unless doing so would pose an undue hardship on the employer\xe2\x80\x99s operation of business.\nDiscriminating against someone because of his or her sex is illegal. It is also illegal to treat primary\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n388\n\n\x0ccaregivers differently because they are male or female. Finally, workplace harassment is illegal if it is\nsevere and pervasive and alters the conditions of an employee\xe2\x80\x99s employment.\n\nEXERCISES\n1.\n\nIf a Jewish or Muslim worker asked for halal or kosher food in the employee cafeteria, should an employer\naccommodate this request? Why or why not? What factors do you think the employer should consider\nbefore making a decision?\n\n2.\n\nIn many countries it is common for r\xc3\xa9sum\xc3\xa9s to contain photos of the job applicants. It is also common to\nclassify jobs by sex (i.e., a job posting for a female secretary or male forklift driver). What do you believe\nthe United States has gained or lost by moving away from this system of job applicant screening?\n\n3.\n\nDo you believe that the school bus driver in Minnesota should be permitted to refuse driving a bus if it\ncarries an advertisement that the driver believes promotes immoral lifestyles? Why or why not? Should a\nvegetarian driver be permitted to refuse to drive a bus with an advertisement for hamburgers? Should a\nPost Office delivery person be permitted to refuse to deliver copies of Playboy magazine on the same\ngrounds?\n\n4.\n\nCan you think of any jobs where speaking English without an accent may be very important or essential?\n\n[1] U.S. Equal Employment Opportunity Commission, \xe2\x80\x9cCharge Statistics FY 1997 through FY\n2009,\xe2\x80\x9d http://eeoc.gov/eeoc/statistics/enforcement/charges.cfm (accessed September 27, 2010).\n[2] Ricci v. DeStefano, 557 U.S. ___ (2009), http://www.law.cornell.edu/supct/html/07-1428.ZS.html (accessed\nOctober 2, 2010).\n[3] U.S. Equal Employment Opportunity Commission, \xe2\x80\x9cUPS Freight to Pay $46,000 to Settle EEOC Religious\nDiscrimination Lawsuit,\xe2\x80\x9d February, 17, 2010,http://eeoc.gov/eeoc/newsroom/release/2-17-10.cfm (accessed\nSeptember 27, 2010).\n[4] Meritor Savings Bank v. Vinson, 477 U.S. 57 (1986).\n[5] Meritor Savings Bank v. Vinson, 477 U.S. 57 (1986).\n[6] U.S. Equal Employment Opportunity Commission, \xe2\x80\x9cEEOC Collects $471,000 Jury Award after Winning Appeal\nfrom Waterproofing Company in Sex Harassment Case,\xe2\x80\x9d May 5,\n2010, http://www.eeoc.gov/eeoc/newsroom/release/5-5-10.cfm (accessed September 27, 2010).\n[7] Burlington Industries, Inc. v. Ellerth, 524 U.S. 742 (1998).\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n389\n\n\x0c[8] Oncale v. Sundowner Offshore Services, 523 U.S. 75 (1998).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n390\n\n\x0c12.3 Other Federal Antidiscrimination Laws\nLEARNING OBJECTIVES\n1.\n\nExplore the 1866 Civil Rights Act.\n\n2.\n\nLearn about the Equal Pay Act.\n\n3.\n\nUnderstand the Age Discrimination in Employment Act.\n\n4.\n\nStudy the Americans with Disabilities Act.\n\nWhile the 1964 Civil Rights Act is the most important federal civil rights law, it isn\xe2\x80\x99t the only basis for\nemployment discrimination. Protections also exist to protect women against unequal pay, pregnant\nwomen, workers older than forty, and people with disabilities. In this section we\xe2\x80\x99ll examine these\nother statutes.\nThe first statute is the 1866 Civil Rights Act. It was passed after the Civil War to guarantee freed slaves\nthe rights of citizenship, and it is still in force today. It prohibits discrimination on the basis of race,\nincluding private discrimination. The 1866 Civil Rights Act provides victims of race discrimination\nseveral advantages over Title VII. Unlike Title VII, victims do not need to file a complaint with the\nEqual Employment Opportunity Commission (EEOC) first\xe2\x80\x94they can go straight to federal court to\nfile a complaint. In addition, the strict filing deadlines under Title VII do not apply. Finally, the\nstatutory limits on punitive damages under Title VII do not apply, so higher damages are possible\nunder the 1866 Civil Rights Act. Unlike Title VII, however, the 1866 Civil Rights Act only prohibits\nracial discrimination. In most race discrimination cases, plaintiffs file both Title VII claims and\nclaims under the 1866 Civil Rights Act. These are commonly known as Section 1983 claims, named\nafter the section of the U.S. statute that allows victims of race discrimination to file their complaints\nin federal court.\nFigure 12.9 Median Weekly Earnings of Women and Men in Management, Professional, and\n\nRelated Occupational Groups, 2008\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n391\n\n\x0cWomen still make less than their male counterparts across all industries.\nSource: Adapted from U.S. Bureau of Labor Statistics, \xe2\x80\x9cWomen and Men in Management,\nProfessional, and Related Occupations, 2008,\xe2\x80\x9d August 7,\n2009,http://bls.gov/opub/ted/2009/ted_20090807.htm (accessed September 27, 2010).\nThe Equal Pay Act of 1963 seeks to eliminate the wage gap between women and men. In 1970 women\nearned roughly sixty-two cents for every dollar men earned. In 2004 that number had climbed to\neighty cents. In 2008 women still earn less than their male counterparts in all sectors of the\neconomy, as the chart from the Bureau of Labor Statistics demonstrates (Figure 12.9 "Median\nWeekly Earnings of Women and Men in Management, Professional, and Related Occupational\nGroups, 2008"). The Equal Pay Act demands that employers provide equal pay for equal work, and it\napplies to all employers. All forms of compensation are covered by the act, including benefits such as\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n392\n\n\x0cvacation and compensation such as salary and bonus. Victims do not need to file a complaint with\nthe EEOC under the Equal Pay Act, but may instead go straight to federal court, as long as they do so\nwithin two years of the alleged unlawful employment practice. Victims typically also pursue Title VII\nclaims at the same time they pursue Equal Pay Act claims.\nThe Equal Pay Act is very difficult to enforce. Since demanding identical pay is virtually impossible\ndue to differences in jobs and job performance, courts have essentially interpreted the law as\nrequiring substantially equal pay for substantially equal work. Courts are extremely reluctant to get\ninto the business of telling employers what they should pay their workers. In 2009 the EEOC\nreceived fewer than one thousand complaints about unequal pay nationwide, or less than 1 percent of\nthe charges filed. [1]\n\nHyperlink: Despite New Law, Gender Salary Gap Persists\nhttp://www.npr.org/templates/story/story.php?storyId=125998232\nIn some part, women make less money than men because they voluntarily leave the workforce to raise\nchildren, or because women are directed to occupations with traditionally less pay. Even if these factors\nare eliminated, however, there is still a pay gap between women and men. This gap grows over time,\nleaving women with hundreds of thousands less at the end of a career when compared with a male\xe2\x80\x99s\ncomparable career. Now, Congress is considering new legislation to address the problem in the\nPaycheck Fairness Act, as this NPR story explains.\n\nThe Pregnancy Discrimination Act of 1978 amended Title VII to make it illegal to discriminate on the\nbasis of pregnancy, childbirth, or related medical conditions. This means employers cannot refuse to\nhire a woman because she is pregnant or is considering becoming pregnant, or because of prejudices\nheld by coworkers or customers about pregnant women. A female worker who becomes pregnant is\nentitled to work as long as she can perform her tasks, and her job must be held open for her while\nshe is on maternity leave. Furthermore, pregnancy-related benefits cannot be limited only to married\nemployees.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n393\n\n\x0cThe Age Discrimination in Employment Act of 1967 (ADEA) makes it illegal to discriminate against\nworkers over the age of forty. It does not protect younger workers, who are of course subject to a\nform of discrimination every time they are told an employer is looking for someone with more\nexperience. The ADEA applies to any employer with over twenty workers, including state\ngovernments. Partnerships such as law firms and accounting firms are also covered under the ADEA.\nIn 2007 a major law firm, Sidley Austin, agreed to pay $27.5 million to former partners the firm had\nterminated because of their age, resulting in a median payout of over $875,000 per terminated\npartner. [2]The ADEA prohibits employers from treating any covered person unfavorably in any term\nor condition of employment, including the hiring decision. It is illegal, for example, to hire an\ninexperienced twenty-five-year-old for a job when a fifty-year-old is better qualified and willing to\nwork for the same conditions. An employer may, however, favor an older worker over a younger\nworker even if the younger worker is over forty years of age. Mandatory retirement age is illegal\nunder the ADEA, except for very high-level executives over the age of sixty-five who are entitled to a\npension.\nEmployers should be very careful about asking for a job applicant\xe2\x80\x99s date of birth during the\napplication process, as this might be a sign of possible discriminatory intent. Employers may\ndiscriminate against older workers if there is a bona fide occupational qualification (BFOQ), such as\na production company casting for a young actor to play a young character, or airlines setting a\nmandatory retirement age for pilots.\nOf course, older workers can still be dismissed for good cause, such as poor job performance or\nemployee misconduct. Companies may also administer a layoff plan or early retirement plan that is\nevenly applied across all workers, and can offer early retirement incentives to induce workers to\nretire. Typically when companies ask a worker to retire early or take an incentive to leave the\ncompany, the worker is asked to sign an ADEA waiver, giving up any claims the worker may have\nunder the ADEA. These waivers are fully enforceable under the ADEA as long as they are \xe2\x80\x9cknowing\nand voluntary,\xe2\x80\x9d in writing, and provide the worker with at least twenty-one days to consider the\nwaiver and seven days to revoke it after signing it.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n394\n\n\x0cAlthough it was passed around the same time as Title VII, for decades courts held that only disparate\ntreatment cases under the ADEA were viable. That meant plaintiffs had to find proof of intentional\ndiscrimination to recover, so there were relatively few successful age discrimination cases. To make\nmatters even harder for older workers, in 2009 the Supreme Court held that older workers suing\nunder the ADEA had to prove that their age was a \xe2\x80\x9cbut-for\xe2\x80\x9d reason for their termination, or the sole\ncause for termination. [3] This makes age discrimination much harder to prove than discrimination\nbecause of sex or race, where illegal discrimination only has to be one of several factors that\nmotivated the employer. In fact, the 2009 decision made it all but impossible for older workers to\nprove intentional discrimination, and congressional efforts to overturn the decision in the form of\nthe Protecting Older Workers Against Discrimination Act are pending.\nIn 2005 the Supreme Court held that the disparate impact theory can apply to age discrimination\ncases. [4] For example, an employer cannot require office workers to undertake strenuous physical\ntests if those tests are not related to the job being performed and would have a disparate impact on\nolder workers. Rather than open the floodgates to ADEA litigation, however, the ensuing years saw\nrelatively little increase in ADEA-related litigation. One reason may be that the Court emphasized\nthat the ADEA contains a unique defense for employers not present in Title VII: employers are\nallowed to take unfavorable action against older workers for \xe2\x80\x9creasonable factors other than age\xe2\x80\x9d\n(RFOA). In the 2005 case, a city had decided to give larger pay increases to younger workers\ncompared to older workers, for the stated reason that the city wanted to make pay for younger\nworkers competitive with the market. The Supreme Court found this explanation reasonable. In 2010\nthe EEOC published a proposed rule to clarify the meaning of \xe2\x80\x9creasonable factors.\xe2\x80\x9d The proposed\nrule would allow neutral policies that negatively affect older workers only if the policy is \xe2\x80\x9cobjectively\nreasonable when viewed from the perspective of a reasonable employer under like\ncircumstances.\xe2\x80\x9d [5] If the proposed rule is adopted, it would make it much more difficult for\nemployers to rely on \xe2\x80\x9creasonable factors\xe2\x80\x9d as a defense to an age discrimination claim.\nAfter the major laws of the 1960s were passed, Congress did very little to protect civil rights in the\nworkplace for many years. This changed in 1990, when Congress passed a major new piece of\nlegislation known as the Americans with Disabilities Act of 1990 (ADA), signed into law by President\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n395\n\n\x0cGeorge H. W. Bush. With passage of the ADA, Congress sought to expand the promise of equal\nopportunity in the workplace to cover persons with disabilities. Unfortunately, the ADA was less than\nclear in many critical aspects when it was written, leaving courts to interpret what Congress may\nhave meant with specific ADA language. An increasingly conservative judiciary, including the\nSupreme Court, began interpreting the ADA fairly narrowly, making it harder for people with\ndisabilities to win their court cases. Congress responded with the\nAmericans with Disabilities Amendments Act of 2008 (ADAA), signed into law by President George W.\n\nBush, which specifically overturned several key Supreme Court decisions to broaden the scope of the\nADA.\nThe ADA is broken down into several titles. Title III, for example, deals with requirements for public\naccommodations such as wheelchair ramps, elevators, and accessible restrooms for new facilities.\nTitle II deals with the ADA\xe2\x80\x99s applicability to state and local governments. For employees, the most\nimportant provisions are located in Title I, which makes it illegal for employers with fifteen or more\nemployees to discriminate against \xe2\x80\x9cqualified individuals with disabilities.\xe2\x80\x9d\nIt is a common misconception that the ADA requires employers to hire disabled workers over ablebodied workers. This is simply not true because the ADA only applies to the qualified disabled. To be\nqualified, the individual must meet the legitimate skill, experience, education, or other requirements\nfor the position he or she is seeking and be able to perform the \xe2\x80\x9cessential functions\xe2\x80\x9d of the job\nwithout reasonable accommodation. In other words, the first step an employer must take is to define\nwhat the essential functions of the job are, and then see if a disabled individual who has applied for\nthe job meets the requirements for the job and can perform those essential functions. Obviously,\nsomeone who is legally blind will not be permitted to be a bus driver or airline pilot under this test.\nSimilarly, a paraplegic will not be qualified to work as a forklift operator since that person will be\nunable to perform the essential functions of that job without reasonable accommodation. On the\nother hand, the \xe2\x80\x9cessential functions\xe2\x80\x9d test means that employers must be very careful in denying\nemployment to someone who is disabled. If the reason for denying employment is the disabled\nperson\xe2\x80\x99s inability to perform some incidental task (rather than an essential function), then that is\nillegal discrimination. The ADA also permits employers to exclude any disabled individual who poses\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n396\n\n\x0ca direct threat to the health or safety to the individual or of others, if the risk of substantial harm\ncannot be reduced below the level of \xe2\x80\x9cdirect threat\xe2\x80\x9d through reasonable accommodation.\nThe ADA makes it illegal for an employer to require a job applicant take a medical exam before an\nemployment offer is made. However, after a job offer has been made, applicants can be asked to take\nmedical and drug exams. Tests for illegal use of drugs, any time during employment, are permitted\nunder the ADA.\nOne of the most vexing questions faced by employers is in defining who is disabled. The ADA states\nthat an individual is disabled if he or she has a \xe2\x80\x9cphysical or mental impairment that substantially\nlimits one or more major life activities,\xe2\x80\x9d has a record of such impairment, or is regarded as having\nsuch an impairment. Major life activities include seeing, hearing, speaking, walking, running,\nbreathing, learning, and caring for oneself. For example, consider a person being actively treated for\ncancer. During the treatment, many major life activities may be substantially limited, so the person is\ndisabled. However, if a major life activity is not limited but the person loses his or her hair as a result\nof chemotherapy, he or she may be \xe2\x80\x9cregarded\xe2\x80\x9d as having an impairment, which makes him or her\ndisabled under the ADA. An employer who purposefully refuses to hire a qualified job applicant with\nno hair because the employer believes the applicant has cancer (regardless of whether the cancer is\nactive or in remission) is therefore violating the ADA. Finally, if the cancer patient recovers fully and\nhas no physical sign of cancer, that patient is still considered protected by the ADA because he has a\n\xe2\x80\x9crecord\xe2\x80\x9d of a qualifying disability.\nAfter the ADA\xe2\x80\x99s passage in 1990, the Supreme Court began confronting the meaning of these terms\nin a series of cases. In one case, the Court held that anyone with a disability that could be mitigated\nor corrected was no longer disabled under the ADA. [6] This decision led to uproar and controversy.\nBy narrowing the definition of who was disabled, the Court made it very hard for disabled persons to\nprove discrimination. A diabetic who can control the disease with insulin, for example, was not\ndisabled under this definition. Therefore, an employer who fired a diabetic for taking breaks to inject\ninsulin was not violating the ADA. The ADAA specifically overturns this case, and now employers are\nprohibited from considering mitigating measures such as medication or technology when\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n397\n\n\x0cdetermining whether or not a major life activity is substantially limited. The ADAA does carve out\none exception: anyone with poor vision that is correctable with glasses or contact lenses is not\ndisabled under the ADA.\nIn another case limiting the definition of who is disabled, the Court held that a physical or mental\nimpairment must have a substantial effect on an employee\xe2\x80\x99s daily life, not just that person\xe2\x80\x99s ability to\nperform his or her specific job. [7] This case has also been overruled by the ADAA, which directs the\nEEOC to issue new guidelines that are much more liberal in interpreting the meaning of what it\nmeans to substantially limit a major life activity.\nUnder the new ADAA and EEOC guidelines, a list of impairments that substantially limit a major life\nactivity that will \xe2\x80\x9cconsistently\xe2\x80\x9d result in a disability determination might include blindness, deafness,\nintellectual disability, missing limbs, mobility impairments requiring the use of a wheelchair, autism,\ncancer, cerebral palsy, diabetes, epilepsy, HIV/AIDS, multiple sclerosis, muscular dystrophy, major\ndepression, bipolar disorder, posttraumatic stress disorder, obsessive compulsive disorder, and\nschizophrenia. [8] Other impairments that may require more analysis to determine if they\nsubstantially limit an individual\xe2\x80\x99s major life activities include asthma, high blood pressure, back and\nleg impairments, learning disabilities, panic or anxiety disorders, some forms of depression, carpal\ntunnel syndrome, and hyperthyroidism. The impairment cannot be temporary or nonchronic (such\nas the common cold, seasonal influenza, sprained joint, minor gastrointestinal disorders, seasonal\nallergies, broken bones, and appendicitis). However, an impairment that is episodic such as epilepsy\nor cancer would qualify if it limits a major life activity while it is active. Pregnant women are\ngenerally not considered disabled, although of course other civil rights statutes, such as Title VII,\nmay protect them. Note that while current illegal drug users are not considered disabled, alcoholics\nmay be considered disabled if the disease substantially limits a major life activity.\nAlthough an employer is not required to hire the unqualified disabled, if it does hire a disabled\nindividual it must provide reasonable accommodation to any disabled worker who asks for it.\nReasonable accommodation is any change or adjustment to the work environment that would allow\nthe disabled worker to perform the essential functions of the job or to allow the disabled worker to\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n398\n\n\x0cenjoy the benefits and privileges of employment equal to employees without disabilities. Reasonable\naccommodation might include allowing the worker to work part-time or modified work schedules;\nreassigning the worker to a vacant position; purchasing special equipment or software; providing\nreaders or interpreters; or adjusting or modifying exams, training materials, and policies. Employers\ndo not have to undertake reasonable accommodation if doing so would cause them undue hardship,\nmeaning it would require significant difficulty or expense, or significantly alter the nature or\noperation of the business. Among factors to be considered in whether an accommodation would pose\nan undue hardship are the cost of the accommodation as well as the employer\xe2\x80\x99s size and financial\nresources.\n\nKEY TAKEAWAYS\nThe 1866 Civil Rights Act prevents private discrimination on the basis of race, and provides a quick route\nfor victims of racial discrimination to federal court without following procedural gateways established by\nthe EEOC. The Equal Pay Act requires employers to pay men and women substantially equal pay for\nsubstantially equal work, but it is very difficult to enforce. Title VII also protects pregnant women from\nworkplace discrimination. The Age Discrimination in Employment Act prohibits discrimination against\nworkers over the age of forty. The BFOQ defense is available for age discrimination claims, as well as\ntaking adverse action for a reasonable factor other than age. The Americans with Disabilities Act prohibits\nemployment discrimination against the qualified disabled and prohibits preemployment medical testing.\nTo be considered disabled, an individual must demonstrate a mental or physical impairment that\nsubstantially limits a major life activity. Disabled persons are entitled to reasonable accommodation in the\nworkplace, as long as reasonable accommodation does not place any undue hardship on the employer.\n\nEXERCISES\n1.\n\nThe Equal Pay Act of 1963 is decades old, but women have still not closed the gap with men when it comes\nto pay. Why do you think this is? Do you believe Congress can play a role in closing this gap?\n\n2.\n\nThe number of age-related claims filed with the EEOC has increased steadily, from 19.6 percent of cases\nfiled in 1997 to 24.4 percent of cases filed in 2009. Why do you think this number is increasing?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n399\n\n\x0c3.\n\nThink about the job that you would like most to have when you graduate college. What do you think the\n\xe2\x80\x9cessential functions\xe2\x80\x9d of that job are? What sorts of disabilities do you think would disqualify you or\nsomeone else from performing those essential functions?\n\n4.\n\nDo you believe that alcoholics should be considered disabled under the ADA? Why or why not?\n\n5.\n\nA person with a lifetime allergy to peanuts is probably disabled under the ADA, but a person with seasonal\nallergies to pollen is not. Does this distinction make sense to you? Why or why not?\n\n[1] U.S. Equal Employment Opportunity Commission, \xe2\x80\x9cCharge Statistics FY 1997 through FY\n2009,\xe2\x80\x9d http://eeoc.gov/eeoc/statistics/enforcement/charges.cfm (accessed September 27, 2010).\n[2] U.S. Equal Employment Opportunity Commission, \xe2\x80\x9c$27.5 Million Consent Decree Resolves EEOC Age Bias Suit\nagainst Sidley Austin,\xe2\x80\x9d October 5, 2007,http://www.eeoc.gov/eeoc/newsroom/release/10-5-07.cfm (accessed\nSeptember 27, 2010).\n[3] Gross v. FBL Financial Services, 557 U.S. ___ (2009),http://www.law.cornell.edu/supct/html/08441.ZS.html (accessed October 2, 2010).\n[4] Smith v. City of Jackson, 544 U.S. 228 (2005).\n[5] U.S. Equal Employment Opportunity Commission, \xe2\x80\x9cEEOC Solicits Comments on Proposed Rule concerning\n\xe2\x80\x98Reasonable Factors other than Age\xe2\x80\x99 under the ADEA,\xe2\x80\x9d February 18,\n2010, http://www.eeoc.gov/eeoc/newsroom/release/2-18-10.cfm (accessed September 27, 2010).\n[6] Sutton v. United Airlines, 527 U.S. 471 (1999).\n[7] Toyota Motor Manufacturing v. Williams, 534 U.S. 184 (2002).\n[8] U.S. Equal Employment Opportunity Commission, \xe2\x80\x9cSummary of Key Provisions: EEOC\xe2\x80\x99s Notice of Proposed\nRulemaking (NPRM) to Implement the ADA Amendments Act of 2008\n(ADAA),\xe2\x80\x9d http://www.eeoc.gov/laws/regulations/adaaa-summary.cfm (accessed September 27, 2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n400\n\n\x0c12.4 Concluding Thoughts\nMost people find the idea of being judged based on the basis of an \xe2\x80\x9cimmutable\xe2\x80\x9d characteristic such as\nrace, color, or sex grossly unfair. We wish to be judged on the basis of our merit and character, things\nthat we can control. The same is true in the workplace, where most people hold firm to the belief that\nthe hardest working, smartest, and most business-savvy should succeed. Employment discrimination\nlaw is meant to address this ideal, but like all laws, it can be a blunt instrument where sometimes a\nfiner approach is called for.\n\nHyperlink: A Class Divided\nhttp://www.pbs.org/wgbh/pages/frontline/shows/divided\nOn the morning after Martin Luther King Jr. was assassinated, Jane Elliott, a third-grade teacher in an\nall-white elementary school in Iowa, divided her class into two groups: those with brown eyes and those\nwith blue eyes. It was 1968, four years after Title VII, and the country was still torn by racial\ndiscrimination. What Jane Elliott found out that day about the nature of discrimination and the lessons\nher students took with them after the experiment was over are the subject of this Frontline documentary.\n\nIn many ways, the debates surrounding what kind of protections against discrimination Americans\nshould enjoy in the workplace mirror larger debates about the role of government in ensuring the\nequal protection of the laws for its citizens. Since the laws in this area are notoriously difficult to\ninterpret, it falls on judges and juries to decide when illegal discrimination has taken place.\nUnfortunately for plaintiffs, the result is often less than justice.\nIt is hard to prove an employment discrimination case, under either disparate treatment or disparate\nimpact cases. For example, the Equal Employment Opportunity Commission (EEOC) collects\nstatistics for each type of charge filed with the commission and how the case is resolved. In 2009, for\nrace-based charges, 66 percent resulted in a finding of \xe2\x80\x9cno reasonable cause,\xe2\x80\x9d meaning the EEOC\nfound no evidence of discrimination. [1] For religion-based charges, 61 percent resulted in a finding of\n\xe2\x80\x9cno reasonable cause.\xe2\x80\x9d [2] The proof necessary to win these cases, as well as the reluctance of plaintiffs\nto come forward when they might be reliant on the employer for a continuing paycheck, mean that\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n401\n\n\x0cmany instances of illegal discrimination go unreported. Often, those being discriminated against are\namong vulnerable populations with no independent means of living if they lose their jobs. To top it\noff, the low success rates mean that attorneys in employment discrimination cases rarely take their\ncases on contingency, so victims have to pay expensive hourly fees. The rise of predispute arbitration\nclauses in the employment setting also means that workers facing illegal discrimination face a huge\nchasm between the promise of equality under the law and the reality of pursuing that promise.\nAs we move into the twenty-first century, new workplace discrimination issues will continue to\nsurface. There is already widespread concern about the use of genetic information found in DNA to\ndiscriminate against employees because of the chances they might get a certain disease. This concern\nled to the passage of the Genetic Information Nondiscrimination Act of 2008. In spite of legislative\naction, however, too many cases of illegal discrimination are still taking place in the workplace.\nAdequately addressing this injustice will ultimately fall on a new generation of business leaders, such\nas you.\n\n[1] U.S. Equal Employment Opportunity Commission, \xe2\x80\x9cRace-Based Charges FY 1997\xe2\x80\x93FY\n2009,\xe2\x80\x9d http://eeoc.gov/eeoc/statistics/enforcement/race.cfm (accessed September 27, 2010).\n[2] U.S. Equal Employment Opportunity Commission, \xe2\x80\x9cReligion-Based Charges FY 1997\xe2\x80\x93FY\n2009,\xe2\x80\x9d http://eeoc.gov/eeoc/statistics/enforcement/religion.cfm (accessed September 27, 2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n402\n\n\x0cChapter 13\n\nBusiness in the Global Legal Environment\nLEARNING OBJECTIVES\nAfter reading this chapter, you should understand the foundational concepts of business in the global\nenvironment. You will learn about why it is important to understand the global legal environment, as well\nas some of the sources of international law that pertain to business. You will examine the concept of\nsovereignty and the unique challenges that concept poses, specifically in relation to ethical questions\narising in the international business context. You will explore concepts critical to conducting business in\nthe international environment, including trade regulations, international contract formation, and\nprohibited activities. At the conclusion of this chapter, you should be able to answer the following\nquestions:\n1.\n\nWhy is the global legal environment important to all businesses?\n\n2.\n\nWhat is international law?\n\n3.\n\nWhat laws are relevant to businesses operating internationally?\n\n4.\n\nWhat are some current ethical issues associated with the global environment of business?\n\n5.\n\nWhat legal considerations exist with respect to trade regulations, international contract formation,\nemployment and human rights issues, and prohibited activities in the international environment?\n\nIt\xe2\x80\x99s a globalizing world. If you are considering starting a small business, it may not occur to you to\nconsider exporting your product. However, according to the Small Business Association, 96 percent\nof the world\xe2\x80\x99s potential customers live outside of the United States. [1] So what\xe2\x80\x99s stopping you? Maybe\nyou are not sure how to negotiate a contract with a supplier or manufacturer overseas. Or maybe you\nare uncertain about U.S. laws relating to importing and exporting. The international market is\nlucrative, though the legal environment for operating in that forum is different from that for a\nbusiness that operates exclusively within the borders of the United States. For this reason, it is\nimportant to be familiar with some of the basic concepts of doing business in the global economy.\nYou may be acquainted with challenges faced by U.S. businesses and workers when considering the\nquestions associated with this new business environment. When we shop for food, computers,\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n403\n\n\x0cclothing, pet food, automobiles, or just about anything produced for the global market, we might very\nwell purchase a final product from a different country, or a product composed of components or\nlabor from many different parts of the world. Economists tell us that this represents the most\nefficient method of production and labor. After all, if a business can pay $1 per hour to a worker\noverseas, why would it choose instead to pay $12 per hour to a U.S. worker?\nOf course, it\xe2\x80\x99s not necessarily a sunny picture for people whose jobs have been outsourced.\nAdditionally, businesses operating in the international environment face unique questions. For\ninstance, if the new labor force that is being paid $1 per hour is composed of workers who are forced\ninto sweatshop conditions, then there may be serious consumer backlash against the company that\nhas chosen to do business with that particular manufacturer. Check outNote 13.2 "Hyperlink:\nNational Labor Committee" to view current stories about modern sweatshops that produce goods\nthat you may own.\n\nHyperlink: National Labor Committee\nhttp://www.nlcnet.org\nClick on Alerts or Reports at the top of the page. Do you recognize any products that you own or\ncompanies that you enjoy shopping with?\n\nEven if the consumers do not respond negatively to business decisions that result in the use of child\nlabor or sweatshop conditions for the production of goods, the question of ethics still remains. For\ninstance, does a company wish to place profit over concerns that it might have about human rights?\nAnd, does a company have any long-lasting duties to its U.S. workforce, or is it all right to simply\noutsource jobs if it makes economic sense to do so?\nBesides human rights issues, other concerns about doing business in the international environment\nexist. For example, it is not uncommon for polluting industries to locate to countries that have laxer\nenvironmental regulations than they would face at home. Environmental degradation, such as the\noveruse of natural resources, generation of pollution, and improper disposal of waste products, is a\ncommon by-product of global businesses.\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n404\n\n\x0cInternational business includes not only trade in new goods but also the disposal of old ones. For\nexample, the U.S. Government Accounting Office found, after an undercover investigation, that\nmany U.S. companies were willing to export old electronic products that contain cathode-ray tubes\n(CRTs), each composed of several pounds of lead, to countries where unsafe recycling practices\noccur, without following U.S. regulatory law. Unsafe recycling of toxic electronic waste, known as ewaste, has serious effects on the environment and on human health. Additionally, some of the\n\ncompanies that were willing to do this have publically proclaimed their commitments to\nenvironmentally safe practices. [2] Check out Note 13.4 "Hyperlink: E-waste: From the United States\nto China" for a video concerning U.S. exporting of toxic waste.\n\nHyperlink: E-waste: From the United States to China\nhttp://www.cbsnews.com/video/watch/?id=5274959n&tag=related;photovideo\n\nEnvironmental degradation is much like sweatshop labor in the sense that some companies that\nengage in harmful practices will pay the price by suffering the fallout from consumer protests. Again,\nregardless of consumer reaction, the question of whether to engage in such practices is not only a\nlegal question but also a question of ethics.\nThis chapter explores the nature of international law. Additionally, it reviews considerations that are\nrelevant to businesses operating internationally, such as trade regulations, contract formation\nbetween international parties, and prohibited activities. It also examines some current ethical issues\nassociated with the global environment of business.\n\nExercises\n1.\n\nCheck out Note 13.2 "Hyperlink: National Labor Committee", the Web site for the National Labor\nCommittee. Click on Alerts or Reports at the top of the page. Do you recognize any products that you\nown or companies that you do business with? Pick a story concerning a company that you do business\nwith, or that you have considered doing business with. After reading the report, would you consider\nboycotting that company\xe2\x80\x99s products? Why or why not?\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n405\n\n\x0c2. View the video in Note 13.4 "Hyperlink: E-waste: From the United States to China". What types of ewaste do you produce? Where does it go? For example, how did you dispose of your last cell phone?\nYour last computer? Your last iPod?\n\n[1] U.S. Small Business Administration, \xe2\x80\x9cTake Your Business Global,\xe2\x80\x9d June\n2010,http://www.sba.gov/idc/groups/public/documents/sba_program_office/oit_sba_fast_facts.pdf (accessed\nSeptember 27, 2010).\n[2] U.S. Government Accountability Office, \xe2\x80\x9cElectronic Waste: EPA Needs to Better Control Harmful U.S. Exports\nthrough Stronger Enforcement and More Comprehensive Regulation,\xe2\x80\x9d GAO 08-1044, August\n2008, http://www.gao.gov/new.items/d081044.pdf (accessed September 27, 2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n406\n\n\x0c13.1 The Nature of International Law\nLEARNING OBJECTIVES\n1.\n\nCompare and contrast the structure of international law with that of domestic law.\n\n2.\n\nUnderstand the difference between international law between states and law as it applies to businesses\noperating internationally.\n\nImagine hearing allegations that your company\xe2\x80\x99s products are being assembled overseas in working\nconditions that have resulted in extreme despondency among workers, including several suicides.\nThis is precisely the situation that Apple, Dell, Hewlett-Packard, and others find themselves in.\nFoxconn, which is part of the Taiwan-based Hon Hai Precision Industry Co., operates a large\nelectronics assembly complex in China. Allegations have arisen that harsh working conditions have\nled to a string of suicides. If true, should these U.S. companies find another electronics manufacturer\nto assemble their products? Do consumers have any voice in this matter?\nFrom your seat, it may seem like an obvious point that businesses should follow the laws and behave\nethically in their business dealings if they wish to be successful for the long haul. However, when we\nlook at the question of how a company might \xe2\x80\x9cfollow the law,\xe2\x80\x9d we need to consider which laws we are\nreferring to. When a U.S. company conducts business in another country, it must comply with\napplicable U.S. law, and with the law of the foreign nation where it is located. Several U.S. laws apply\nto the business activities of U.S. companies operating on foreign soil. However, it is perfectly legal for\na U.S. company to contract with an overseas manufacturer for labor, without insisting that those\nworkers are paid a wage equal to the U.S. federal minimum wage. In the case of Hon Hai and\nFoxconn, none of the U.S. companies can get into legal trouble regarding the fact that, until very\nrecently, the average worker there made the equivalent of $132 per week, which is, of course, far\nbelow the U.S. federal minimum wage. [1] There are several reasons for this.\nImagine that Apple alleged that labor conditions were not contractually satisfied and, therefore,\nFoxconn and Hon Hai Precision Industry Co. breached the agreement that they had made with\nApple. If this were the case, Apple may wish to terminate its relationship with these companies.\nHowever, it is unlikely that the Asian companies would agree. This means that a dispute could arise\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n407\n\n\x0cunder a contract between international parties. If Foxconn and Hon Hai disputed this allegation,\nwhich rule of law should govern the dispute? In the United States, contracts laws are state law rather\nthan federal law, so should the laws of a particular state, like California, be applied to this dispute?\nOr should Chinese law apply? This can be a complicated question for several reasons. However, it is\nnecessary to first examine of the nature of international law to understand this complexity. Try to\nmake a distinction between the nature of international law between nation-states and the nature of\nlaw as it applies to businesses operating in the international arena. In the next section, we will return\nto the question of which type of law should apply to disputes in international contracts.\n\nThe Basics of International Law between Nation-States\nWe are all subject to domestic laws, because we all live in a sovereign state. A sovereign state is a political\nentity that governs the affairs of its own territory without being subjected to an outside authority.\nCountries are sovereign states. The United States, Mexico, Japan, Cambodia, Chile, and Finland are all\nexamples of sovereign states. In domestic law, or law that is applicable within the nation where it is\ncreated, some legitimate authority has the power to create, apply, and enforce a rule of law system. There\nis a legitimate law-creating authority at the \xe2\x80\x9ctop,\xe2\x80\x9d and the people to be governed at the \xe2\x80\x9cbottom.\xe2\x80\x9d The law\nmight be conceived of as being \xe2\x80\x9chanded down\xe2\x80\x9d to the people within its jurisdiction. This is a vertical\nstructure of law, because there is some \xe2\x80\x9chigher\xe2\x80\x9d authority that imposes a rule of law on the people. In the\nUnited States, laws are handed down by the legislative branch in the form of statutory law, by the judicial\nbranch in the form of common law, and by the executive branch in the form of executive orders, rules, and\nregulations. These government branches have legitimate authority to create a rule of law system, and this\nauthority is derived from the U.S. Constitution. See Figure 13.3 "The Vertical Nature of U.S. Domestic\nLaw" for a simple illustration of the vertical nature of domestic law in the United States. Of course, people\ncan influence who become members of the branches of government through elections and which issues\nare brought before government to consider and possibly legislate, but that does not change the fact that\npeople are subjected to laws that are handed down in a vertical nature.\nFigure 13.3 The Vertical Nature of U.S. Domestic Law\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n408\n\n\x0cIt\xe2\x80\x99s important to note, however, that not all law can be conceived as a vertical structure. Some laws, such\nas international law, or law between sovereign states, are best thought of in a horizontal structure. For\nexample, treaties have a horizontal structure. This is because the parties to international treaties are\nsovereign states. Since each state is sovereign, that means that one sovereign state is not in a legally\ndominant or authoritative position over the other. SeeFigure 13.4 "An Illustration of the Horizontal\nNature of International Law between Nation-States" for an illustration of the horizontal nature of\ninternational law between nation-states, using the North American Free Trade Agreement as an example.\nFigure 13.4 An Illustration of the Horizontal Nature of International Law between Nation-States\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n409\n\n\x0cAn obvious challenge to laws created in horizontal power structures that lie outside of any legitimate\nlawmaking authority \xe2\x80\x9cabove\xe2\x80\x9d the parties is that enforcement of violations can be difficult. For this reason,\nmany horizontal laws, like treaties, contain provisions that require the parties to the treaty to submit to a\ntreaty-created dispute resolution panel or other neutral tribunal, such as\nthe International Court of Justice (ICJ). Though it is common for treaties to set forth expectations that\ndisputes will be heard before some predesignated tribunal, some international relations experts believe\nthat the state of international law is one of persistent anarchy.\nExamine the differences between vertical structure and horizontal structures of law. Consider the case of a\ncriminal in the United States. The criminal can be prosecuted by the laws of the United States (federal or\nstate, depending on the jurisdiction of the offence) and, if convicted, will have to submit to the authority\nof the United States for punishment. This is because we recognize that there is some legitimate authority\nin domestic law that allows the U.S. government to exact punishment against convicted criminals.\nCompare this to a sovereign state that violates a treaty agreement. For example, perhaps a member of a\ntreaty has broken its treaty promise to refrain from fishing in a certain fishery. Since in the international\narena there is no overarching power \xe2\x80\x9cabove\xe2\x80\x9d the parties to a treaty, enforcement of treaty agreements can\nbe difficult.\nAnother common challenge in international law is that the laws are applicable only to parties who\nvoluntarily choose to participate in them. This means that a sovereign state cannot generally be compelled\nto submit to the authority of the international law if it chooses not to participate. Compare this with\ndomestic law. Everyone within the United States, for example, is subject to the jurisdiction of certain state\nand federal courts, whether they voluntarily choose to submit to jurisdiction or not. This is why fleeing\ncriminals can legitimately be caught and brought to justice in domestic law through extradition.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n410\n\n\x0cThe Nature of Law as It Applies to Businesses Operating in the International\nArena\nBusinesses are not involved in signing treaties or in creating law that applies between sovereign states.\nIndeed, the sovereign states themselves have the only power to conduct foreign affairs. In the United\nStates, that power rests with the president, though Congress also has important roles. For example, the\nSenate must ratify a treaty before the treaty binds the United States and before its provisions become law\nfor the people within the United States.\nHowever, businesses are required to abide by their own applicable domestic laws as well as the laws of the\nforeign country in which they are conducting business. When domestic laws apply to businesses operating\ninternationally, that is a vertical legal structure, such as is illustrated in Figure 13.3 "The Vertical Nature\nof U.S. Domestic Law". This is because there is a legitimate authority over the business that governs its\nbehavior.\nAs noted in the example concerning U.S. companies doing business with Foxconn and Hon Hai Precision\nIndustry Co., international business can involve creating contracts between parties from different nations.\nThese contracts are horizontal in nature, much like a treaty. However, they are also subject to a vertical\nlegal structure, because the parties to the contact will have chosen which laws will apply to resolve\ndisputes arising under the contract. For example, if Microsoft, a U.S. company, has a contract with KYE\nSystems Corp., a Chinese manufacturer, to assemble its products, the contract might very well include a\nchoice of law clause that would require any contract dispute to be settled in accordance with Washington\nState law. A choice of law clause is a contractual provision that specifies which law and jurisdiction will\napply to disputes arising under the contract. The contract might contain such a clause because Microsoft\xe2\x80\x99s\nheadquarters are in Washington State, and it would be more convenient for Microsoft to settle any\ndisputes arising under a contract by using the laws in the state where it is located. This probably would be\nterribly inconvenient for KYE Systems Corp., but the benefits of obtaining a Microsoft contract probably\noutweigh the potential inconvenience of resolving disputes in the Washington State court system.\nAdditionally, a well-established United Nations treaty,\ntheConvention on the Recognition and Enforcement of Foreign Arbitral Awards, provides for the\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n411\n\n\x0cenforcement of arbitral awards among member states. That means Microsoft and KYE Systems Corp.\ncould agree in a predispute arbitration clause, perhaps in a purchase order or invoice, to arbitrate their\ndisputes in Washington, using Washington contract law, and in English. The prevailing party in the\narbitration could take the award to court in either Washington or China and convert it into a legally\nbinding judgment under the treaty. Choice of law clauses have consequences regarding the way the\ncontract will be interpreted in the event of a dispute, costs associated with defending a complaint arising\nunder a contract, and convenience. See Figure 13.5 "The Horizontal and Vertical Nature of Contract\nRelationships in the Global Legal Environment" for an illustration of the horizontal and vertical nature of\ncontract law in international business.\nFigure 13.5 The Horizontal and Vertical Nature of Contract Relationships in the Global Legal\n\nEnvironment\n\nKEY TAKEAWAYS\nWhile international law between sovereign states is relevant to business in many ways\xe2\x80\x94for instance, it\nwould be illegal for a company to ignore the terms of a treaty that its own country had ratified\xe2\x80\x94the types\nof law that are relevant to businesses operating in the international environment are domestic laws. A\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n412\n\n\x0cchoice of law clause within the contract designates which country\xe2\x80\x99s law will apply to a dispute arising\nunder an international contract.\n\nEXERCISES\n1.\n\nIf you were creating a contract with a supplier in a different country, what types of things would you\nconsider when deciding on the choice of law clause?\n\n2.\n\nCheck out http://www.ustr.gov/trade-agreements/free-trade-agreements/north-american-free-tradeagreement-nafta. How might this international law present opportunities for businesses in the United\nStates that might wish to export or import products to or from Canada or Mexico?\n\n3.\n\nCould a U.S. state enter into a treaty with a sovereign nation outside the United States? Why or why not?\n\n[1] Ting-I Tsai, \xe2\x80\x9cHon Hai Gives Workers a Raise,\xe2\x80\x9d Wall Street Journal, May 29,\n2010,http://online.wsj.com/article/SB10001424052748703957604575272454248180106.html?mod=WSJ_hpp_sec\ntions_tech (accessed September 27, 2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n413\n\n\x0c13.2 Trade Regulations, Contracts, and Prohibited Activities in\nInternational Business\nLEARNING OBJECTIVES\n1.\n\nExamine U.S. trade regulations.\n\n2.\n\nExplore considerations for contracts in the international environment.\n\n3.\n\nExamine prohibitions of certain business activities in the international context.\n\nSeveral U.S. laws apply to U.S. companies conducting business internationally. For example, trade\nregulations are relevant to importers and exporters of products. Also, some activities are prohibited\nto U.S. businesses, such as doing business with a terrorist organization. It is important for all\ncompanies contemplating doing business in the international environment to understand the laws\nthat apply to their activities so that they can avoid criminal and civil liability, and maintain a\ncommitment to ethics.\n\nTrade Regulations\nThe removal or reduction of trade barriers in accordance with the former\nGeneral Agreement on Tariffs and Trade (GATT) and most recently the\nWorld Trade Organization presents opportunities for businesses. Likewise, multinational agreements that\nremove trade barriers to create largely duty-free and tariff-free trading zones, such as the\nNorth American Free Trade Agreement, allow for freer flow of goods and services between specific\ncountries. These agreements create tremendous opportunities for businesses because they lower the costs\nassociated with importing and exporting, which is a primary consideration for many companies.\nCompanies wishing to export or import products are subject to federal trade\nregulations. Export controls prohibit or restrict the export of certain types of products while limiting or\nrestricting specific products from entering a country, perhaps by way of tariffs or quotas. The U.S.\ngovernment views exporting as a privilege and not as a right and has the authority to impose a total ban\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n414\n\n\x0con exporting on U.S. companies for export control violations. Try to imagine what an export ban would do\nto companies such as Microsoft, Boeing, or Apple.\nThe activities of companies that ship products overseas are subject to federal export controls.\nTo export simply means to transport products to another country. Export controls are regulated by several\ndepartments of the federal government. For example, the Export Administration Regulations are\nadministered by the U.S. Department of Commerce Bureau of Industry and Security, and they regulate\nitems that may have a dual commercial or military use, such as computers and electronics. The U.S.\nDepartment of the Treasury Office of Foreign Assets Control regulates and enforces trade sanctions. The\nU.S. Department of State International Traffic in Arms Regulation prohibits certain types of trade, such as\nthe unlicensed export of weaponry and certain chemicals.\nOther federal agencies and programs exist in a supportive capacity, to assist U.S. businesses in their\nexport endeavors rather than to regulate and enforce export controls. For example, the U.S. Department\nof Commerce\xe2\x80\x99s International Trade Administration supports U.S. exports and competitiveness abroad.\nCheck out Note 13.21 "Hyperlink: Exporting?" for several short videos designed to teach companies how\nto engage in this lucrative and large marketplace.\n\nHyperlink: Exporting?\nhttp://www.census.gov/foreign-trade/aes/exporttraining/videos\nCheck out these short training videos to learn about regulatory compliance.\nSimilarly, the National Export Initiative was created by the Obama administration, and it assists U.S.\nbusinesses to operate in the global market. Check out President Obama discussing the need to boost\nexports at a recent import/export conference.\n\nHyperlink: President Obama Discussing the Importance of Export and the\nCreation of the National Export Initiative\nhttp://www.export.gov/nei/index.asp\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n415\n\n\x0cCompanies wishing to import products are also subject to import controls. Import controls take many\nforms including tariffs, quotas, and bans or restrictions. The U.S. Department of Homeland Security\nCustoms and Border Protection Agency (CBA) has a primary role in import control administration and\nregulation. For example, it inspects imports to classify them to establish their tariff schedule.\nA tariff applies to certain goods imported from other countries. Tariffs are import taxes. They are imposed\nto render the imported product more expensive and to keep the cost of nonimported products (domestic\nproducts) attractive to consumers. CBA customs officers classify the imported goods, which determines\nthe applicable tariff. However, the Customs Modernization and Informed Compliance Act places\nresponsibility for compliance with import laws on the importer.\nQuotas apply to certain goods. Quotas are simply limits on quantity. No absolute quotas exist, but certain\ntariff rate quotas apply to certain items, such as specific types of textiles and dairy products.\nA tariff rate quota simply provides favorable tariffs on certain quantities of particular types of imports.\nBans apply to goods that are prohibited by law to import, because they are dangerous to public safety,\nhealth, the environment, or national interests. Other items are restricted from import. For example, it is\nillegal to import items of cultural heritage from other countries without permission. Check out Note 13.28\n"Hyperlink: What? These Old Rocks?" to see a recent story about 525-million-year-old fossils that were\nillegally imported into the United States and have been returned to China.\n\nHyperlink: What? These Old Rocks?\nhttp://www.cbp.gov/xp/cgov/newsroom/highlights/chinese_fossils.xml\nAlong with the CBA, the U.S. International Trade Commission investigates import injuries to the United\nStates, such as dumping and subsidized imports, and the need for safeguards. Dumping is when a foreign\nproducer exports products to sell at prices less than its cost of manufacturing. Subsidized imports are\nproducts produced overseas for which a government has provided financial assistance for the production.\nWhen dumping or subsidized imports materially injure or threaten to injure domestic producers, the\nUnited States may impose a countervailing duty for subsidized products or an antidumping duty for\ndumped products. These duties, which are particular types of tariffs, reduce the negative impact that such\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n416\n\n\x0cpractices could have on U.S. companies. Safeguards are limited duration growth restrictions that are\nimposed when domestic markets are threatened or injured from imports. This allows for domestic\nmarkets to adjust to the surge from the import market. For example, the United States imposed\nsafeguards on Chinese textiles in response to actual or threatened market disruption of the U.S. textile\nindustry.\n\n[1]\n\nContracts\nThe U.N. Convention on Contracts for the International Sale of Goods(CISG) applies to the sale of goods\nbetween parties from countries that are signatories to this treaty. Like\nthe Uniform Commercial Code (UCC), it creates a uniform law for the parties that adopt it. Specifically,\nthe CISG applies to contracts for international sale of commercial goods. Additionally, like the UCC, it\nprovides gap-fillers for terms that may not be expressly stated in the contract. However, important\ndifferences between the UCC and the CISG exist, particularly with respect to revocability of an offer,\nacceptance, the requirement for a writing to be enforceable, and essential terms. See Figure 13.7 "A\nComparison of Differences between the CISG and the UCC" for a comparison between the CISG and the\nUCC.\n\n[2]\n\nThe contracting parties may opt out of the CISG, providing that they do it expressly.\n\nFigure 13.7 A Comparison of Differences between the CISG and the UCC\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n417\n\n\x0cThe CISG does not limit the parties to a particular forum to resolve disputes, and it does not limit the\nterms of the contract itself. It is important for parties to choose which forum will apply to disputes arising\nunder the contract. Choice of forum clauses specify where complaints will be heard. If parties opt out of\nthe CISG, then they must choose which law will apply to their contract by a choice of law clause. The\nparties will also need to agree on the official language of the contract. Given the precise language\nnecessary for contractual agreements to be interpreted, this choice clearly matters to the interests of the\ncontracting parties.\n\nEmployment Law and Human Rights\nU.S. citizens that are working for U.S. companies overseas are protected by U.S. federal employment laws,\nsuch as Title VII of the Civil Rights Act and the Americans with Disabilities Act. This means that U.S.\ncompanies may not illegally discriminate against U.S. employees with a protected characteristic simply\nbecause those employees happen to report to work for the company on foreign soil.\nAdditionally, the Alien Torts Claims Act allows noncitizens to bring suit in U.S. federal court against U.S.\nbusinesses or citizens that have committed torts or human rights violations in foreign lands.\n\nProhibited Activities\nThose engaged in international business must be aware of prohibited activities, because severe criminal\npenalties are possible. For example, paying bribes to get things done is not permitted. The\nForeign Corrupt Practices Act (FCPA) prohibits the payment of bribes by U.S. companies and the\nemployees of those companies. Violation of this law is a criminal offense. It does, however,\npermit grease payments, or facilitating payments, if such payments are permitted by the local government\nwhere the payments occurred. Since it is extremely rare to find a jurisdiction that legally permits grease\npayments (even in countries where corruption is rampant, it\xe2\x80\x99s probably still illegal), the grease payments\nexception provides false comfort to those who undertake to use it.\nU.S. citizens and companies must refrain from doing business with prohibited people or entities. The U.S.\nDepartment of the Treasury Office of Foreign Assets Control (OFAC) maintains a list of Specially\nDesignated Nationals and Blocked Persons, which is a list of persons, businesses, and entities with which\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n418\n\n\x0cU.S. citizens are forbidden from conducting business. Similarly, U.S. citizens are not permitted to engage\nin trade or business dealings with those in countries in which a U.S. embargo or U.S. imposed economic\nsanctions exists. Check out Note 13.42 "Hyperlink: Prohibited Parties" for these lists.\n\nHyperlink: Prohibited Parties\nSpecially Designated Nationals and Blocked Persons List\nhttp://www.treas.gov/offices/enforcement/ofac/sdn\nEconomic Sanctions\nhttp://www.treas.gov/offices/enforcement/ofac/programs/index.shtml\nU.S. citizens are also blocked from conducting transactions with terrorists or terrorist\norganizations.\n\n[3]\n\nConducting transactions with prohibited persons, entities, or businesses can result in\n\nserious criminal violations, which carry financial penalties and long prison sentences.\nFinally, while the United States maintains economic boycotts against several countries, under\nU.S. antiboycott laws it is illegal for U.S. persons and companies to comply with any unsanctioned foreign\nboycott. The most important unsanctioned foreign boycott is the long-standing Arab League boycott of\nIsrael. If a U.S. person or company receives a request to comply with the boycott of Israel (such as a\nrequest from a buyer in Saudi Arabia not to ship goods via Israel, or not to ship on an Israeli flag ship, or\neven to state whether the seller has any operations in Israel or to state the religious affiliations of each\nemployee in the company), then the U.S. person or company must refuse to comply with the request and\nreport it to the appropriate U.S. government agency within a specified period of time.\n\nKEY TAKEAWAYS\nInternational business opportunities are lucrative, and the global marketplace provides vast opportunities\nfor growth. However, U.S. companies that engage in international business are subject to trade\nregulations, must be cognizant of the challenges inherent when forming international contracts, and are\nprohibited from engaging in certain activities.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n419\n\n\x0cEXERCISES\n1.\n\nLook at the clothing labels of the clothes you are wearing. Was anything that you are wearing produced in\nthe United States? Besides garment appeal, what types of considerations might consumers weigh when\ndeciding to buy apparel?\n\n2.\n\nWhat are the benefits and drawbacks of import controls for domestic industries? Do you favor stronger\ncontrols? More lax controls? Why?\n\n3.\n\nSeveral U.S. sanctions programs are limited to U.S. companies only. The decades-old sanctions program\nagainst Cuba, for example, has meant that Asian and European companies can do as much business as\nthey wish in Cuba. How effective do you think a sanctions program like this can be? Who are the winners,\nand who are the losers?\n\n4.\n\nWal-Mart, as a U.S. company, does not do any business in Cuba and does not purchase from any Cuban\nsuppliers. Wal-Mart Canada, a Canadian company, found out several years ago that a supplier outsourced\nthe manufacture of pajamas to Cuba, and that these Cuban-made pajamas were being sold in Wal-Mart\xe2\x80\x99s\nCanadian stores. The U.S. parent company ordered the Canadian subsidiary to pull the product, but the\nCanadian subsidiary reported that doing so would violate Canadian law, which prohibits Canadian\ncompanies from complying with the U.S. boycott of Cuba. What should Wal-Mart U.S. do? What should\nWal-Mart Canada do?\n\n[1] U.S. Government Accountability Office, \xe2\x80\x9cU.S.-China Trade: Textile Safeguards Should Be Improved,\xe2\x80\x9d GAO-05296, April 2005, http://www.gao.gov/new.items/d05296.pdf (accessed September 27, 2010).\n[2] U.S. Department of Commerce, Office of the Chief Counsel for International Commerce, \xe2\x80\x9cThe U.N. Convention\non Contracts for the International Sale of Goods,\xe2\x80\x9d August\n2002,http://www.osec.doc.gov/ogc/occic/cisg.htm (accessed September 27, 2010).\n[3] U.S. Department of the Treasury, Office of Foreign Assets Control, \xe2\x80\x9cTerrorism: What You Need to Know about\nU.S. Sanctions,\xe2\x80\x9d Executive Order 13224 \xc2\xa72(a), September 23,\n2001,http://www.treasury.gov/offices/enforcement/ofac/programs/terror/terror.pdf (accessed September 27,\n2010).\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n420\n\n\x0c13.3 Concluding Thoughts\nTremendous opportunities exist for companies that wish to operate in the international markets.\nHowever, the international legal environment requires careful planning to avoid costly mistakes\nassociated with violations of trade regulations, the formation of international contracts, and criminal\nprohibitions. Additionally, ethical considerations involving human rights and the natural\nenvironment are ever present.\n\nSaylor URL: http://www.saylor.org/books\n\nSaylor.org\n421\n\n\x0c'