b'Fundamentals of Business Law\n\n\x0cFundamentals of\nBusiness Law\nMELISSA RANDALL AND\nCOMMUNITY COLLEGE OF DENVER\nSTUDENTS\n\n\x0cFundamentals of Business Law by Melissa Randall is licensed under a\nCreative Commons Attribution 4.0 International License, except where\notherwise noted.\n\nFundamentals of Business Law by Melissa Randall and Community\nCollege of Denver Students is licensed under a Creative Commons\nAttribution 4.0 International License, except where otherwise noted.\nMore information about this license may be found at\nhttps://creativecommons.org/licenses/by/4.0.\n\n\x0c\x0cContents\n\nIntroduction\n\n1\n\nWhat is an Open Textbook?\n\n1\n\nThe Authors and Contributors\n\n2\n\nFeedback Requested\n\n3\n\n1. Introduction to Law and Types of Legal\n\n4\n\nSystems\n1.1 Introduction to Law and Types of Legal\n\n4\n\nSystems\n1.2 What Is Law and What Functions Does It\n\n6\n\nServe?\n1.3 Modern Legal Systems of the World\n\n8\n\n1.4 Sources of Law\n\n14\n\n1.5 Concluding Thoughts\n\n22\n\n2. The United States Court System\n\n24\n\n2.1 Introduction\n\n24\n\n2.2 Separation of Powers\n\n25\n\n2.3 Federalism\n\n29\n\n2.4 Trial and Appellate Courts\n\n32\n\n2.5 Concluding Thoughts\n\n35\n\n\x0c3. Litigation\n\n37\n\n3.1 Introduction\n\n37\n\n3.2 The Parties, Attorneys, and Jury\n\n38\n\n3.3 Standing\n\n42\n\n3.4 Subject Matter and Personal Jurisdiction\n\n42\n\n3.5 Venue\n\n44\n\n3.6 Pretrial Procedures\n\n45\n\n3.7 The Trial and Appeal\n\n52\n\n3.8 Concluding Thoughts\n\n55\n\n4. Alternative Dispute Resolution\n\n56\n\n4.1 Introduction\n\n56\n\n4.2 Negotiation\n\n58\n\n4.3 Mediation\n\n60\n\n4.4 Arbitration\n\n62\n\n4.5 Concluding Thoughts\n\n65\n\n5. The Constitution\n\n66\n\n5.1 Introduction\n\n66\n\n5.2 Federalism and Preemption\n\n67\n\n5.3 The Commerce Clause\n\n75\n\n5.4 Business and the Bill of Rights\n\n76\n\n5.5 Concluding Thoughts\n\n86\n\n\x0c6. International Law\n\n89\n\n6.1 Introduction\n\n89\n\n6.2 The Nature of International Law\n\n91\n\n6.3 Sources of International Law\n\n93\n\n6.4 US Laws that Apply to US Nationals\n\n99\n\nAbroad\n6.5 Concluding Thoughts\n\n100\n\n7. Administrative Law\n\n101\n\n7.1 Introduction\n\n101\n\n7.2 Creation of Administrative Agencies\n\n102\n\n7.3 Agency Functions\n\n105\n\n7.4 Judicial Review of Agency Actions\n\n109\n\n7.5 Public Access to Agency Information\n\n111\n\n7.6 Concluding Thoughts\n\n113\n\n8. Criminal Law\n\n114\n\n8.1 Introduction\n\n114\n\n8.2 The Nature of Criminal Law\n\n115\n\n8.3 Constitutional Rights and Defenses\n\n122\n\n8.4 Common Business Crimes\n\n129\n\n8.5 Concluding Thoughts\n\n133\n\n9. Torts\n\n134\n\n9.1 Introduction\n\n134\n\n9.2 Intentional Torts\n\n137\n\n9.3 Negligence\n\n145\n\n9.4 Strict Liability\n\n153\n\n9.5 Concluding Thoughts\n\n156\n\n\x0c10. Contracts\n\n159\n\n10.1 Introduction\n\n159\n\n10.2 Contract Elements\n\n161\n\n10.3 Types of Contracts\n\n165\n\n10.4 Performance and Breach of Contract\n\n168\n\n10.5 Defenses to Contracts\n\n171\n\n10.6 Assignment, Delegation, and Third Party\n\n177\n\nBeneficiaries\n10.7 Parol Evidence Rule\n\n179\n\n10.8 Remedies\n\n179\n\n10.9 Concluding Thoughts\n\n186\n\n11. Sales Contracts\n\n187\n\n11.1 Introduction\n\n187\n\n11.2 Scope of the UCC\n\n188\n\n11.3 Sales Contract Formation\n\n193\n\n11.4 Performance\n\n198\n\n11.5 Warranties\n\n199\n\n11.6 Concluding Thoughts\n12. Writing Contracts\n\n200\n201\n\n12.1 Writing Contracts\n\n201\n\n12.2 Structure of Contracts\n\n202\n\n12.3 Common Mistakes\n\n211\n\n12.4 Tips for Writing a Contract\n\n213\n\n12.5 Concluding Thoughts\n\n218\n\n\x0c13. Employment Law\n\n219\n\n13.1 Introduction\n\n219\n\n13.2 Employment At Will\n\n220\n\n13.3 Common Employment Law Torts\n\n225\n\n13.4 Wage and Hour Laws\n\n225\n\n13.5 Family Medical Leave Act\n\n228\n\n13.6 Occupational Safety and Health Act\n\n229\n\n13.7 Employee Retirement Income Security Act\n\n230\n\n13.8 Workers\xe2\x80\x99 Compensation Laws\n\n231\n\n13.9 Unemployment Compensation\n\n233\n\n13.10 Labor Relations\n\n234\n\n13.11 Concluding Thoughts\n\n242\n\n14. Anti-Discrimination Law\n\n243\n\n14.1 Introduction\n\n243\n\n14.2 The Equal Pay Act of 1963\n\n246\n\n14.3 Title VII of the Civil Rights Act of 1964\n\n248\n\n14.4 Enforcement of Title VII\n\n258\n\n14.5 The Age Discrimination in Employment\n\n261\n\nAct of 1967\n14.6 The Americans with Disabilities Act of\n\n262\n\n1990\n14.7 Genetic Information Nondiscrimination\n\n265\n\nAct of 2008\n14.8 Concluding Thoughts\n\n266\n\n\x0c15. Agency\n\n268\n\n15.1 Introduction\n\n268\n\n15.2 The Agency Relationship\n\n269\n\n15.3 Duties of Agents and Principals\n\n273\n\n15.4 Liability to Third Parties\n\n277\n\n15.5 Termination of Agency Relationship\n\n280\n\n15.6 Concluding Thoughts\n16. Business Organizations\n\n281\n283\n\n16.1 Introduction\n\n283\n\n16.2 Sole Proprietorship\n\n285\n\n16.3 Partnerships\n\n286\n\n16.4 Franchises\n\n289\n\n16.5 Joint Venture\n\n290\n\n16.6 Corporations\n\n292\n\n16.7 Limited Liability Entities\n\n297\n\n16.8 Concluding Thoughts\n\n302\n\n17. Partnerships\n\n303\n\n17.1 Introduction\n\n303\n\n17.2 Types of Partnerships\n\n303\n\n17.3 Partnership Agreements\n\n305\n\n17.4 Rights and Duties of Partners\n\n308\n\n17.5 Termination of a Partnership\n\n311\n\n17.6 Concluding Thoughts\n\n313\n\n\x0c18. Corporations\n\n314\n\n18.1 Introduction\n\n314\n\n18.2 Corporate Structure\n\n315\n\n18.3 Shareholder Rights\n\n316\n\n18.4 Corporate Officer and Directors\n\n321\n\n18.5 Legal Theories\n\n324\n\n18.6 Mergers, Consolidations, and Dissolutions\n\n326\n\n18.7 Concluding Thoughts\n\n329\n\n19. Antitrust Law\n\n331\n\n19.1 Introduction\n\n331\n\n19.2 Historical Development\n\n332\n\n19.3 Monopoly\n\n335\n\n19.4 Unreasonable Restraints on Trade\n\n339\n\n19.5 Price Discrimination\n\n345\n\n19.6 Enforcement\n\n349\n\n19.7 Concluding Thoughts\n\n350\n\n20. Consumer Law\n\n351\n\n20.1 Introduction\n\n351\n\n20.2 Protecting the Purchaser\n\n352\n\n20.3 Protecting the Debtor\n\n355\n\n20.4 Enforcement\n\n363\n\n20.5 Concluding Thoughts\n\n364\n\n\x0c21. Workplace Privacy and Information Security\n\n365\n\n21.1 Introduction\n\n365\n\n21.2 Right to Privacy\n\n366\n\n21.3 Workplace Privacy\n\n370\n\n21.4 Information Security Issues\n\n380\n\n21.5 Concluding Thoughts\n\n386\n\n22. Property\n\n387\n\n22.1 Introduction\n\n387\n\n22.2 Personal Property\n\n388\n\n22.3 Real Property\n\n393\n\n22.4 Wills and Trusts\n\n404\n\n22.5 Land Use Regulation\n\n408\n\n22.6 Environmental Law\n\n410\n\n22.7 Concluding Thoughts\n\n417\n\n23. Intellectual Property\n\n419\n\n23.1 Introduction\n\n419\n\n23.2 Intellectual Property\n\n420\n\n23.3 Constitutional Roots\n\n423\n\n23.4 Patents\n\n425\n\n23.5 Trade Secrets\n\n431\n\n23.6 Trademarks\n\n432\n\n23.7 Copyright\n\n440\n\n23.8 Concluding Thoughts\n\n444\n\n\x0c24. Bankruptcy\n\n445\n\n24.1 Introduction\n\n445\n\n24.2 Types of Bankruptcy\n\n446\n\n24.3 Bankruptcy Proceedings\n\n452\n\n24.4 Concluding Thoughts\n\n456\n\n\x0cIntroduction\nWhat is an Open Textbook?\nOpen textbooks are complete textbooks that have been\nfunded, published, and licensed to be freely used, adapted, and\ndistributed. As a particular type of Open Educational Resource\n(OER), this open textbook may be used and reused freely with\nno direct cost to the user.\nUnless otherwise noted, all content in this book is licensed\nwith a Creative Commons Attribution 4.0 license (CC BY 4.0),\nwhich allows it to be adapted, remixed, and shared under the\nsame license with attribution. Instructors and students may\nbe interested in rearranging and adapting content or in\ntransforming content into other formats. If so, please include\nthe appropriate attribution under the Creative Commons\nlicense. More information about this license is available at\nhttps://creativecommons.org/licenses/by/4.0.\n\n1 | Introduction\n\n\x0cThe Authors and Contributors\nMelissa Randall is an attorney who teaches business law and\nConstitutional law at the Community College of Denver.\nFrustrated that the expensive textbook her business students\nwere using contained legal errors, heavily edited case studies\nthat confused students, and was a roadblock to their learning,\nMs. Randall sought a better option, which ultimately led her\ndown the OER path. Special thanks to Terence Lau and Lisa\nJohnson for their OER textbook \xe2\x80\x9cIntroduction to Business Law,\xe2\x80\x9d\nwhich served as the inspiration for several chapters of this\nbook.\nMs. Randall\xe2\x80\x99s business law students edited, updated, and\nrevised the chapters contained in this textbook. They are also\nresponsible for the visual depictions of the material. Although\nMs. Randall is the subject matter expert who ensured the\naccuracy of the material, her students ensured the effective\ndelivery of the content to undergraduate business students. It\nwas truly a collaborative effort. Special thanks to Lucy Reyes\nand Krissy Main who turned the students\xe2\x80\x99 rough visual\nconcepts into professional quality graphics.\nThanks also to the Colorado Department of Higher Education\n(CDHE) for the grant that partially funded the development of\nthis book. Without it, we could not have hired Lucy and Krissy\nto be our graphic designers. Nor would we have been able to\nhave written so many chapters so quickly. The CDHE\xe2\x80\x99s support\nof OER and open pedagogy validated our classes\xe2\x80\x99 commitment\nto doing meaningful work and to contribute to the future of\nhigher education.\nLast, and certainly not least, thanks to the professionals who\ncontributed their expertise to our book. Judges and attorneys\nfilled our Counselor\xe2\x80\x99s Corner with practical insights and advice\n\nIntroduction | 2\n\n\x0cto business professionals. Their insight from \xe2\x80\x9cthe trenches\xe2\x80\x9d was\nan invaluable contribution. Subject matter experts peer\nreviewed chapters and worked with our students to ensure\naccurate information in dynamic areas of the law. Kathy was\nour dedicated copy editor who thoroughly proofread anything\nwe gave her. Special thanks to the professional who was in\nthe trenches the most: Tom. A successful businessman, Tom\nput his MBA to use by tirelessly editing the entire textbook\nto ensure that it was consistent and accurate in a business\ncontext. Our professional contributors volunteered their\nexpertise and gave enthusiastically to our project. Words\ncannot express our gratitude for accompanying us on this\njourney.\n\nFeedback Requested\nThe authors seek content-related suggestions from faculty,\nstudents, and users of this book. Please email Ms. Randall at\nMelissa.Randall@ccd.edu with any suggestions or feedback\nyou may have. Also, faculty are invited to contact Ms. Randall to\ndiscuss other OER used in the business law course, including\njudicial opinions we use as case studies in lieu of heavily edited\nexcerpts in textbook dialogue boxes.\nThis textbook was finalized during the Spring 2020 semester.\nWith the outbreak of covid-19, our collaborative efforts were\ncurtailed. As a result, readers may find that some chapters are\nbetter edited than others. Please help us with any constructive\nfeedback you may have to improve the book.\nIf you are an instructor reviewing, adopting, or adapting this\ntextbook, please help us understand how this book is being\nused. This helps all of us in the OER community understand our\nimpact and justify future grant money.\n3 | Introduction\n\n\x0c1. Introduction to Law\nand Types of Legal\nSystems\n1.1 Introduction to Law and Types of\nLegal Systems\nLEARNING OBJECTIVES\n1. Understand the nature and sources of law.\n2. Know the types of modern legal systems in the world.\n3. Understand the various functions of a legal system.\n4. Learn the primary sources of law in the United States.\nIt is important for business people to understand the legal\nenvironment in which they are operating. To be successful,\nbusinesses must understand how law and economic principles\ninfluence each other. Businesses want to be successful, which\nusually means they want to be profitable. While a basic\neconomic principle is that businesses act in their own selfinterest, they must do so within the parameters of the law.\nSometimes businesses weigh the penalties of violating the law\nagainst the chances of getting caught to determine how they\nshould behave. In both instances, the law is a restraint on\nbehavior.\nMost people want to conduct their business legally. Following\nthe rules saves money, time, and frustration, and it preserves\nindividual and professional reputations. So, if businesses have\nIntroduction to Law & Legal\nSystems | 4\n\n\x0can incentive to operate legally, why are do so many legal\ndisputes occur? There are many reasons for this, including that\nmany of our laws are poorly written, and reasonable people\nmay disagree about what is \xe2\x80\x9cright.\xe2\x80\x9d Legal injuries happen even\nunder the best of circumstances, and parties need a method to\nbe compensated for their damages.\nA common theme in the study of law is responsibility. Law\nseeks to answer the questions:\n1. Who is responsible, and what is their liability? and\n2. How does a business limit exposure to liability in the first\nplace?\nA solid understanding of business law minimizes the risk of\nliability and avoids legal disputes. The law provides a\nreasonable expectation of how things will be in the future\nbased on how they have been in the past. It provides\npredictability and stability.\nThis book does not teach how to practice law or conduct legal\nresearch. The goals of this book are practical. Think about\nstudying business law as a map by which to navigate business\ndealings. We want to help you minimize the risk of legal liability\nand avoid serious legal disputes. This book serves as an\nintroduction to legal topics that affect businesses. By\nunderstanding the legal landscape, you will have a better\nopportunity for business success.\n\nCounselor\xe2\x80\x99s Corner Even if a business is not officially\n\xe2\x80\x9cinternational,\xe2\x80\x9d it is important to understand the\nlegal systems of the world because consumers\ncome from all over. Consumers, business partners,\n\n5 | Introduction to Law & Legal Systems\n\n\x0cand competitors are products of their environments,\nincluding their societies and legal systems.\nTherefore, their expectations and how they interact\nwith each other are influenced directly by their legal\nsystems of origin. The most successful businesses\ntake this into account. Not only for avoiding legal\nliability, but also for enhanced consumer\nsatisfaction.\n~Arham M.,\nattorney\n\n1.2 What Is Law and What Functions\nDoes It Serve?\nLaw is the system of rules which a particular nation or\ncommunity recognizes as regulating the actions of its\nmembers and which it may enforce by the imposition of\npenalties. In a nation, the law can serve to (1) keep the peace,\n(2) maintain the status quo, (3) preserve individual rights, (4)\nprotect minorities, (5) promote social justice, and (6) provide\nfor orderly social change. Some legal systems serve these\npurposes better than others.\nAlthough a nation ruled by an authoritarian government may\nkeep the peace and maintain the status quo, it may also\noppress\n\nminorities\n\nor\n\npolitical\n\nopponents\n\n(e.g.,\n\nChina,\n\nZimbabwe, or Syria). Under colonialism, European nations\noften imposed peace in nations whose borders were created\nby those same European nations. With regard to the functions\nof the law, the empires may have kept the peace\xe2\x80\x94largely with\nIntroduction to Law & Legal Systems | 6\n\n\x0cforce\xe2\x80\x94but they changed the status quo and seldom promoted\nthe native peoples\xe2\x80\x99 rights or social justice.\nIn nations with various ethnic and tribal groups, it is often\ndifficult for a single, united government to rule effectively. In\nRwanda, for example, power struggles between Hutus and\nTutsis resulted in the genocide of the Tutsi minority. In nations\nof the former Soviet Union, the withdrawal of a central power\ncreated power vacuums that were exploited by local leaders.\nWhen\n\nYugoslavia\n\nbroke\n\nup,\n\nthe\n\ndifferent\n\nethnic\n\ngroups\xe2\x80\x94Croats, Bosniaks, and Serbs\xe2\x80\x94fought bitterly rather\nthan share power. In Iraq and Afghanistan, the blending of\ndifferent groups of families, tribes, sects, and ethnic groups\ninto an effective national governing body continues to be a\nchallenge.\nThese situations highlight the struggle of a nation to\nimplement and maintain the Rule of Law. The Rule of Law\nis a system in which laws are public knowledge, are clear in\nmeaning, and apply equally to everyone. These systems uphold\nnational political and civil liberties. Rule of law systems\nestablish authority, create expectations for behavior, and\nestablish redress for grievances and penalties for deviance.\nGovernance of conflict and the attainment of peace among the\ngoverned are its primary goals. One of the greatest benefits of\nthe Rule of Law is that it allows people to understand what is\nexpected of them.\nThe United States is a Rule of Law System. The US Constitution\nis based on the principle that people have rights that cannot\nbe taken away by the government. Instead, the role of the\ngovernment is to protect the individual rights of its citizens. The\nUS Constitution\xe2\x80\x99s preamble states, \xe2\x80\x9cWe the People\xe2\x80\xa6in Order\nto\xe2\x80\xa6insure domestic Tranquility.\xe2\x80\x9d This is just one example of how\nthe US legal system was established to address the functions of\na legal system.\n\n7 | Introduction to Law & Legal Systems\n\n\x0c1.3 Modern Legal Systems of the\nWorld\nThere are four main legal systems in the modern world:\n1. Common law;\n2. Civil law;\n3. Religious law; and\n4. Customary law/monarchy.\nAs the world becomes more interdependent, a fifth category of\nlegal systems has developed \xe2\x80\x94 the hybrid legal system, which\nis a legal system that is a combination of two or more legal\nsystems.\n\nIntroduction to Law & Legal Systems | 8\n\n\x0cType of\nLegal\nSystem\n\nCharacteristics\n\nCommon\nLaw\n\n\xe2\x80\xa2 Written judicial decisions of appellate courts are\nbinding legal authority on lower courts when\ninterpreting and applying the same or similar\nquestions of law\n\xe2\x80\xa2 The legal system is adversarial\n\xe2\x80\xa2 The outcome of a case is often decided by a jury of\nthe parties\xe2\x80\x99 peers\n\nCivil Law\n\n\xe2\x80\xa2 All legal rules are in comprehensive legislative\nenactments often called Codes\n\xe2\x80\xa2 Written judicial decisions of appellate courts are\nnot binding legal authority\n\xe2\x80\xa2 The legal system is inquisatorial\n\nReligious\nLaw\n\n\xe2\x80\xa2 Religious documents are used as legal sources\n\xe2\x80\xa2 All major world religions have a religious legal\nsystem\n\xe2\x80\xa2 Most nations that have religious legal systems use\nthem to supplement a secular national system\n\nCustomary\nLaw\n\n\xe2\x80\xa2 Legal system used by a monarchy or tribe\n\xe2\x80\xa2 Grants specific legal powers to kings, queens,\nsultans or tribal leaders as heads of state\n\xe2\x80\xa2 Monarchs and leaders often seen to be \xe2\x80\x9cabove the\nlaw\xe2\x80\x9d\n\nHybrid\nLaw\n\n\xe2\x80\xa2 Combination of 2 or more legal systems within a\nnation\n\nCommon Law Systems\nThe legal system in the United States comes from the English\ncommon law tradition and the US Constitution. English\n9 | Introduction to Law & Legal Systems\n\n\x0ccommon law is a system that gives written judicial decisions\nthe force of law. As a result, the US legal system recognizes an\nappellate court\xe2\x80\x99s ability to interpret and apply the law to future\nlitigants through precedent. Precedent is a judicial opinion\nthat is considered legal authority for future cases involving the\nsame or similar questions of law. The benefit of this system is\nconsistency and resolution of disputes without requiring the\nparties to take legal matters to court.\nA famous example of how precedent works is the US Supreme\nCourt case Brown v. Board of Education of Topeka. In this\nlandmark 1954 case, the Justices unanimously ruled that racial\nsegregation of children in public schools is unconstitutional.\nBrown v. Board of Education is one of the cornerstones of\nthe Civil Rights Movement and helped establish the precedent\nthat \xe2\x80\x9cseparate-but-equal\xe2\x80\x9d education and other services were\nnot, in fact, equal at all. The case required all racially segregated\npublic schools to integrate, not just in Topeka, Kansas. In\naddition, Brown has been cited as legal precedent in\nthousands of cases nationwide involving racial equality.\nThe common law legal system is adversarial. This means that\nthe parties bring their cases to the court for resolution. The\njudge or jury hears the parties\xe2\x80\x99 evidence and arguments before\nmaking a final decision. It is the parties\xe2\x80\x99 burden to investigate\nthe facts, argue the law, and present their best case. Judges\nand juries do not do independent investigations nor are they\nresponsible for helping parties argue their cases. It is a party\xe2\x80\x99s\nresponsibility to raise all legal issues.\nAnother characteristic of common law systems is that cases\nare often decided by juries of the parties\xe2\x80\x99 peers. In both civil\nand criminal matters, the parties usually have a right to have\na jury pulled from local citizens to resolve the dispute. When\na jury determines the outcome of a case, the judge acts as a\n\xe2\x80\x9cgatekeeper,\xe2\x80\x9d who decides what evidence and legal arguments\n\nIntroduction to Law & Legal Systems | 10\n\n\x0cthe jury can properly consider. The judge ensures the parties\nreceive a fair trial while the jury decides the outcome of the\ntrial.\nThe common law tradition is unique to England, the United\nStates, and former British colonies. Although there are\ndifferences among common law systems (e.g., whether\njudiciaries may declare legislative acts unconstitutional and\nhow frequently juries may be used), all of them recognize the\nuse of precedent, and none of them relies solely on the\ncomprehensive, legislative codes that are prevalent in civil law\nsystems.\n\nCivil Law Systems\nCivil law systems were developed in Europe and are based on\nRoman and Napoleonic law. Civil law systems are also called\ncode systems because all the legal rules are in one or more\ncomprehensive legislative enactments. During Napoleon\xe2\x80\x99s\nreign, a comprehensive book of laws\xe2\x80\x94a code\xe2\x80\x94was developed\nfor all of France. The code covered criminal law and procedure,\nnon-criminal law and procedure, and commercial law. The\ncode is used to resolve only cases brought to the courts, which\nare usually decided by judges without a jury.\nCivil law systems are inquisitorial systems in which judges\nactively investigate cases. Judges have the authority to request\ndocuments and testimony, as well as to shape the parties\xe2\x80\x99 legal\nclaims. In addition, judges are not required to follow the\ndecisions of other courts in similar cases. The law is in the code,\nnot in the cases. The legislature, not the courts, is the primary\nplace to enact and modify laws.\nCivil law systems are used throughout Europe, Central and\nSouth America, Asia and Africa. France, Germany, Holland,\n11 | Introduction to Law & Legal Systems\n\n\x0cSpain, and Portugal had colonies outside of Europe, and many\nof these colonies adopted the legal practices that were\nimposed on them by colonial rule.\nThere are also communist and socialist legal systems that differ\nsignificantly from traditional civil law systems. Legal scholars\ndebate whether this is a separate type of legal system or a\nsubset of modern civil law systems. In a communist or socialist\nlegal system, the nation has a code but most property is owned\nby the government or agricultural cooperatives. In addition, the\njudiciary is subservient to the Communist party and is not an\nindependent branch of government.\n\nReligious Law Systems\nReligious law systems arise from the sacred texts of religious\ntraditions and usually apply to all aspects of life, including social\nand business relations. In religious legal systems, a religious\ndocument is used as a primary legal source. All major world\nreligions\xe2\x80\x93Judaism,\n\nChristianity,\n\nIslam,\n\nBuddhism\n\nand\n\nHinduism\xe2\x80\x93have a religious legal system. The Islamic legal\nsystem (Sharia) with Islamic jurisprudence (Fiqh) is the most\nwidely used religious legal system in the world. Most nations\nthat have religious legal systems use them to supplement their\nsecular national system. Only Saudi Arabia (Islamic) and the\nVatican (Christian) are pure theocracies that have only a\nreligious legal system in their nations.\n\nCustomary Law Systems\nCustomary legal systems are becoming increasingly less\ncommon. A customary system is used by a monarchy and\ngrants specific legal powers to the kings, queens, sultans or\nIntroduction to Law & Legal Systems | 12\n\n\x0ctribal leaders as heads of state. A challenge of a customary\nsystem is that the ruler is seen to be \xe2\x80\x9cabove the law\xe2\x80\x9d because\nthe laws do not apply equally to the ruler and subjects. There\nare only a handful of monarchies remaining in the world, and\nmost of them have evolved into hybrid legal systems or have\nadopted a different type of legal system.\n\nHybrid Law Systems\nHybrid legal systems are a combination of two or more legal\nsystems within a nation. India is a classic example of a nation\nwith a hybrid legal system. As a former British colony, India has\na common law legal system, which recognizes the power of\nthe Supreme Court and High Courts to make binding judicial\ndecisions as a form of precedent. However, most of its laws\nare integrated codes found in a Napoleonic code system. In\naddition, India has separate personal codes that apply to\nMuslims, Christians, and Hindus. As a result, India has a hybrid\nsystem made up of common law, civil law and religious law\nsystems.\nFigure 1.1 Legal Systems of the World Map\n\n13 | Introduction to Law & Legal Systems\n\n\x0c1.4 Sources of Law\nWhere does law come from? How do individuals and\nbusinesses know right from wrong? Not all actions that are\nconsidered \xe2\x80\x9cwrong\xe2\x80\x9d or inappropriate are violations of the law.\nThey simply may represent social norms. So what is the\ndifference? There are two types of rules in our society\xe2\x80\x94social\nnorms and laws.\nSocial norms are the informal rules that govern behavior in\ngroups and societies. Social norms and cultural expectations\nmay\n\nbe\n\nviolated\n\nwith\n\nnegative\n\nsocial\n\nor\n\nprofessional\n\nconsequences for doing so. However, no legal repercussions\nfollow violating social norms alone.\nViolations of law are different. Violating the law carries\npenalties, such as civil liability, fines, or loss of liberty. While it is\noptional to conform to social customs, people are compelled to\nobey the law under threat of penalty.\nLaws are generally classified as public law or private law. Public\nlaw applies to everyone. It is law that has been created by a\nlegitimate authority with the power to create law, and it applies\nto the people within its jurisdiction. In the United States, the\nlawmaking authority itself is also subject to those laws, because\nno one is \xe2\x80\x9cabove\xe2\x80\x9d the law. If the law is violated, penalties may\nbe levied against violators. Examples of public law include\nconstitutions, criminal laws, and administrative laws. For\nexample, if someone steals items from a store, the thief is\nviolating public law. He committed the crime of theft which\naffects the community as a whole (not just the store owners),\nand the crime is defined in public legislation.\nPrivate law is law that is binding on specific parties. For\ninstance, parties to a contract are involved in a private law\nagreement. The terms of the contract apply to the parties of\nIntroduction to Law & Legal Systems | 14\n\n\x0cthe contract but not anyone else. If the parties have a contract\ndispute, the terms of the contract and the remedy for breach\nwill apply only to the parties of the contract. In addition to\ncontracts, other examples of private law include tort and\nproperty laws. For example, if someone installs an industrial\nsmoker on his property and the smoke creates a dense haze\nin the neighbor\xe2\x80\x99s yard, there may be a violation of private law\nbecause the smoke is interfering with the neighbor\xe2\x80\x99s right to\npeacefully enjoy one\xe2\x80\x99s property.\nLaws are also classified as civil or criminal. Civil law is usually\nbrought by a private party against another private party. For\nexample, one company decides to sue another for breach of\ncontract. Or a customer sues a business when injured by the\ncompany\xe2\x80\x99s product. Most laws affecting businesses are civil.\nCriminal law involves a governmental decision to prosecute\nsomeone for violating a criminal statute. If someone breaks a\ncriminal law, he or she could lose their freedom (i.e. be sent to\nprison) or lose their life (i.e. if convicted of a capital offense). In\na civil action, no one is sent to prison. Usually, liability results in\nthe loss of property such as money or assets.\nCivil\n\nCriminal\n\nSource of\nLaw\n\nstatute or common law\n\nstatutes defining crimes\n\nWho files\ncase?\n\nbusiness or individual\nsuffering harm\n\nthe government (e.g.\nDistrict Attorney)\n\nBurden of\nProof\n\npreponderance of\nevidence\n\nbeyond a reasonable doubt\n\nRemedy\n\ndamages, injunction,\nspecific performance\n\npunishment (e.g. fine or\nimprisonment)\n\nPurpose\n\nprovide compensation\nor private relief\n\nprotect society\n\nAdditionally, some law is procedural and some law is\nsubstantive. Procedural law describes the legal process and\n15 | Introduction to Law & Legal Systems\n\n\x0crules that are required and must be followed. For instance,\nparties who are sued in court must receive notice of the lawsuit\nbefore the court can impose judgment against them.\nSubstantive law refers to the actual substance of the law or the\nmerits of the claim, case, or action. Substantive law embodies\nthe ideas of legal rights and duties and is captured by different\nsources of law, including the Constitution, statutes, and\ncommon law.\nFor example, if someone drives fifty-five miles per hour in a\nforty mile-per-hour zone, she has broken the substantive rule\nof law of the speed limit. However, how and what gets decided\nin court related to the speeding ticket is a matter of procedural\nlaw. For example, whether the driver is entitled to a hearing\nbefore a judge, whether she has a right to be represented by\nlegal counsel, whether the hearing takes place within a certain\namount of time after the ticket was issued, and what type of\nevidence can be presented are procedural law issues.\n\nSources of Law\nIn the United States, our laws come primarily from:\n\xe2\x80\xa2 Federal and state constitutions;\n\xe2\x80\xa2 Statutory law from Congress, the state legislatures, and\nlocal legislative bodies;\n\xe2\x80\xa2 Common law from federal and state appellate courts;\n\xe2\x80\xa2 Administrative rules and regulations;\n\xe2\x80\xa2 Treaties and conventions; and\n\xe2\x80\xa2 Executive orders.\n\nIntroduction to Law & Legal Systems | 16\n\n\x0cConstitutions\nThe most fundamental law in the United States is the US\nConstitution, which is the supreme law of the nation. Any law\nthat conflicts with it is void. The Constitution serves three\nimportant functions. First, it establishes the structure of our\nnational government and identifies the powers of the\nlegislative, executive, and judicial branches. Second, it defines\nthe boundaries of each branch\xe2\x80\x99s authority and creates \xe2\x80\x9cchecks\xe2\x80\x9d\non each branch by the other branches. For example, the\npresident is the commander-in-chief of the armed forces, but\ndoes not have the power to declare war. That duty falls to\nCongress. And, third, the Constitution guarantees civil liberties\nand individual rights.\nThe power granted to the federal government by the\nConstitution is limited. Any powers not expressly granted to\nthe federal government by the Constitution are reserved to\nthe states. This means that if the Constitution does not give\nthe federal government power over a particular area, then the\nstates regulate it.\nThe first ten amendments to the Constitution are known as the\nBill of Rights. Despite the limited power granted to the federal\ngovernment by the Constitution, the Bill of Rights protects\ncertain individual civil rights and liberties from governmental\ninterference. These rights include the freedom of speech and\nreligion, the right to bear arms, and the rights of individuals\nwho are suspected and accused of crimes.\nFigure 1.2 Separation of Powers of the Federal Government\n\n17 | Introduction to Law & Legal Systems\n\n\x0cEach state also has its own constitution, which serves\nessentially the same function for the state government as the\nUS Constitution serves for the federal government. Specifically,\nthey establish limits of state government power, establish the\norganization\n\nand\n\nduties\n\nof\n\nthe\n\ndifferent\n\nbranches\n\nof\n\ngovernment at the state level, and protect fundamental rights\nof state citizens. This dual system of government in the United\nStates is called federalism, which is a governance structure\nwhereby the federal government and the state governments\ncoexist through a shared power scheme.\nFigure 1.3 Separation of Powers of the State Governments\n\nIntroduction to Law & Legal Systems | 18\n\n\x0cStatutes\nStatutes are laws created by a legislative body. Congress is\nthe federal legislative body, and each state also has its own\nlegislative body. Almost all statutes are created by the same\nmethod. An idea for a new law is proposed in the legislature.\nThis proposal is called a bill. The House of Representatives and\nSenate independently vote on a bill. If the majority of both\nchambers approves it, the bill is sent to the president or\ngovernor for approval. If the president or governor signs the bill,\nthen it becomes a statute.\nLocal governments, such as counties, cities, and townships,\nmay be authorized under a state constitution to create or adopt\nordinances. An ordinance is a legislative act of a local\n\n19 | Introduction to Law & Legal Systems\n\n\x0cgovernment entity. Examples of ordinances include building\ncodes, zoning laws, and misdemeanors such as jaywalking.\n\nCommon Law\nBinding legal principles also come from the courts. When\nappellate courts decide a case, they may interpret and apply\nlegal principles in a way that are binding on lower courts in the\nfuture. The process of applying a prior appellate decision to a\ncase is called precedent. Simply put, precedent is when judges\nuse past decisions to guide them. The benefit of precedent is\nthat it makes the law predictable and furthers the rule of law\nby applying legal principles to the greater community, not just\nthe parties to a lawsuit. Businesses value common law systems\nbecause they reduce the cost of business. For example, if a\nbusiness is unsure of how its contract rights will be applied by\nthe court, it can understand its rights by learning how courts\ninterpreted similar contract provisions in past lawsuits. This\nallows businesses to assess their risks, determine their liability,\nand make rational business decisions without the expense of\nlitigation.\n\nAdministrative Rules and Regulations\nAdministrative law is the collection of rules and decisions\nmade by agencies to fill in particular details missing from\nconstitutions and statutes. For example, the Internal Revenue\nService (IRS) is the federal agency responsible for collecting\nnational taxes and administering the Internal Revenue Code\nenacted by Congress. All businesses and individuals must\nfollow the IRS rules and regulations about how to report, file,\nand pay applicable taxes that Congress levies. Congress passes\n\nIntroduction to Law & Legal Systems | 20\n\n\x0cstatute defining \xe2\x80\x9cwhat\xe2\x80\x9d taxes need to be paid. The IRS adopts\nthe rules about \xe2\x80\x9chow\xe2\x80\x9d those taxes are paid.\nIn the United States, many of the day-to-day regulation of\nbusinesses is done by administrative agencies. These agencies\nare created by the legislature to implement and enforce a\nparticular statute. Agencies often report to the executive\nbranch, but some are run by independent commissions.\nLegislative bodies give agencies the power to create rules and\nregulations that individuals and businesses must follow to\ncomply with the statute. For example, the Environmental\nProtection Agency (EPA) was created to implement and\nenforce the Clean Air Act and the Clean Water Act.\n\nTreaties and Conventions\nA treaty is a binding agreement between two nations. A\nconvention is a binding agreement among a group of nations.\nIn the US, a treaty or convention is generally negotiated by the\nexecutive branch. To be binding, the US Constitution requires\nthe Senate to ratify treaties by a two-thirds vote. Once ratified,\na treaty becomes part of federal law with the same weight and\neffect as a statute passed by the entire Congress. Therefore,\ntreaties and conventions have equal standing as statutes in US\nlaw.\n\nExecutive Orders\nArticle II, Section 1 of the US Constitution gives the president\nthe power to \xe2\x80\x9ctake care that the laws be faithfully executed.\xe2\x80\x9d\nUnder this power, the president may issue executive orders\nrequiring officials in the executive branch to perform their\nduties in a particular manner. State governors have the same\n21 | Introduction to Law & Legal Systems\n\n\x0cauthority under state constitutions. Although they are not laws\nthat apply directly to individuals and businesses, executive\norders are important legal documents because they direct the\ngovernment\xe2\x80\x99s enforcement efforts.\nHierarchy of Sources of Law\nPriority\n\nSource\n\nComment\n\n1\n\nConstitutions\n\nExist at both federal and state levels\n\n2 (tie)\n\nStatutes\n\nLaws passed by the federal or state\nlegislatures\n\n2 (tie)\n\nTreaties and\nConventions\n\nInternational agreements that have the\nsame standing as statutes\n\n4\n\nJudicial\nOpinions\n\nCourt interpretation and application of\nconstitutions, statutes, treaties, agency\nregulations, and executive orders\n\n5\n\nAgency\nRegulations\n\nRules and regulations adopted by\nadministrative agencies at the federal,\nstate, or local level\n\n6\n\nExecutive\nOrders\n\nGuidance from the president or\ngovernor to executive branch officials\nabout how to perform their duty\n\n1.5 Concluding Thoughts\nUnderstanding business law is essential to successfully\nrunning any type of business because a solid understanding\nof laws and regulations helps avoid liability and minimizes risk.\nIn business, it is not enough to conduct business ethically.\nKnowledge of business law is essential to successful business\npractices. Ultimately, business people should be able to\nrecognize legal issues, minimize liability exposure, and know\nwhen to consult an attorney.\nLegal systems vary widely in their aims and in the way they\n\nIntroduction to Law & Legal Systems | 22\n\n\x0cresolve disputes. Common law systems are adversarial, use\njuries and adhere to precedent. Civil law systems are\ninquisatorial, do not use juries and do not recognize precedent.\nAll major world religions have a legal system, although only two\nnations have a purely national religious system. Many nations\nhave hybrid legal systems that combine two or more legal\nsystems.\nThe legal system in the United States is composed of multiple\njurisdictions at the local, state and federal levels. Local and state\nlaws may not conflict with federal laws. Primary sources of law\nin the United States include constitutional law, statutory law,\ncommon law, administrative law, treaties, and executive orders.\n\n23 | Introduction to Law & Legal Systems\n\n\x0c2. The United States\nCourt System\n2.1 Introduction\nLEARNING OBJECTIVES\n1. Understand the US court system and how it affects the\nconduct of businesses.\n2. Understand the three branches of government and how\nthey check and balance each other\xe2\x80\x99s powers.\n3. Explore the state and federal court systems.\nIn the United States, law and government are interdependent.\nThe US Constitution establishes the basic framework of the\nfederal government and imposes certain limitations on the\npowers of government. In turn, the various branches of\ngovernment are intimately involved in making, enforcing, and\ninterpreting the law. Most law comes from Congress and the\nstate legislatures. Courts interpret the laws and apply them to\ncases.\nLaws are meaningless if they are not enforced. Companies have\nto make many decisions daily, from product development to\nmarketing to maintaining growth. These decisions are based\non financial considerations and legal requirements. If a\ncompany violates a law, it is often held accountable through\nlitigation in courts.\n\nThe United States Court\nSystem | 24\n\n\x0cCounselor\xe2\x80\x99s Corner Under the Supreme\nCourt\xe2\x80\x99s Citizens United decision, business entities\nenjoy the same right as natural persons to influence\nthe political process through contributions.\nBecause federal judges are appointed for life,\nbusinesses cannot directly influence actions of the\njudicial branch. However, they can do so indirectly\nby lobbying Congress on laws that it considers and\nlobbying the president concerning enforcement\npriorities. While all states have a comparable threebranch system, in some states (not in Colorado),\njudges obtain office through partisan elections. In\nsuch states, businesses can seek to influence the\njudicial branch through supporting judges whose\nphilosophy favors business generally or a particular\nindustry. For these reasons, in choosing whether to\nlitigate in state or federal court, businesses should\nconsider that federal judges may be more likely to\ntake politically unpopular actions.\n\n~John W., judge\n\n2.2 Separation of Powers\nUnder the US Constitution, power is separated among three\nbranches of government. Article I of the Constitution allocates\nthe legislative power to Congress, which is composed of the\nHouse of Representatives and the Senate. Congress makes\nlaws and represents the will of the people. Article II of the\nConstitution creates the executive power in the president and\nmakes the president responsible for enforcing the laws passed\nby Congress. Article III of the Constitution establishes a\n25 | The United States Court System\n\n\x0cseparate and independent judiciary, which is in charge of\napplying and interpreting the meaning of the law. The US\nSupreme Court is the highest court in the federal judiciary and\nconsists of nine Justices.\nFigure 2.1 Separation of Powers of the Branches of the Federal\nGovernment\n\nThe Constitution is remarkably short in describing the judicial\nbranch.\n\nUnder\n\nthe\n\nConstitution,\n\nthere\n\nare\n\nonly\n\ntwo\n\nrequirements to becoming a federal judge: nomination by the\npresident and confirmation by the Senate. Article III provides:\n\xe2\x80\x9cThe judicial power of the United States, shall be vested in one\nSupreme Court, and in such inferior courts as the Congress\nmay from time to time ordain and establish.\xe2\x80\x9d The Constitution\nalso guarantees that how judges decide cases does not affect\n\nThe United States Court System | 26\n\n\x0ctheir jobs because they have lifetime tenure and a salary that\ncannot be reduced.\nSeparation of powers is discussed in more detail in Chapter 5.\n\nMarbury v. Madison\nIn 1800, the presidential election between John Adams and\nThomas Jefferson nearly tore the nation apart. John Adams\nwas the President and his Vice-President, Thomas Jefferson,\nran against him. They were both Founding Fathers but were\nmembers of different political parties that had opposing\nvisions for the future of the new nation. The election was bitter,\npartisan, and divisive. Jefferson won but wasn\xe2\x80\x99t declared the\nwinner until early in 1801. In the meantime, Adams and other\nFederalists in Congress attempted to leave their mark on\ngovernment by creating a slate of new life-tenured judgeships\nand appointing Federalists to those positions. For the\njudgeships to become effective, official commissions had to\nbe delivered in person to the new judges. At the time power\ntransitioned from Adams to Jefferson, several commissions\nhad not been delivered, and Jefferson ordered his acting\nsecretary of state to stop delivering them. When Jefferson\ncame to power, there was not a single federal judge from his\nDemocratic-Republican Party, and he refused to expand the\nFederalist influence any further.\nOne Federalist judge, William Marbury, sued Secretary of State\nJames Madison to deliver his commission. The case was filed\nin the Supreme Court, led by Chief Justice John Marshall, who\nwas also a Federalist. In a shrewd move, Marshall ruled against\nMarbury while declaring that it was the Supreme Court\xe2\x80\x99s role\nto decide the meaning of the Constitution. This is called judicial\nreview, and it makes the US Supreme Court an equal branch\nof government to the Executive and Legislative branches.\nBecause President Jefferson won the case, he was willing to\n\n27 | The United States Court System\n\n\x0caccept the Supreme Court\xe2\x80\x99s assertion of power as an equal\nbranch of government.\n\nChecks and Balances\nThe US Constitution establishes the three branches of the\nfederal government as independent branches with their own\nauthority. The Founding Fathers were fearful of setting up an\nauthoritarian regime, where the rulers of the government are\nabove the law and often rule arbitrarily. Therefore, the\nFounding Fathers ensured that each branch of government\nhad a \xe2\x80\x9ccheck\xe2\x80\x9d on the other two branches in order to \xe2\x80\x9cbalance\xe2\x80\x9d\nthe power of the government among the branches. Therefore,\nif a president decided to become a dictator, the other two\nbranches could prevent him.\nFigure 2.2 Checks and Balances of the Federal Government\n\nJudicial review means that any federal court can hold any act\n\nThe United States Court System | 28\n\n\x0cof the president or Congress to be unconstitutional. This is the\npower of the Judicial Branch to ensure that the Executive and\nLegislative branches do not overstep their powers and violate\nthe Constitution.\nThe other branches each have a \xe2\x80\x9ccheck\xe2\x80\x9d on the judiciary. For\nexample, the president (Executive branch) can control the\njudiciary by nominating judges. The president can also pardon\nthose convicted by a federal court. A pardon is an executive\norder vacating a criminal sentence for a crime.\nCongress also plays an important role in \xe2\x80\x9cchecking\xe2\x80\x9d the\njudiciary. The most obvious role is in confirming judicial\nselections. In addition to confirmation, Congress also controls\nthe judiciary through its annual budgetary process. Although\nthe Constitution protects judicial salaries from any reductions,\nCongress is not obligated to grant any raises. Finally, Congress\ncan control the judiciary by determining how the courts are\norganized and what kind of cases the courts can hear, except\nfor the types of cases the Constitution lists as the original\njurisdiction of the Supreme Court.\n\n2.3 Federalism\nThere are fifty-six separate legal systems in the United States:\nthose of the fifty states, the federal government, the District\nof Columbia, the military, and three territorial systems. Within\neach legal system is a complex interplay among executive,\nlegislative, and judicial branches of government. This division\nof authority between a central, federal government and state\ngovernments is known as federalism.\nIn the United States, the federal government only has the\nauthority given to it by the states via the US Constitution. If\n\n29 | The United States Court System\n\n\x0ca power is not granted to the federal government, the states\nretain the power. For example, the federal government cannot\ntax the exchange of goods between states as \xe2\x80\x9cexports.\xe2\x80\x9d The\nConstitution limits the power of the federal government, and\nthe\n\nstate\n\nconstitutions\n\nlimit\n\nthe\n\npower\n\nof\n\nthe\n\nstate\n\ngovernments.\nFigure 2.3 Federalism Between Federal and State Governments\n\nFederalism is discussed in more detail in Chapter 5.\n\nJurisdiction\nThe authority of a court to hear a particular type of case is\ncalled jurisdiction. State and federal courts hear different types\nof cases, involving different laws, different law enforcement\nagencies, and different judicial systems. The rules governing\nthe procedures used in these courts are known as civil\nprocedure or criminal procedure.\n\nThe United States Court System | 30\n\n\x0cThe rules of subject matter jurisdiction dictate whether a case\nis heard in federal or state court. The vast majority of civil\nlawsuits are filed in state courts, including lawsuits involving\nstate laws such as property, contracts, probate law, and torts.\nState laws also involve most criminal cases, and domestic\nissues such as divorce and child custody. Torts are any civil\nwrong other than a breach of contract and include a variety of\nsituations in which people and businesses suffer legal injury.\nSome states are friendlier toward torts than others, and the\nresulting patchwork of tort laws means that companies that\ndo business across the nation need to know the different\nstandards they are held to based on the state their customers\nlive in.\nGiven the wide array of subject areas regulated by state law,\nmost businesses deal with state courts. Federal court subject\nmatter jurisdiction is generally limited to federal question\njurisdiction. In other words, federal courts hear cases involving\nthe Constitution or a federal law. Cases involving the\ninterpretation of treaties to which the United States is a party\nare also subject to federal court jurisdiction. Finally, lawsuits\nbetween states can be filed directly in the US Supreme Court.\nSometimes a federal court may hear a case involving state law.\nThese cases are called diversity jurisdiction cases, and they\narise when all plaintiffs in a civil case are from different states\nthan all defendants, and the amount claimed by the plaintiffs\nexceeds seventy-five thousand dollars. For example, a citizen\nof New Jersey may sue a citizen of New York over a contract\ndispute in federal court. But if both were citizens of New York,\nthe plaintiff would be limited to the state court of New York.\nDiversity jurisdiction cases allow one party who feels it may\nnot receive a fair trial where its opponent has a \xe2\x80\x9chome court\nadvantage\xe2\x80\x9d to seek a neutral forum to try the case.\n\n31 | The United States Court System\n\n\x0cType of\nJurisdiction\n\nDescription\n\nMinimum\nDollar\nRequirement\n\nApplicable\nLaw\n\nFederal\nQuestion\n\nCases involving\nthe US\nConstitution,\ntreaties, or\nfederal laws &\nregulations\n\nNone\n\nFederal law\n\nDiversity of\nCitizenship\n\nCases brought\nbetween\ncitizens of\ndifferent states\n\n$75,000\n\nState law\n\n2.4 Trial and Appellate Courts\nWithin the federal court and the state court systems, there are\na hierarchy of courts. The first level of court is a trial court or\na court of limited jurisdiction such as traffic court and small\nclaims court. Trial courts accept evidence and testimony to\ndetermine what happened in a case. Appellate courts review\nthe decisions of the trial court, without holding a new trial, to\ndetermine whether the parties received a fair trial and whether\nthe appropriate law was applied.\nFigure 2.4 Court System Hierarchy\n\nThe United States Court System | 32\n\n\x0cIn the federal court system, cases are filed in the US District\nCourt. There are ninety-four judicial districts in the nation,\nwhich are named for their geographical location. However,\nsome states with low population have only one judicial district,\nwhile more populous states have multiple judicial districts. The\nUS Department of Justice, which acts as the prosecutor\nrepresenting the federal government in both civil and criminal\ncases, divides its attorneys among the ninety-four judicial\ndistricts.\nAs a trial court, the US District Courts hear both civil and\ncriminal cases. At trial, witnesses are called and their\ntestimonies are recorded into a trial record. The losing party is\nentitled to appeal the case to the US Circuit Court of Appeals.\nThere are thirteen circuit courts in the United States. A party\nlosing an appeal at the circuit court level may ask the US\nSupreme Court to hear its case. However, the Constitution only\nrequires the Supreme Court to hear a few types of appeals.\nFigure 2.5 Map of Federal Circuit Courts\n\n33 | The United States Court System\n\n\x0cIn the state court system, a trial court of general jurisdiction\naccepts most types of civil and criminal cases. These courts are\ncalled various names such as superior court, circuit court, or\ndistrict court. There may be other courts of limited jurisdiction\nat the state level, such as traffic court, family court, or small\nclaims court. Like their federal counterparts, state trial courts\nhold trials, and preserve a trial record for review by an appellate\ncourt. Finally, in certain state cases that involve a federal\nconstitutional right, a party that loses at the state supreme\ncourt level can appeal to the US Supreme Court. These cases\ntypically involve the application of the Constitution to criminal\nprocedure, evidence collection, or punishment.\nWhenever an appeal is filed, the trial record is forwarded to\nthe appellate court for review. Appellate courts do not conduct\nnew trials and are unable to recall witnesses or call new\nwitnesses. The trial court\xe2\x80\x99s duty is to figure out the facts of the\ncase\xe2\x80\x94who did what, when, why, or how. This process of factfinding is an important part of the judicial process, and a great\ndeal of deference is placed on the judgment of the fact finder,\nwhich is usually the jury. The issues on appeal are therefore\nlimited to questions of law or legal errors. The deference to the\n\nThe United States Court System | 34\n\n\x0cfact finder means that, as a practical matter, appeals are hard\nto win.\nFigure 2.6 Roles of Trial and Appellate Courts\n\n2.5 Concluding Thoughts\nThe US Constitution establishes the three branches of the\nfederal government and gives them the ability to check each\nother\xe2\x80\x99s authority. The Judicial branch oversees the actions of\nthe Executive and Legislative branches through judicial review\nto ensure that they do not violate the Constitution. While not\nperfect, the US federalist system was designed to restrain\ngovernmental power and to prevent the rise of an authoritarian\nregime.\n35 | The United States Court System\n\n\x0cThe Judicial Branch is the only unelected branch of\ngovernment. Marbury v. Madison established the doctrine of\njudicial review, which allows courts to determine the final\nvalidity of laws as well as the meaning of the Constitution. The\npresident can check the judiciary through appointments and\nthe pardon power. Congress can check the judiciary through\nconfirming judges, administrative control of court calendars\nand funds, and legislation about the types of cases a court can\nhear.\nThere are fifty-six separate legal systems in the United States.\nSubject matter jurisdiction is the authority of a court to hear\na case based on the type of dispute. State law claims are\ngenerally heard in state courts, while federal question cases\nare generally heard in federal court. Federal courts may hear\nstate law claims under diversity jurisdiction. Federal cases are\nfiled in a US District Court and appealed to a US Circuit Court\nof Appeals. State cases are typically filed in a trial court and\nappealed to an intermediate court of appeals.\n\nThe United States Court System | 36\n\n\x0c3. Litigation\n3.1 Introduction\nLEARNING OBJECTIVES\n1. Identify the parties involved in litigation.\n2. Explore the responsibilities of attorneys.\n3. Understand the roles and types of juries.\n4. Explore the standing requirement.\n5. Follow a trial from opening statements to closing\narguments.\nLitigation provides an opportunity for each side in a dispute to\ntell their story to an impartial jury or judge to decide who wins.\nBusiness professionals have a responsibility to their company\nand stakeholders to avoid legal liability. Acting ethically helps\nachieve this goal. Agreeing to mediation or arbitration may\nhelp businesses avoid court. However, litigation may be the\nonly dispute-resolution mechanism available or the one that is\nbest for the situation.\n\nCounselor\xe2\x80\x99s Corner Litigation is like any other\nbusiness effort: you are trying to get someone to see\nthings your way. The best way to do that is to be\nlikable and persuasive to the judge, other lawyers,\nand the jury. Construct your theory of the case early\non. Meet your deadlines. Maintain a strict ethical\n\n37 | Litigation\n\n\x0cstandard in your professional life. Work hard to\nexplore both sides of the case, and develop a short\nand compelling statement about why your side\nshould prevail. If you do all that, you will make it easy\nfor others to want to find in your favor. Why does\nthis work? Because as humans, we want good to\nprevail. Be good.\n\n~Valerie M., magistrate\n\n3.2 The Parties, Attorneys, and Jury\nThe Parties\nThe litigation system relies on parties to bring forth and defend\ntheir respective claims. The party that begins a civil lawsuit is\ncalled the plaintiff. The plaintiff sues the defendant to recover\ndamages for, or to stop, a legal wrong. In a criminal trial, the\nparty that initiates litigation is the prosecution, representing\nthe people within a state or federal government. In a criminal\ntrial the accused wrongdoer is also called the defendant.\nCases may involve multiple plaintiffs and multiple defendants.\nCivil procedure encourages parties to bring their complaints\nagainst each other at once. All parties, and every possible claim\n(each claim is a separate violation of law) arising out of a single\nincident or series of related incidents, should be identified and\nraised in a lawsuit.\nExcept in some small-claims courts, parties may hire attorneys\nto represent them. Individuals who represent themselves are\ncalled pro se litigants. The complexities of litigation require\nLitigation | 38\n\n\x0cknowledge and objectivity to succeed. Courts hold pro se\nlitigants to the same standards as they do attorneys. Therefore,\na pro se litigant is expected to understand and follow all the\nrules of the court and applicable laws.\n\nAttorneys\nIn the United States, law school is a graduate-level program\nthat usually takes three years to complete. Law school\ngraduates earn a Juris Doctorate degree, or JD. Graduates then\ntake the bar exam in the state where they wish to practice. If\nthey pass the exam and background check, they can apply to\nbe licensed in that state. Because the practice of law in the\nUnited States varies widely by jurisdiction, attorneys are only\npermitted to practice in jurisdictions where they are licensed.\nAttorneys are bound by a professional code of ethics that is\noverseen by the supreme court of the state where they are\nlicensed. One of the most important rules of professional\nresponsibility is the obligation to keep a client\xe2\x80\x99s secrets. The\ncommunications between a client and his or her attorney are\nabsolutely confidential under the attorney-client privilege\ndoctrine. The privilege belongs to the client, and the attorney is\nnot permitted to reveal any of these communications without\nthe client\xe2\x80\x99s consent. A narrow exception exists for clients who\ntell their attorneys they intend to harm others or themselves.\nAttorneys must avoid violating the privilege because it exists\nfor the client\xe2\x80\x99s benefit. Someone who cannot communicate\nwith his or her attorney freely is unable to help the attorney\nprepare the best possible case.\nIn spite of an attorney\xe2\x80\x99s professional obligations to his or her\nclient, it\xe2\x80\x99s important to remember that ultimately an attorney\xe2\x80\x99s\nfirst duty is to the administration of justice. The requirements\n\n39 | Litigation\n\n\x0cfor attorneys to be civil, honest, and fair are written to ensure\nthat attorneys represent the very best aspects of the judicial\nsystem. For example, a client admits to his attorney that he is\nguilty of a crime. The client then wants to testify under oath\nthat he is innocent. Although an attorney cannot reveal what\nher client has told her, the attorney is prohibited from\nknowingly suborning perjury. The attorney must either\nconvince the client to not testify or withdraw from the case.\nAn attorney owes her client zealous advocacy, but her zeal\nmust be constrained within the bounds placed on her as an\nofficer of the Court and under the Court\xe2\x80\x99s rules. Attorneys\ncannot assert legal claims or arguments that are not wellfounded under existing law or through the modification or\nexpansion of law. Attorneys are also prohibited from using the\ncourts for a purpose unrelated to the resolution of a legitimate\nlegal cause of action.\n\nThe Jury\nIn the US legal system, the jury has a very special role of citizen\nparticipation in the administration of justice. As the trier of fact,\nthe jury has the duty of determining the truth in any given\nsituation: who said and did what, why, and when. The litigation\nsystem is a process in which each side gets to present its case\nto a group of unbiased citizens, and then ask them to decide\nwho wins the case.\nThere are two types of juries. A grand jury is a group of citizens\nconvened by the prosecution in serious criminal cases to\ndetermine (1) whether probable cause exists to believe that a\ncrime has occurred, and (2) whether it\xe2\x80\x99s more likely than not\nthat the defendant committed the crime. If the grand jury\ndecides probable cause exists, then the government may bring\n\nLitigation | 40\n\n\x0ccriminal charges against the defendant. The grand jury\nprevents prosecutors from abusing their powers of arrest and\nindictment. The grand jury requirement exists at the federal\nlevel and in most states. A grand jury typically meets for an\nextended period of time and hears several different cases.\nThe grand jury does not determine guilt or innocence. A petit\njury does that. This jury is impaneled for a specific trial. During\nthe trial, members of the jury listen to the evidence presented\nand then deliberate as a group on the facts of the case. They\nthen apply the law, as instructed by the judge, to the facts.\nThere are typically twelve members in a petit jury in criminal\ntrials and from six to twelve members in civil trials. In a criminal\ntrial, a jury must arrive at a unanimous verdict to convict a\ndefendant of the crimes charged.\nThe jury system is incredibly important because ordinary\ncitizens adjudicate all sorts of disputes. There are problems\nwith administering this system, however.\nBoth grand and petit juries are drawn from citizen voter and\ndriver license rolls. In high-profile cases, it may be difficult to\nfind citizens who have not heard about the case or who can be\nimpartial. Another problem arises from the burdens placed on\njurors\xe2\x80\x99 personal lives through their service. While most states\nhave laws that prevent an employer from firing a worker or\ntaking any negative action against workers on jury duty, there\nis no legal requirement that an employer continue to pay a\nworker on jury duty. Some citizens, such as those who are selfemployed, risk losing personal income by serving on juries.\nAnother potential problem arises in the composition of the jury.\nTo provide a fair jury, courts attempt to draw from a crosssection of society to reflect the diversity of the surrounding\ncommunity. Local court rules typically allow judges to excuse\npotential jurors for hardship or extreme inconvenience. The\nonly professions that are automatically exempt are active-duty\n41 | Litigation\n\n\x0cmilitary members, police officers, firefighters, and public\nofficers. In spite of these administrative problems, the jury\nsystem remains a cornerstone of the US legal system.\n\n3.3 Standing\nStanding is a constitutional requirement. Article III of the US\nConstitution grants the judiciary the power to hear \xe2\x80\x9ccases\xe2\x80\x9d and\n\xe2\x80\x9ccontroversies.\xe2\x80\x9d This means actual cases and controversies, not\nmerely hypothetical ones. The standing requirement means\nthat courts are unable to give advisory opinions. Standing is a\ndoctrine that limits judicial overreach by limiting the types of\ncases that are litigated in court.\nTo demonstrate standing, a party has to prove that it has an\nactual case to proceed. This is a procedural matter, and it\nrequires the case to be brought at the right time. If a case is\nbrought too early, it is not yet ripe. If it\xe2\x80\x99s brought too late, then\nthe case is moot.\nThe case also has to be brought by the right person. To show\nstanding, a plaintiff has to demonstrate that he or she has an\nactual stake in the litigation, or something of value that would\nbe lost if he or she loses the case. It\xe2\x80\x99s important to note that\nstanding is not related to the merits of the case. It only means\nthat a party may proceed with litigation.\n\n3.4 Subject Matter and Personal\nJurisdiction\nIn order to hear a case, courts must have subject matter\njurisdiction over the type of dispute and personal jurisdiction\nLitigation | 42\n\n\x0cover the parties. As discussed in Chapter 2, subject matter\njurisdiction is the legal authority to hear and decide a case or\ncontroversy. The court must dismiss a case if it lacks either form\nof jurisdiction.\nPersonal jurisdiction is the power of the court to compel the\nparties to appear in court. Personal jurisdiction requires\nlitigants to have some form of minimum contacts with the\nstate where the case is filed. Personal jurisdiction seeks to avoid\ninconvenient litigation, even if the case has merit.\nA court obtains personal jurisdiction over the plaintiff when the\nplaintiff files a lawsuit. The court obtains personal jurisdiction\nover a defendant when he or she is served with process or\nwaives service.\nObtaining personal jurisdiction over the defendant requires\nsome connection between the defendant and the state where\nthe court is located. Businesses that incorporate, have a\nphysical location, or do business in a state create personal\njurisdiction through their actions within the state. Owning\nproperty in a state also creates personal jurisdiction.\nPersonal\n\njurisdiction,\n\nlike\n\nstanding,\n\nis\n\na\n\nconstitutional\n\nrequirement. Most states have long-arm statutes that set forth\nthe procedure by which out-of-state defendants can be\nrequired to appear before a court. The statutes provide for how\nservice of process occurs. Service of process is the process\nby which a defendant is notified that it is being sued. Service\nof process typically requires a copy of the notice to appear\nbefore a court to be personally delivered to the defendant or\nthe defendant\xe2\x80\x99s agent. In the case of businesses, service of\nprocess is usually delivering a copy of the notice to appear to\ntheir registered agent. Service can be more challenging with\nindividuals.\n\n43 | Litigation\n\n\x0cBasis of\nPersonal\nJurisdiction\n\nDescription\n\nConsent\n\n\xe2\x80\xa2 A business or individual agrees to the\njurisdiction of the court\n\nResidence\n\n\xe2\x80\xa2 A business or individual resides in the state\n\nService of\nProcess\n\n\xe2\x80\xa2 The defendant is served a summons and\ncomplaint within the state\n\nLong-arm\nStatute\n\n\xe2\x80\xa2 A resident business or individual was\ninvolved in an incident in another state; or\n\xe2\x80\xa2 A non-resident business or individual was\ninvolved in an incident within the state\n\n3.5 Venue\nVenue is the proper geographic location of the court to hear a\ncase because the place has some connection with the events\nthat give rise to the lawsuit. While multiple courts may have\nsubject matter and personal jurisdiction over a dispute, only a\nfew may be the proper venue. For example, by doing business\nin Colorado a company is subject to the jurisdiction of Colorado\ncourts. However, the court in the county where the plaintiff was\ninjured or where the business maintains an office would be the\nproper court to hear the dispute.\n\nLitigation | 44\n\n\x0c3.6 Pretrial Procedures\nFigure 3.1 Litigation Flowchart\n\nPleadings\nIn civil cases, litigation begins with the filing of a complaint by\nthe plaintiff. The complaint is a legal document setting forth\nwho the parties are, the facts of the case, and what laws the\nplaintiff claims defendant has violated. The complaint ends\nwith a prayer for relief. The plaintiff may be seeking damages\n(money), specific performance in certain types of contract\ncases, or an injunction.\nThe complaint is filed with the clerk of the court where the\nlawsuit is to be heard. The clerk will issue a summons, which is\n\n45 | Litigation\n\n\x0can official notice that a lawsuit has been filed with the court\nand summons the defendant(s) to court to defend against it.\nTo be effective, the defendant(s) must be served the summons\nand a copy of the complaint.\nIn certain types of cases, there may be a large number of\nplaintiffs injured by a defendant\xe2\x80\x99s actions. This may happen\nin a product liability lawsuit where a product is purchased by\nmany thousands of consumers, all of whom experience the\nsame product failure. In these cases, several lead plaintiffs may\nattempt to form a class in a class action lawsuit against the\ndefendant(s). Under federal civil procedure rules, class actions\nmay be granted when:\n1. There are so many plaintiffs that\n2. It is impractical for them to file separate lawsuits;\n3. There are questions of law or fact that are common to\nmembers of the class; and\n4. The lead plaintiffs will fairly and adequately protect the\ninterests of the class.\nThe defendant must file an answer to the complaint within a\nspecified period of time, usually thirty days. The answer is a\nparagraph-by-paragraph response to the complaint, admitting\ncertain allegations and denying others. The answer may admit,\nfor example, noncontroversial claims by the plaintiff such as the\ndefendant\xe2\x80\x99s name, address, and the nature of the defendant\xe2\x80\x99s\nrelationship with the plaintiff. Each time the defendant denies\na plaintiff\xe2\x80\x99s claim in the complaint, that sets up a controversy or\nargument that must be litigated. The answer may also contain\nany affirmative defenses and counterclaims the defendant\nwishes to pursue. Taken together, the complaint and answer\nare known as the pleadings.\n\nLitigation | 46\n\n\x0cDiscovery\nAfter pleadings are filed, litigation moves into the discovery\nphase. Discovery is a process in which each side finds out\ninformation about the other\xe2\x80\x99s case. Discovery is designed to\nprevent trial by surprise, where either side may suddenly\nproduce a damning piece of evidence. Because trials are based\non the discovery of truth, they should be tried on the merits of\nthe case rather than a party\xe2\x80\x99s deceit. In that spirit, the rules of\ndiscovery are broad. Relevant evidence is discoverable even if\nit is later ruled to be inadmissible at trial by the judge. Parties\nare also obligated to turn over material that supports their case,\nwithout demand from the other side unless it is protected by\nthe attorney-client privilege.\n\n47 | Litigation\n\n\x0cType of\nDiscovery\n\nDescription\n\nRequest for\nAdmission\n\n\xe2\x80\xa2 Ask opposing party to admit specific facts or\nclaims\n\xe2\x80\xa2 Ex: confirm legal name and address, existence\nof contract, etc.\n\nInterrogatory\n\n\xe2\x80\xa2 Written questions to opposing party about\nnature of claim\n\xe2\x80\xa2 Ex: identity of witnesses, extent of injuries,\ndescription of injury, etc.\n\nRequest for\nProduction\n\n\xe2\x80\xa2 Ask opposing party to produce documents and\nevidence relevant to lawsuit\n\xe2\x80\xa2 Ex: copies of contracts, records, reports, emails,\netc.\n\nDeposition\n\n\xe2\x80\xa2 Sworn testimony of potential witnesses at trial\n\xe2\x80\xa2 Court reporter is present and makes official\ntranscript of questions and answers but judge is\nnot present\n\nThere are four types of discovery. The simplest is a request\nfor admission. Remember that a complaint contains a series\nof claims the plaintiff is making against the defendant. The\nparties may ask each other to admit that certain facts are true\nor that a contested claim is true. Doing so narrows the issues\nfor trial because it is one less thing that the jury has to decide.\nEven if the parties dispute legal liability, if they agree upon the\nfacts that caused the dispute, the case may take less time and\nmoney to resolve.\nThe second type of discovery is an interrogatory. These are\nwritten questions addressed to the other party. The questions\ntend to be simple and straightforward. Interrogatories seek to\ngather information about what happened, who was involved,\nLitigation | 48\n\n\x0ca company\xe2\x80\x99s structure, and the names and addresses of\nwitnesses.\nA third form of discovery is a request for production. A party\ncan request another party produce relevant documents to the\nlawsuit, including internal company reports, emails, product\nmanuals, and employee records. In some cases physical\nevidence may also be produced. For example, if a consumer\nsued a vehicle manufacturer because a wheel fell off while\ndriving, the manufacturer may ask the consumer to produce\nthe vehicle so that its engineers can inspect it. Failure to\npreserve and produce key evidence in litigation can lead to\ncharges of spoliation, which may result in severe sanctions\nagainst the offending party.\nFinally, discovery can take the form of a deposition. A\ndeposition is a sworn oral statement, in response to questions,\ngiven by a potential witness in a trial to the attorneys in the\ncase. A deposition is attended by the witness being deposed,\nattorneys from all the parties, and a court reporter who keeps a\nwritten or video transcript of the deposition. There is no judge\npresent, so there is great latitude for parties to ask questions,\neven if the answers are not admissible in court. Depositions\nhelp prepare for trial by knowing everything a witness may say\nin court. They also serve to pin down a witness\xe2\x80\x99s testimony,\nbecause a witness who changes testimony between a\ndeposition and trial can be impeached.\n\nMotions\nAt any point in litigation, either party may file motions with the\ncourt. A motion is a request to the court to rule on an issue or\nclaim.\nIf a defendant is properly served and does not answer the\n49 | Litigation\n\n\x0ccomplaint, the plaintiff can file a motion for default judgment.\nIn essence, the plaintiff asks the court to enter judgment in his\nor her favor because the defendant refused to show up to court\nto defend against the case. The alleged facts are admitted by\ndefault and the plaintiff may receive all the relief requested.\nAt the beginning of a lawsuit, a party can file a motion to\ndismiss for failure to state a claim. In this motion, the\ndefendant argues that even if everything in the complaint is\nfactually true, the plaintiff is not entitled to legal relief. In other\nwords, the defendant\xe2\x80\x99s conduct has not broken any laws.\nIf a long period of time has passed since the incident in\nquestion and the filing of the lawsuit, a defendant may file a\nmotion to dismiss based on the statute of limitations. Every\ncivil and criminal action has a statute of limitations, which\nrequires lawsuits to be brought within a specified period of\ntime. Statutes of limitations exists to encourage parties to file\ntheir lawsuits quickly, while evidence is still fresh and relevant\nwitnesses remember what occurred. As time passes, evidence\nmay be destroyed, witnesses may die or move away, and those\nwho can be located can\xe2\x80\x99t remember what they saw or heard. In\nother words, the quicker a lawsuit is filed, the more likely that\nthe truth will be discovered through litigation. For businesses, a\nstatute of limitations also allows it to \xe2\x80\x9cclose the books\xe2\x80\x9d on past\nliabilities.\nAnother motion that is filed before discovery and trial is\na motion for judgment on the pleadings. This motion asks the\ncourt to determine whether a genuine issue of material fact\nexists that allows the case to proceed. These motions are not\nas common as motions to dismiss but they are an important\ntool to dismiss lawsuits that are fatally flawed before the parties\nspend too much money. For example, if a business is sued\nby several parties for injuries resulting from a common cause\nbut the complaints allege conflicting facts, the business may\n\nLitigation | 50\n\n\x0cfile a motion for judgment on the pleadings. In other words,\nthe defendant is asking the court to dismiss the complaints\nbecause they contradict each other in a way that it is\nimpossible to reconcile. If dismissed, the plaintiffs may file new\ncomplaints that are not flawed.\nSimilar to a motion for judgment on the pleadings, a motion\nfor summary judgment asks the court to enter judgment in\na party\xe2\x80\x99s favor instead of trying the case. Filed after discovery,\nthis motion asks the court to rule that there are no genuine\nissues of facts for trial. For example, if a plaintiff admits during\nhis deposition that he lied about being involved in an accident,\nthe defendant may bring a motion for summary judgment\nbecause the plaintiff brought a fraudulent lawsuit. Although\nany party may file a motion for summary judgment,\ndefendants file and win many more motions for summary\njudgment than plaintiffs.\n\n51 | Litigation\n\n\x0cPretrial Motion\n\nDescription\n\nMotion for\nDefault\nJudgment\n\n\xe2\x80\xa2 Defendant was served but does not answer\nthe complaint\n\xe2\x80\xa2 Plaintiff wins because defendant does not\ndefend against the lawsuit\n\nMotion to\nDismiss for\nFailure to State a\nClaim\n\n\xe2\x80\xa2 Determination of whether the law supports\nthe plaintiff\xe2\x80\x99s claim(s)\n\xe2\x80\xa2 Defendant wins because conduct did not\nbreak the law\n\nMotion for\nJudgment on\nthe Pleadings\n\n\xe2\x80\xa2 Determination of whether plaintiff is\nentitled to judgment or damages, even if\nthe facts alleged are true\n\xe2\x80\xa2 Defendant wins because complaint is fatally\nflawed\n\nMotion for\nSummary\nJudgment\n\n\xe2\x80\xa2 Determination of whether genuine issue of\nmaterial fact exists to support plaintiff\xe2\x80\x99s\nclaim(s) based on pleadings and evidence\nduring discovery\n\xe2\x80\xa2 Defendant wins because evidence does not\nsupport plaintiff\xe2\x80\x99s claim(s)\n\nA party may submit an affidavit in support of any motion. An\naffidavit is a written statement made under oath. Affidavits\nplay an important role in pretrial procedure because they are\nan effective way for parties to tell their side of the story to the\njudge.\n\n3.7 The Trial and Appeal\nAfter discovery is completed, the case is scheduled for a trial. In\ncivil litigation, well over 90 percent of cases filed are resolved\n\nLitigation | 52\n\n\x0cor settled before trial. If a case goes to trial, it means there are\ngenuine issues of fact that the parties cannot resolve, and both\nsides are determined to win.\nThe first step in this process is to select a jury. The process of\nselecting a jury is called voir dire. Voir dire typically begins with\nthe jurors filling out a written questionnaire. The questionnaire\nasks the jurors to identify their occupation, any work or\noccupational conflicts, and any potential conflicts of interest\nwith the case. The process then continues with attorneys\nquizzing each potential juror to determine if he or she has any\nbiases against upholding the law and whether he or she can\nkeep an open mind during the trial.\nAfter a jury has been selected and sworn in, the trial begins. The\nplaintiff or prosecution begins by giving an opening statement\nthat is a preview of the trial. Attorneys inform the jury during\nopening statements what they expect to prove at trial.\nAttorneys do not make any arguments during the opening\nstatement; they simply lay out what jurors can expect from the\ntrial ahead. After plaintiff\xe2\x80\x99s opening statement, the defendant\nmay give an opening statement.\nAfter opening statements, the trial moves into the examination\nphase. The plaintiff presents evidence first. Evidence may be\nin the form of documents and witness testimony. The other\nparties have the right to cross-examine witnesses who testify\nat trial. During the cross-examination, the attorney will try to\ndiscredit the witness to convince the jury that the witness is\nnot credible. The attorney may probe into any potential biases\nthe witness may have or try to prove that the witness\xe2\x80\x99s\nrecollection of events may not be as clear or certain as the\nwitness believes.\nOnce the plaintiff has called all their witnesses and introduced\nall their evidence, the plaintiff will rest their case. The\ndefendant then has an opportunity to present witnesses and\n53 | Litigation\n\n\x0cevidence on their behalf. After the defense has rested its case,\nthe attorneys once again address the jury in closing\narguments. Here, the attorneys summarize the case for the\njury. They address what witnesses were called and what the\nwitnesses said. During closing arguments, the attorneys are\npermitted to be much more persuasive and argumentative\nthan during the opening statement. They appeal to the jury\xe2\x80\x99s\nemotions and argue how the jury should interpret the\nevidence before them.\nAfter closing arguments are made, the judge instructs the jury\non the relevant law. The jury then deliberates. During\ndeliberations, the jury will decide what facts are true. Then\nit will apply those facts to the law as outlined in the jury\ninstructions.\nCentral to the jury\xe2\x80\x99s deliberations is the burden of proof\napplicable to the case. In civil cases the burden of proof is\npreponderance of the evidence. This standard requires the\nscales of justice to tilt ever so slightly toward one party. If the\njury believes one side is 51 percent correct and the other is 49\npercent correct, that is enough to declare a winner. It is an easy\nstandard to meet because it only requires a party to prove that\nits side is more likely than not telling the truth.\nDuring jury deliberations, the jurors are permitted to ask the\njudge for clarification about the law and to request to see the\nevidence again. If the jury is unable to come to a verdict, the\njury is said to be deadlocked, and a mistrial results. Since trials\nare expensive and time consuming, the judge will usually\ninstruct the jury to try its best before giving up. If the jury\narrives at a decision, it is called a verdict.\nThe judge enters the jury\xe2\x80\x99s verdict as a judgment of the court.\nAfter that, the losing party has the right to file an appeal. The\nappellate court only reviews the record for legal errors and\n\nLitigation | 54\n\n\x0ccannot call new witnesses or substitute its judgment on the\nfacts for the jury\xe2\x80\x99s.\nOnce all appeals are exhausted, the winning party may collect\nthe judgment entered in its favor. This process is called\nexecution. If a party is unable or unwilling to pay the judgment,\nthe court can order the party\xe2\x80\x99s assets to be sold to satisfy the\njudgment.\nA party cannot refile a lawsuit once it has been decided in\nthe hopes of a more favorable outcome. The doctrine of res\njudicata holds that once a dispute is litigated and resolved,\nthe parties are barred from relitigating the issue again. Res\njudicata is a Latin phrase that means \xe2\x80\x9cthe thing has been\ndecided\xe2\x80\x9d and it is a rule of finality in the legal system.\n\n3.8 Concluding Thoughts\nLitigation is a method for parties who cannot resolve their\ndisputes to have a judge or jury determine what happened and\nwhether legal liability exists. Although it may be challenging\nto keep the names of the parties, motions, and parts of the\nprocess straight, businesses need to understand the process\nto navigate it successfully. Litigation is a long and expensive\nprocess, but is often a part of a business\xe2\x80\x99s activities.\nThe goal of civil litigation is to find the truth. An attorney\xe2\x80\x99s\nhighest duty is to the administration of justice. Attorneys are\nethically bound to represent their clients with zealous\nadvocacy. A grand jury acts as a body of citizens to prevent\nabuse by prosecutors. A petit jury sits in trials as the trier of\nfact to ascertain the truth through their observations of the\npresented evidence.\n\n55 | Litigation\n\n\x0c4. Alternative Dispute\nResolution\n4.1 Introduction\nLEARNING OBJECTIVES\n1. Understand alternative dispute resolution (ADR) methods.\n2. Learn the benefits and drawbacks of different methods of\ndispute resolution.\nImagine that someone has a legal claim against a supplier,\nemployer, or a business where he or she is a customer. What\nwill happen? They probably don\xe2\x80\x99t want to immediately initiate\nlitigation because litigation is very expensive and time\nconsuming. Besides, they may want to continue doing\nbusiness with the supplier, employer, or business. Perhaps the\nmatter is of a private nature, and they do not want to engage in\na public process to determine the outcome. They would like the\ndispute to be resolved, but do not want to engage in a public,\ntime-consuming, expensive process like litigation to do it.\nA common method of dispute resolution that avoids many of\nthe challenges associated with litigation is alternative dispute\nresolution. Alternative dispute resolution (ADR) encompasses\nmany different methods of resolving disputes outside of the\njudicial process. Some ADR methods vest power to resolve the\ndispute in a neutral third party, while other strategies vest that\npower in the parties themselves.\nFigure 4.1 Alternative Dispute Resolution Continuum\nAlternative Dispute\nResolution | 56\n\n\x0cThe most common methods of ADR are negotiation,\nmediation, and arbitration. ADR is often used to resolve\ndisputes among businesses, employers and employees, and\nbusinesses and consumers.\nADR methods are used outside of the courtroom, but\nparticipation in ADR has important legal consequences. For\ninstance, parties that have agreed by contract to be subject\nto binding arbitration give up their constitutional right to go\nto court. The Federal Arbitration Act (FAA) is a federal statute\nthat requires parties to participate in arbitration when they\nhave agreed by contract to do so, even in state court matters.\nThe FAA preempts state power to create a judicial forum for\ndisputes arising under contracts with mandatory arbitration\nclauses. The FAA encompasses transactions within the\nbroadest permissible exercise of congressional power under\nthe Commerce Clause in the US Constitution. This means that\nthe FAA requires mandatory arbitration clauses to be\nenforceable for virtually any transaction involving interstate\ncommerce, which is very broadly construed. This is an example\n57 | Alternative Dispute Resolution\n\n\x0cof federal preemption exercised through the Supremacy\nClause in the US Constitution.\n\nCounselor\xe2\x80\x99s Corner \xe2\x80\x9cAlternative dispute resolution.\xe2\x80\x9d\nThe term suggests that litigation is the primary\nmeans of dispute resolution and that mediation,\narbitration, and other means are \xe2\x80\x9calternatives.\xe2\x80\x9d But,\nactually, negotiation is the primary means of\ndispute resolution and the others are the alternative\nmeans\xe2\x80\x94with litigation being the last (legal)\nalternative. In negotiation and mediation, the\nparticipants make decisions based on their values\nand predispositions, needs, criteria for satisfying\nthose needs, pertinent information they are aware\nof, and available ways to satisfy their needs.\nNegotiation is the most used means of resolving\ndisputes. It is an invaluable life skill. Don\xe2\x80\x99t wing\nit\xe2\x80\x94learn how to do it well.\n\n~Russell C., judge\n\n4.2 Negotiation\nImagine that Han is a tent manufacturer. Han\xe2\x80\x99s supplier of tent\nfabric routinely supplies him with appropriate water-resistant\nfabric to construct tents, so that he can make and sell them.\nAfter many years of a good working relationship, Han\xe2\x80\x99s fabric\nsupplier delivered nonconforming goods. Specifically, the\nfabric delivered was not water-resistant, despite the need for\nwater-resistant fabric to make tents. However, when Han\nnotified the supplier of the problem, the supplier denied that\nthe fabric was nonconforming to his order. Han refused to pay\n\nAlternative Dispute Resolution | 58\n\n\x0cfor the goods. The fabric supplier insisted on payment before\nfuture delivery of any additional fabric. Without water-resistant\nfabric, Han cannot continue to make tents.\nThis is an example of a business to business dispute. Despite\nthe problem, Han wants to continue working with this supplier,\nsince they have a good, long-standing relationship. This\nproblem seems to be a \xe2\x80\x9chiccup\xe2\x80\x9d in the regular business\nrelationship so they want to resolve this dispute quickly and\nwithout hard feelings. It is very unlikely that Han will\nimmediately hire an attorney to file a formal complaint against\nhis supplier. However, that does not change the fact that there\nis a dispute that needs to be resolved.\nOne of the first strategies that Han and his supplier are likely\nto use is negotiation. Negotiation is a method of alternative\ndispute resolution in which the parties retain power to resolve\ntheir dispute. No outside party is vested with decision-making\npower. Negotiation requires the parties to define the conflict\nand agree to an outcome. Often, this can take the form of\na compromise. Note that a compromise does not mean that\nanyone \xe2\x80\x9closes.\xe2\x80\x9d If both parties are satisfied with the result of\nthe negotiation and the business relationship can continue\nmoving forward, then both parties will likely consider the\nsettlement a \xe2\x80\x9cwin.\xe2\x80\x9d\nBenefits to negotiation as a method of ADR include its\npotential for a speedy resolution, the inexpensive nature of\nparticipation, and the fact that parties participate voluntarily.\nDrawbacks include the fact that there are no set rules, and\neither party may bargain badly or even unethically. In a\nnegotiation, there is no neutral third party to ensure that rules\nare followed, that the negotiation strategy is fair, or that the\noverall outcome is sound. Moreover, any party can walk away\nwhenever it wishes. There is no guarantee of resolution\n\n59 | Alternative Dispute Resolution\n\n\x0cthrough this method. The result may not be \xe2\x80\x9cwin-win\xe2\x80\x9d or \xe2\x80\x9cwinlose,\xe2\x80\x9d but no resolution at all.\nIn addition, the parties may not have equal bargaining power.\nIf Han\xe2\x80\x99s business and the supplier are both dependent on each\nother for roughly equal portions of their businesses, then they\nare most likely relatively equal with respect to bargaining\npower. However, if Han has a small business but his supplier\nhas\n\na\n\nlarge\n\nbusiness,\n\nthen\n\nnegotiation\n\nis\n\npotentially\n\nunbalanced, since one party has a much more powerful\nbargaining position than the other. For example, if Han needs\nthat particular type of fabric, which is only available from one\nsupplier. But the supplier does not need Han\xe2\x80\x99s business\nbecause he do not provide a significant amount of its profit.\nThis would be an example of unequal bargaining power.\n\n4.3 Mediation\nMediation is a method of ADR in which parties work to form\na mutually acceptable agreement to resolve their dispute with\nthe help of a neutral third party. Like negotiation, parties in\nmediation do not vest authority in a third party to decide the\ndispute. Instead, this authority remains with the parties\nthemselves, who are free to end mediation if it is not working.\nOften, when parties end mediation, they pursue another form\nof ADR, such as arbitration, or they choose to litigate their\nclaims in court. Like negotiation, mediation seeks a \xe2\x80\x9cwin-win\xe2\x80\x9d\noutcome for the parties involved. Additionally, mediation is\nconfidential, which may be attractive to people who wish to\navoid the public nature of litigation. Discussions during a\nmediation are not admissible as evidence if the parties proceed\nto litigation. This encourages parties to be open with each\nother when trying to resolve their dispute. Finally, the\n\nAlternative Dispute Resolution | 60\n\n\x0cmediation process is usually much faster than litigation, and\nthe associated costs can be substantially less.\nUnlike negotiation, a third party is involved in mediation.\nIndeed, a neutral mediator is crucial to the mediation process.\nMediators act as a go-between for the parties, seeking to\nfacilitate the agreement. Mediators do not provide advice on\nthe subject matter of the dispute. Mediators might not possess\nany subject-matter expertise concerning the nature of the\ndispute. The value of mediators, however, is their training and\nexperience in conflict resolution, which they use to facilitate an\nagreement between the parties.\nAdvantages of Mediation\n\xe2\x80\xa2 Quick resolution\n\xe2\x80\xa2 Less expensive than\nlitigation & arbitration\n\xe2\x80\xa2 Non-adversarial process that\ncan preserve the\nrelationship between the\nparties\n\xe2\x80\xa2 Allows parties to work\ntogether to solve shared\nproblem\n\xe2\x80\xa2 Confidentiality\n\xe2\x80\xa2 Set ground rules by a third\nparty\n\xe2\x80\xa2 Possibility of a \xe2\x80\x9cwin-win\xe2\x80\x9d\noutcome\n\nDrawbacks of Mediation\n\n\xe2\x80\xa2 Requires genuine\nparticipation by parties\n\xe2\x80\xa2 Results may depend on skill\nof mediator\n\xe2\x80\xa2 No uniform rules or\nprocedures that apply to all\nmediations\n\xe2\x80\xa2 No guarantee of a mutually\nagreeable outcome\n\nParties often enter into a legally binding contract that\nembodies the terms of the resolution immediately after a\nsuccessful mediation. Therefore, the terms of the mediation\ncan become binding if they are reduced to a contract.\nMediation is often required by courts as part of the litigation\nprocess. In an effort to reduce the court\xe2\x80\x99s docket and\nencourage the parties to settle their own disputes, parties to\nlawsuits often must mediate their disputes after discovery and\n\n61 | Alternative Dispute Resolution\n\n\x0cbefore trial. If the parties cannot settle their dispute with the\nhelp of a mediator, the case will proceed to trial before a judge\nor jury who will determine the outcome of the case.\n\n4.4 Arbitration\nArbitration is a method of ADR in which parties vest authority\nin a neutral third-party decision maker to hear their case and\nissue a decision, which is called an arbitration award.\nAn arbitrator presides over arbitration proceedings. Arbitrators\nare neutral decision makers who are often experts in the law\nand subject matter at issue in the dispute. Arbitrators act like\njudges during trials. For instance, they determine which\nevidence can be introduced, hear the parties\xe2\x80\x99 cases, and issue\ndecisions. They may be certified by the state in which they\narbitrate, and they may arbitrate only certain types of claims.\nFor instance, the Better Business Bureau trains its own\narbitrators to hear common complaints between businesses\nand consumers (B2C). However, their decisions do not form\nbinding precedent like appellate court decisions.\nParticipation in the arbitration proceeding is sometimes\nmandatory. Parties must arbitrate if they signed a contract\nrequiring mandatory arbitration for that type of dispute.\nArbitration is also mandatory when state law requires it.\nVoluntary arbitration is frequently used in business disputes.\nSometimes parties simply agree that they do not want to\nlitigate a dispute because they believe that the benefits of\narbitration outweigh the costs of litigation, so they choose\narbitration in hopes of a speedy and relatively inexpensive\noutcome.\nIn binding arbitration, the arbitration award is final. Therefore,\nAlternative Dispute Resolution | 62\n\n\x0cappealing the merits of a binding arbitration award to court\nis not available. An arbitration award may be converted to a\njudgment by the court, thereby creating the legal mechanism\nthrough which the judgment can be collected. This process is\ncalled confirmation.\nAlthough courts review arbitration awards, their review is very\nlimited and all doubts are resolved in favor of the validity of the\naward. Courts review whether (1) the arbitration award covered\nmatters beyond the issues submitted; (2) the arbitrator failed to\napply the law correctly; and (3) fraud occurred. Courts do not\nreview the merits of the award.\nLike any other form of dispute resolution, arbitration has\ncertain benefits and drawbacks. Arbitration is an adversarial\nprocess like a trial, and it will produce a \xe2\x80\x9cwinner\xe2\x80\x9d and a \xe2\x80\x9closer.\xe2\x80\x9d\nArbitration is more formal than negotiation and mediation and,\nin many ways, it resembles a trial. Parties present their cases\nto the arbitrator by introducing evidence. After both sides have\npresented their cases, the arbitrator issues an arbitration\naward.\nThe rules of procedure during arbitration are often less formal\nor less restrictive on the presentation of evidence than in\nlitigation. Arbitrators decide which evidence to allow, and they\nare not required to follow precedents or to provide their\nreasoning in the final award. In short, arbitration adheres to\nrules, but those rules are not the same as the rules for litigation.\nArbitration can be more expensive than negotiation or\nmediation, but it is often less expensive than litigation. Parties\nmust pay the costs of the arbitrator, and they often hire\nattorneys to represent them. Additionally, in mandatory\narbitration clause cases, the arbitration may be required to take\nplace far from one of the parties. This means that a party may\nhave to pay travel costs during the arbitration proceeding.\nArbitration is also faster than litigation.\n63 | Alternative Dispute Resolution\n\n\x0cA common issue is whether mandatory arbitration is fair in\ncertain circumstances. It\xe2\x80\x99s easy to imagine that arbitration is\nfair when both parties are equally situated. For example,\nbusiness to business (B2B) arbitration is often perceived as\nfair, especially if businesses are roughly the same size or have\nroughly equal bargaining power. This is because they will be\nable to devote approximately the same amount of resources\nto resolve the dispute, and they both understand the issues\ninvolved.\nHowever, issues of fairness often arise in business to employee\n(B2E) and business to consumer (B2C) disputes, particularly\nwhere parties with unequal bargaining power have entered\ninto a contract that contains a mandatory arbitration clause. In\nsuch cases, the weaker party has no real negotiating power to\nmodify or to delete the mandatory arbitration clause, so that\nparty is required to agree to such a clause if it wants to engage\nin certain types of transactions. In B2E contexts, unequal\nbargaining power alone is insufficient to hold arbitration\nagreements unenforceable.\nIn B2C cases, different issues of fairness exist. As noted\npreviously, when the parties possess unequal power, these\nissues can be magnified. Consumers tend to fare better in\nlitigation than in arbitration. Incentives exist to favor businesses\nover consumers in the arbitration process, including the lack of\nappeal rights to the courts, the limits on consumers\xe2\x80\x99 remedies,\nprohibitions against class-action suits, limitations on access to\njury trials, limitations on abilities to collect evidence, and\ngreater out-of-pocket expenses.\nNot all binding arbitration clauses have been upheld by courts\nin B2C cases. The FAA does not prevent the courts from\napplying state law, including the unconscionability of contract\nterms. In other words, if the terms of the contract make it\n\nAlternative Dispute Resolution | 64\n\n\x0cunreasonable to enforce the arbitration provision, then a party\nmay still bring claims to court for resolution.\nSimilarly, arbitration agreements may be rescinded on the\nsame grounds as other contracts. Fraud, mutual mistake, and\nlack of capacity are grounds for voiding arbitration contracts.\nRevocation is also possible in the event of death or bankruptcy\nof one of the parties, as well as destruction of the subject\nmatter of the underlying contract.\n\n4.5 Concluding Thoughts\nADR is the body of dispute-resolution methods outside of the\nlitigation process. ADR is often faster, less expensive, and more\nprivate than litigation. For this reason, ADR may be the\npreferred dispute resolution method, particularly when an\nongoing relationship between parties is desired. Common\nmethods of dispute resolution are negotiation, mediation, and\narbitration. Mandatory arbitration clauses are common in\ncontracts, and such clauses are usually enforceable against the\nparties even if they wish to litigate their claims.\n\n65 | Alternative Dispute Resolution\n\n\x0c5. The Constitution\n5.1 Introduction\nLEARNING OBJECTIVES\n1. Explore how the US Constitution creates a limited\ngovernment through the separation of powers and\nthrough checks and balances among the three branches\nof government.\n2. Learn how the US Constitution resolves conflicts between\nstate and federal laws.\n3. Explore how the US Constitution grants Congress the\npower to regulate interstate commerce.\n4. Understand how the US Constitution protects the civil\nliberties of business entities.\nOur\n\nfirst\n\nnational\n\nconstitution\n\nwas\n\nthe\n\nArticles\n\nof\n\nConfederation. The Articles granted limited authority to the\nfederal government, including the power to wage wars,\nconduct foreign policy, and resolve issues regarding claims by\nthe states on western lands. Many leading statesmen, known\nas\n\nFederalists,\n\nthought\n\nthe\n\nArticles\n\ncreated\n\na\n\nfederal\n\ngovernment that was too weak to survive. The lack of power\nto tax, for example, meant that the federal government was\nfrequently near bankruptcy. Larger states resented the\nstructure under the Articles, which gave small states an equal\nvote as larger states. Finally, the Articles reserved the power to\nregulate commerce to the states, meaning each pursued its\nown trade and tariff policy with other states and with foreign\nnations. Because the federal government was too weak to\n\nThe Constitution | 66\n\n\x0cfunction, the Articles were abandoned and the current\nConstitution was adopted in 1787.\n\nCounselor\xe2\x80\x99s Corner The Constitution is the\nfundamental law of our nation and is extremely\npowerful. It\xe2\x80\x99s also beautiful in its simplicity. The\nConstitution in action, though, is often messy.\nPeople\xe2\x80\x99s rights conflict with each other. Branches of\ngovernment clash over which has the power to act.\nFederal and state governments argue over who has\nultimate authority to govern. But as long as we\ncontinue to cherish the values instilled in the\ndocument, the Constitution will remain a living\nprotection against tyranny. We must protect it at all\ncosts if we expect it to protect us. Tyranny starts\nwhen our dedication to Constitutional principles\nends.\n\n~John K., judge\n\n5.2 Federalism and Preemption\nMuch of the Constitution deals with the allocation of power\namong three separate and coequal branches of government.\nSubstantively, much more attention is paid to the limitations\non the power given to each of the three branches than to\nany positive grant of rights. The Constitution is a document of\nprohibition, outlining what government cannot do as opposed\nto what government must do. This is the result of the Founders\xe2\x80\x99\ndistrust of authoritarian regimes.\n\n67 | The Constitution\n\n\x0cSeparation of Powers\nThe Constitution provides for the separation of powers, which\nrequires each branch of government to play its own unique role\nin governing the people.\nFigure 5.1 Separation of Powers of the Branches of the Federal\nGovernment\n\nArticle I of the Constitution establishes the legislative branch\nthrough a bicameral legislature. The House of Representatives,\nwith elections every even-numbered year, has 435 members,\nwith representation determined proportionately by state\npopulation as determined by a census every decade. The most\npopulous state, California, has fifty-three representatives, while\nseveral states have only one representative. The House is led by\nThe Constitution | 68\n\n\x0cthe Speaker of the House, typically from the party that holds\nthe majority seats in the House. The House is generally thought\nto represent the most contemporary views of the American\npublic, with its large body of members and frequent elections.\nAs a check on the majority will, and on the power of larger\nstates, the Senate is a smaller body with one hundred\nmembers (two from each state) and with less frequent\nelections (every six years). The Senate is meant to be a\ndeliberative body to ensure debate of significant issues and\nprevent hastily rushed law. The makeup of the Senate means\nthat citizens from smaller states, representing many fewer\npeople, may frustrate the will of the majority of Americans. The\nConstitution places the power to legislate with both chambers,\nbut the House retains the exclusive right to originate bills\nraising revenue (taxation), while the Senate maintains the\nexclusive right to ratify treaties.\nArticle II of the Constitution establishes the executive branch\nof government. It sets forth some of the mechanisms for\nbecoming president\xe2\x80\x94and is the only place in the Constitution\nthat prescribes a specific oath of office. Article II grants the\npresident power to be the primary architect of foreign affairs,\nincluding the power to negotiate treaties and appoint\nambassadors. The president is also commander-in-chief of the\narmed forces. The president is mainly responsible for enforcing\nthe laws of the nation. Through prosecutorial and police\nfunctions, the president ensures that the will of the people, as\nexpressed through Congress, is carried out.\nArticle III of the Constitution establishes the judicial branch of\nthe federal government. The judicial branch plays a critical role\nin interpreting the Constitution and outlining the powers of the\nlegislature and executive branches. The power to adjudicate\ndisputes is given to the Supreme Court and any other lower\ncourts established by Congress. Federal courts have the power\n\n69 | The Constitution\n\n\x0cto hear disputes under the Constitution, federal laws and\ntreaties. Also, if disputes arise between citizens of different\nstates, a federal court may have diversity jurisdiction. Federal\njudges are nominated by the president and confirmed by the\nSenate. Federal judges serve for life, which helps insulate them\nfrom political pressures.\n\nChecks and Balances\nThe Constitution establishes a system of checks and balances\namong the legislative, executive, and judicial branches. Under\nthis system, each branch of government restrains the power\nof the other two branches of government. For example, the\npresident may veto a bill passed by Congress. And Congress\ncan override a presidential veto by a two-thirds vote.\nFigure 5.2 Checks and Balances of the Federal Government\n\nThe judicial branch has the power of judicial review of\n\nThe Constitution | 70\n\n\x0cexecutive and legislative actions to determine whether they\nviolate the Constitution. Although not expressly written in the\nConstitution, judicial review was established in 1803 in a\nlandmark case, Marbury v. Madison. Judicial review also\nincludes review of state action for violations of the US\nConstitution. As a result, judicial review ensures that the US\nConstitution is the supreme law of the land and that the\njudicial branch has the authority to interpret the Constitution.\n\nFederalism\nAnother aspect of the separation of powers is the separation\nof power between the federal and state governments, known\nas federalism. To avoid tyranny, the Constitution grants certain\npowers to Congress, reserving all other powers to the states.\nThis is a result of the Founders\xe2\x80\x99 distrust of a central government\nand their effort to address the failures of the Articles of\nConfederation. These powers are listed in Article I, Section 8\nand are called enumerated powers.\nCongress has the power to borrow money, lay and collect taxes,\nregulate interstate commerce, establish a uniform law on\nbankruptcy and naturalization, make money and establish its\nvalue, punish the counterfeiting of US money, and establish a\nuniform system of weights and measures. Congress also has\nthe power to establish post offices and to protect intellectual\nproperty in copyrights and patents. Congress can create lower\ncourts under the Supreme Court created in Article III and to\ndefine crimes committed on the \xe2\x80\x9chigh seas\xe2\x80\x9d and against the\n\xe2\x80\x9claw of nations.\xe2\x80\x9d Congress is also given fiscal responsibility over\nthe armed forces.\n\n71 | The Constitution\n\n\x0cState Police Powers\nThe Constitution reinforces that states have police power,\nwhich is the authority to regulate public safety, health, welfare,\nand morals. States may grant more civil rights to its citizens\nthan the federal government does. For example, some states\nhave passed anti-discrimination laws that protect more\nminority\n\ngroups\n\nthan\n\nare\n\nrecognized\n\nby\n\nthe\n\nfederal\n\ngovernment. States are permitted to do so as long as the\nexercise of their power does not violate the US Constitution.\nGenerally, this means the state legislation must be reasonable\nand applied fairly rather than arbitrarily.\n\nConcurrent Powers\nThe federal and state governments have some of the same\npowers, which are called concurrent powers. For example,\nboth federal and state governments may tax businesses and\nindividuals. States are permitted to tax, but only if the activity\ntaxed has a nexus to the state. A transaction (such as a sale)\nthat takes place inside the state creates a nexus for a sales tax.\nWorking in the state typically creates a nexus for state or local\nincome tax to apply, and owning real property creates a nexus\nfor real estate tax to apply.\nFigure 5.3 Venn Diagram of the Powers of the Federal and State\nGovernments\n\nThe Constitution | 72\n\n\x0cWhat happens, however, if a state\xe2\x80\x99s citizen purchases goods\nfrom a seller out of state? Traditionally, buyers do not pay sales\ntax to the government directly\xe2\x80\x94rather, they pay the sales tax\nto the seller, who collects the tax on behalf of the government\nand turns it over to the government at regular intervals. As\nthe popularity of e-commerce has skyrocketed, more and more\nstates are reexamining how to tax transactions from out-ofstate sellers by compelling those sellers to collect the\napplicable state sales tax. In June 2018, the US Supreme Court\nruled that states may impose sales tax on e-commerce sales\non businesses that do not have a physical presence within the\nstates\xe2\x80\x99 boundaries. If the business has a clear connection to\nstate consumers and generate a certain threshold of sales, a\nstate can collect sales tax.\n\nPreemption\nWhat happens when state and federal laws exist on the same\nsubject matter and they contradict each other? Under the\nConstitution\xe2\x80\x99s Supremacy Clause (Article VI, Section 2), the\n73 | The Constitution\n\n\x0cConstitution, federal laws and treaties are the \xe2\x80\x9csupreme law of\nthe land\xe2\x80\x9d and judges in every state \xe2\x80\x9cshall be bound\xe2\x80\x9d by those\nlaws. This means that federal laws are superior to state laws.\nTherefore, when a federal law conflicts with a state law, the\nfederal law prevails.\nWhen Congress states its intent to regulate an area completely,\nthis is called express preemption. Implied preemption occurs\nwhen Congress intends to completely regulate an area but\ndoes not say so explicitly. Instead, Congress passes laws that\n\xe2\x80\x9coccupy the field\xe2\x80\x9d so much that no room for state regulation\nexists. Finally, some areas of the law allow both state and\nfederal governments to regulate together. For example, both\nfederal and state governments have laws to protect consumer\nrights.\n\nConstitutional Rules Between the States\nThere are several important Constitutional provisions that\nensure our federalist system works properly. The first is the\nPrivileges and Immunities Clause in Article IV. This Clause\nensures that people in different states are treated equally by\nthe government. For example, the federal government cannot\npass laws that subject citizens in the West to more regulations\nthan citizens in the East. Federal laws must be applied equally\nacross the nation. The Founders included this provision to\nencourage travel and business between the states.\nAnother important Constitutional provision is the Full Faith\nand Credit Clause in Article IV. This Clause requires states to\n\xe2\x80\x9crespect the public acts, records, and judicial proceedings of\nevery other state.\xe2\x80\x9d This is important for businesses because\nit ensures that state courts respect the judgments of courts\nfrom other states. Therefore, a judgment won in Colorado may\n\nThe Constitution | 74\n\n\x0cbe enforced in another state, without relitigating the\nunderlying issues. This facilitates business because litigation\ncan be finalized without subjecting a company to endless\nliability across states.\n\n5.3 The Commerce Clause\nThe most important Constitutional provision related to the\nfederal regulation of business is the Commerce Clause, which\ngrants Congress the power to \xe2\x80\x9cregulate Commerce with\nforeign Nations, and among the several States, and with the\nIndian Tribes\xe2\x80\x9d (Article I, sec. 8). Over time, the Commerce\nClause has been interpreted to apply to more and more\nbusinesses and industries. In addition to business transactions\nacross state lines, the Commerce Clause now applies to\nbusiness activity within one state that substantially affects or\nimpacts commerce in other states. The growth of e-commerce,\nthe internet, and federally-insured banks results in most\nbusinesses today being subject to federal regulation under the\nCommerce Clause.\n\nDormant Commerce Clause\nStates cannot interfere with Congress\xe2\x80\x99s power to regulate\ninterstate commerce. This concept is known as the Dormant\nCommerce Clause. This clause restricts the states\xe2\x80\x99 abilities to\nregulate commerce, rather than the federal government\xe2\x80\x99s.\nA state law that discriminates against out-of-state commerce,\nor places an undue burden on interstate commerce, violates\nthe dormant commerce clause. For example, if a state required\nout-of-state corporations to pay a higher tax or fee than an\n\n75 | The Constitution\n\n\x0cin-state corporation, that is unconstitutional. However, this\nprohibition against out-of-state discrimination does not\nprevent a state from exercising its police power to protect state\ncitizens, as long as the power is exercised evenly and equally.\nFor example, a state may weigh trucks on highways to ensure\nthey do not exceed maximum weight rules, even if the trucks\ncame from out of state, as long as all trucks on the highways\nare weighed.\n\n5.4 Business and the Bill of Rights\nDuring the debate surrounding the Constitution, there was\nmuch discussion about whether an explicit protection of civil\nliberty was necessary. Some believed that the common law\nsystem adequately protected civil liberties, so a written\ndeclaration of rights wasn\xe2\x80\x99t necessary. Others believed that a\nwritten declaration of rights was necessary to protect the\npeople from government overreach. In 1791, the first ten\namendments to the Constitution were ratified and became\nknown as the Bill of Rights.\nWhen we speak of civil liberties protected in the Constitution,\nwe often think of how these liberties apply to people. Although\nthe Constitution does not contain the word \xe2\x80\x9ccorporation,\xe2\x80\x9d\nCongress has defined \xe2\x80\x9cperson\xe2\x80\x9d to include \xe2\x80\x9ccorporations\xe2\x80\x9d so\nmany civil rights also apply to business entities.\nIt\xe2\x80\x99s worth making some observations about civil liberties in\ngeneral. First, there are no absolute rights, in spite of the\nwording of any specific amendment. For example, the First\nAmendment states that \xe2\x80\x9cCongress shall make no law\nabridging the freedom of speech.\xe2\x80\x9d In fact, there are many laws\nthat limit the freedom of speech. People aren\xe2\x80\x99t allowed to libel\nor slander someone, for example, or incite a crowd into a riot.\nThe Constitution | 76\n\n\x0cInstead of absolute rights, courts have to constantly balance\ncompeting interests in deciding where the limits of individual\nrights lie. The right of the public to know information about the\nlives of politicians and other high-profile figures, for example,\nmust often be balanced by the right those citizens have to their\nown privacy.\nSecond, while the Constitution sets up a system of government\nbased on principles of representative democracy, the Bill of\nRights exists to protect the minority, not the majority. Other\nthan the right to vote, the civil liberties protected by the\nConstitution extend to all persons physically on US soil, not\njust citizens or legal immigrants. Persons visiting the United\nStates temporarily, such as tourists and students, as well as\nundocumented aliens, are also entitled to the full protections\nof the US Constitution.\nThird, the extent of civil liberty protections vary from time to\ntime. Society evolves with progress and challenges. The\nFounders could not contemplate a digital world where an act\nof defamation on social media can spread to millions of people\nin a matter of minutes. The Eighth Amendment illustrates how\ntime shifts the meaning of a right. The Eighth Amendment\nprohibits \xe2\x80\x9ccruel and unusual\xe2\x80\x9d punishment. The Supreme Court,\nin 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\nwords, what is cruel and unusual today may have been normal\nin years past.\nFinally, major portions of the Bill of Rights apply equally to the\nstates as they do the federal government. When adopted, the\namendments were meant to restrict the federal government\nonly. For example, the First Amendment states \xe2\x80\x9cCongress shall\nmake no law respecting an establishment of religion.\xe2\x80\x9d States\nwere not similarly restricted, and many states established\nofficial churches. After the Civil War, the Constitution was\n\n77 | The Constitution\n\n\x0camended to include the Fourteenth Amendment, which\nprevents any state from depriving citizens of their rights\nwithout \xe2\x80\x9cdue process of law.\xe2\x80\x9d Gradually, the Supreme Court\ndeveloped a doctrine called incorporation, by which the\nlimitations on government behavior in the Bill of Rights were\nextended to apply to the states as well. While many portions\nof the Bill of Rights apply to the states, not all of it does. There\nis no requirement, for example, that states use a grand jury\nsystem to indict criminals. There is also no requirement that\nstates provide juries in civil trials.\n\nFirst Amendment\nFigure 5.4 Language of the First Amendment\n\nThe First Amendment contains several important clauses\npertaining to speech and religion. The two different clauses on\nreligion may conflict with each other in some circumstances.\nOn the one hand, the First Amendment prohibits the\ngovernment from establishing any religion\xe2\x80\x94this is called the\nThe Constitution | 78\n\n\x0cEstablishment\n\nClause.\n\nOn\n\nthe\n\nother\n\nhand,\n\nthe\n\nFirst\n\nAmendment prohibits the government from restricting the\nfree exercise of religion\xe2\x80\x94this is called the Free Exercise Clause.\nIn theory, this allows individuals the right to freely practice\ntheir religion while prohibiting the government from doing so.\nConflict arises when people choose to practice their religion\nfreely and openly on government property, such as in a public\nschool or city hall.\nAs is often true in Bill of Rights cases, courts have had to fashion\na test to draw the line between the Establishment and Free\nExercise Clauses. The use of public funds for religious purposes\nand the public display of religious life is generally acceptable\nas long as the primary motivation is not to advance a specific\nreligion. A city that wishes to display a Christmas tree or nativity\nscene, for example, is permitted to do so as part of a general\nholiday-themed cultural display that also includes a menorah.\nThe First Amendment also protects the right to freedom of\nspeech. While many nations believe in the right of citizens to\nthink and speak freely, the United States is fairly unique in\nenshrining those principles into constitutional law.\nNot all speech is protected by the First Amendment, and the\ntype of speech drives its level of protection. Political speech,\nwhich relates to matters of public interest, receives the most\nprotection. Political dissent, displeasure with the government,\nparty membership, and even speech advocating the overthrow\nof government, all deserve extraordinary protection under the\nFirst Amendment.\nFigure 5.5 Spectrum of First Amendment Protection of Speech\n\n79 | The Constitution\n\n\x0cOn the other end of the spectrum is speech that deserves no\nprotection under the First Amendment at all, such as speech\nthat incites a panic (e.g. yelling \xe2\x80\x9cFire\xe2\x80\x9d in a crowded theater\nwhen there is no fire). Defamation, libel and slander are all\nactionable torts. Obscene speech and fighting words are also\nnot protected under the First Amendment.\nIn the middle of the spectrum is commercial speech, which\nrelates to business transactions. Commercial speech is entitled\nto some protection under the First Amendment as long as it\nis not false or misleads consumers. If the information is false\nor misleading, it is not protected at all. Under an intermediate\nlevel of scrutiny test, freedom of commercial speech is not\nviolated as long as (1) there is a substantial government interest\nin restricting or regulating speech; (2) the restriction directly\nadvances that interest, and (3) the restriction is no more\nextensive than necessary.\nThe prior restraint doctrine prohibits formal censorship before\nthe publication of speech. In other words, the government\ncannot restrict speech or publications before their actual\nexpression. Prior restraints violate the First Amendment unless\nthe speech is obscene, is defamatory, or creates a clear and\npresent danger to society.\nThe US Supreme Court has ruled that corporations are\n\xe2\x80\x9cpersons\xe2\x80\x9d entitled to First Amendment rights to speech and\n\nThe Constitution | 80\n\n\x0creligion. In striking down federal and twenty-two state\nrestrictions on corporate spending on political campaigns, the\nSupreme Court held that corporations are persons and\ntherefore entitled to engage in political speech. Since\ncorporations are unable to literally \xe2\x80\x9cspeak,\xe2\x80\x9d they speak through\nspending money, and thus restrictions on how corporations\nmay\n\nspend\n\nmoney\n\nduring\n\npolitical\n\ncampaigns\n\nare\n\nunconstitutional. Similarly, Congress defined \xe2\x80\x9cpersons\xe2\x80\x9d to\ninclude\n\ncorporations,\n\ncompanies,\n\nassociations,\n\nfirms,\n\npartnerships, societies, and joint stock companies. As a result,\nthose types of businesses have religious rights that allow them\nto opt out of providing healthcare insurance to their employees\nthat violates the businesses\xe2\x80\x99 religious beliefs.\nNot all protected speech is protected all the time in all places.\nThe government is permitted to place reasonable time, place,\nand manner restrictions on speech to maintain important\ngovernmental functions. These restrictions are generally\nupheld\n\nif\n\nthey\n\nfurther\n\nan\n\nimportant\n\nor\n\nsubstantial\n\ngovernmental interest, they are content neutral, and any\nrestriction on First Amendment freedoms is no greater than\nthat necessary to further governmental interests (i.e. the\nrestriction is not overbroad). Thus, for example, courts have\nupheld restrictions on posting signs on city-owned utility poles,\nas well as picketing and protest permit requirements.\n\nFifth Amendment\nFigure 5.6 Langue of the Fifth Amendment\n\n81 | The Constitution\n\n\x0cAnother important restriction on governmental authority\nactually appears twice in the Constitution. The due process\nclause appears in both the Fifth Amendment (\xe2\x80\x9cNo person\nshall\xe2\x80\xa6be deprived of life, liberty or property without due\nprocess of law\xe2\x80\x9d) and the Fourteenth Amendment (\xe2\x80\x9cNor shall\nany State deprive any person of life, liberty, or property, without\ndue process of law\xe2\x80\x9d). The Fifth Amendment applies to the\nfederal government and to the states. At its core, due process\nmeans \xe2\x80\x9cfundamental fairness and decency.\xe2\x80\x9d The clause\nrequires that all government action that involves the taking\nof life, liberty, or property be done fairly and for fair reasons.\nNotice that the due process clause applies only to government\naction\xe2\x80\x94it does not apply to the actions of private citizens or\nentities such as corporations.\nDue process contains two components. The first is called\nprocedural due process. Procedural due process requires that\nany government action that takes away life, liberty, or property\nmust be made fairly and using fair procedures. Procedural due\nprocess includes: (1) notice that the government is going to act\nand why; (2) a hearing prior to the governmental action; and\n\nThe Constitution | 82\n\n\x0c(3) the ability to appeal the determination made at the hearing.\nThis ensures those affected by a government action have a fair\nchance to oppose it.\nThe second type of the due process is substantive due process.\nSubstantive\n\ndue\n\nprocess\n\nfocuses\n\non\n\nthe\n\ncontent\n\nof\n\ngovernment legislation itself. Generally speaking, government\nregulation is justified whenever the government can articulate\na rational reason for the regulation. In certain categories,\nhowever, the government must articulate a compelling reason\nfor the regulation. This is the case when the regulation affects a\nfundamental right, which is a right deeply rooted in American\nhistory and implicit in the concept of ordered liberty. The\ngovernment must also set forth compelling reasons for\nrestricting the right to vote or the right to travel. Substantive\ndue process is often used as a basis for any lawsuit challenging\ngovernment procedures or laws that affect an individual\xe2\x80\x99s or\ncompany\xe2\x80\x99s civil liberties.\nGovernments have the power of eminent domain, which is the\npower to take privately owned property and convert it for\npublic use. The Takings Clause of the Fifth Amendment\nprohibits the government from taking private property for\npublic use without just compensation. A law or regulation that\ndenies all beneficial use of property is a taking that requires\ncompensation. A common issue in eminent domain cases is\nwhat constitutes \xe2\x80\x9cjust compensation.\xe2\x80\x9d What the value of the\nproperty was before the government announces its intent to\ntake the property or after? Property includes land, intellectual\nproperty, and personal property.\n\nFourteenth Amendment\nFigure 5.7 Language of the Fourteenth Amendment\n\n83 | The Constitution\n\n\x0cThe Equal Protection Clause of the Fourteenth Amendment\nstates that \xe2\x80\x9cNo state shall deny to any person within its\njurisdiction the equal protection of the laws.\xe2\x80\x9d In other words,\nit requires the government to treat people equally. This clause\nincorporates Constitutional protections against the states in\naddition to the federal government.\nThe Equal Protection Clause is implicated anytime a law limits\nthe liberty of some people but not others. It scrutinizes\ngovernment-sponsored\n\xe2\x80\x9cdiscrimination\xe2\x80\x9d\ndiscrimination\n\nhas\nis\n\ndiscrimination.\na\n\nnegative\n\nillegal.\n\nFor\n\nWhile\n\nthe\n\nconnotation,\n\nexample,\n\na\n\nword\n\nnot\n\ncriminal\n\nall\nlaw\n\ndiscriminates against those who steal. The Equal Protection\nClause seeks to determine what forms of discrimination are\npermissible.\nTo establish a guideline for courts to use in answering equal\nprotection cases, the US Supreme Court has established three\nstandards\n\nof\n\nreview\n\nwhen\n\nexamining\n\nstatutes\n\nthat\n\ndiscriminate: minimal scrutiny, intermediate scrutiny, and strict\nscrutiny.\n\nThe Constitution | 84\n\n\x0cUnder the minimal scrutiny test, the government needs only a\nrational basis for the law\xe2\x80\x94the law simply has to be reasonably\nrelated to some legitimate government interest. If the law is\nbased on some rational basis, then the law passes equal\nprotection. Thus, a law that imprisons thieves easily passes\nminimal scrutiny, since there are many rational reasons to\nimprison thieves. The majority of cases that are scrutinized\nunder minimal scrutiny pass review.\nThe intermediate scrutiny test applies to cases where the\ngovernment discriminates on the basis of gender. Under this\ntest, the government has to prove that the law in question\nis substantially related to an important government interest.\nUsing this test, courts have invalidated gender restrictions on\nadmissions to nursing school, laws that state only wives can\nreceive alimony, and a higher minimum drinking age for men.\nThe strict scrutiny test is used when the government\ndiscriminates against a suspect class. Under this test, the\ngovernment has to prove that the law is justified by a\ncompelling governmental interest, that the law is narrowly\ntailored to achieve that goal or interest, and that the law is the\nleast restrictive means to achieve that interest. The standard\nis reserved for only a few classifications: laws that affect\n\xe2\x80\x9cfundamental rights\xe2\x80\x9d such as the rights in the Bill of Rights\nand any government discrimination that affects a \xe2\x80\x9csuspect\nclassification\xe2\x80\x9d such as race or national origin. In practice, the\ngovernment has a hard time meeting this burden.\n\n85 | The Constitution\n\n\x0cTest\n\nRelationship\n\nGovernmental\nLikely Result\nInterest\n\nStrict\nScrutiny\n\nNecessarily\nrelates\n\nCompelling\n\nGovernmental action\nis likely\nunconstitutional\n\nIntermediate Substantially\nScrutiny\nrelates\n\nImportant\n\nCase-by case\ndetermination\n\nRational\nBasis\n\nLegitimate\n\nGovernmental action\nis likely\nconstitutional\n\nReasonably\nrelates\n\nThere are a few cases where the Supreme Court has held that\nracial discrimination may be permissible even under strict\nscrutiny. For example, cases challenging affirmative action\npolicies in higher education have held that admission\npreferences for underrepresented racial groups does not\nviolate the Constitution. The Supreme Court has found that\ndiversity in higher education is a compelling state interest, and\nthat schools could consider race in deciding whether to admit\nstudents, as long as race is a \xe2\x80\x9cpotential plus factor\xe2\x80\x9d considered\nwith other factors.\n\n5.5 Concluding Thoughts\nThe US Constitution is the most important and fundamental\nlaw in the nation. The Constitution establishes our government\nstructure, identifies the powers of the branches, and identifies\nour fundamental rights. In this age of e-commerce, the vast\nmajority of businesses are engaged in interstate commerce\nand are, therefore, regulated by Congress under the Commerce\nClause. The Dormant Commerce Clause prevents states from\nunfairly burdening interstate commerce. Although the Bill of\nRights is often thought of as applying to individuals, it also\ngrants civil liberties to businesses.\n\nThe Constitution | 86\n\n\x0cThe Constitution is mainly a structural document, setting forth\nthe allocation of power among the three branches of the\nfederal government and the limitations on that power. It is\nconcerned mainly with what the government cannot do, as\nopposed to what the government must do. Article I of the\nConstitution establishes a bicameral legislature, with the\nHouse of Representatives and Senate. Both chambers must\nagree before legislation can be passed. Article II of the\nConstitution establishes the executive power in the president,\nwho must enforce the laws passed by Congress. Power is also\ndivided between state and federal governments under\nfederalism. The Supremacy Clause states that when there is a\nconflict between state and federal law, federal law wins. If there\nis no direct conflict, the state law survives unless Congress\nexpressly preempts state law or occupies the field. The\nConstitution also provides rules to facilitate state laws across\nstate lines.\nThe Bill of Rights provides key civil liberties to all people on US\nsoil. These liberties are not absolute. Many of the restrictions on\ngovernment activity found in the Bill of Rights also apply to the\nstates through incorporation.\nThe First Amendment prohibits the government from\nestablishing religion and from restricting the free exercise\nthereof. The First Amendment also prohibits the government\nfrom restricting the freedom of speech. Political speech is\nprotected to the fullest extent by the First Amendment, while\nobscene and defamatory speech is not protected at all but\nsubject to the doctrine of prior restraint. Generally speaking,\nthe government may impose reasonable time, place, and\nmanner restrictions on the delivery of speech.\nProcedural due process requires that the government use fair\nprocedures anytime it seeks to deprive a citizen of life, liberty,\nor property. Substantive due process requires the government\n\n87 | The Constitution\n\n\x0cto articulate a rational basis for passing laws or, when\nfundamental rights are involved, to articulate a compelling\nreason to do so.\n\nThe Constitution | 88\n\n\x0c6. International Law\n6.1 Introduction\nLEARNING OBJECTIVES\n1. Define international law.\n2. Understand sovereignty and the principles of international\njurisdiction.\n3. Know what types of laws apply to businesses operating\ninternationally.\n4. Understand the types of international jurisdiction.\nAccording to the Small Business Association, 96 percent of the\nworld\xe2\x80\x99s customers live outside of the United States. The\ninternational market is lucrative but the international legal\nenvironment is different from the US legal environment.\nTherefore, it is important to be familiar with the basic concepts\nof doing business in the global economy.\nAny business that operates across a national border is an\nInternational Business Entity (IBE). IBEs may be large, such\nas Samsung, or they may be small, such a souvenir stand that\nsells products across the border at Niagara Falls. When an IBE\nconducts business in another nation, it must comply with\napplicable laws in its nation of origin, in all nations where it\ndoes business, and applicable international laws. For example,\nif the Molson Coors Brewing Company, which is headquartered\nin Colorado, wants to sell its products in Mexico, it would need\nto comply with all applicable US, Mexican, and international\n\n89 | International Law\n\n\x0claws, such as the US-Mexico-Canada Agreement (USMCA). This\nincludes local and state laws within both the US and Mexico.\nUS Laws\n\nForeign Laws\n\n\xe2\x80\xa2 Federal laws\n(including\nimport & export\nregulations)\n\xe2\x80\xa2 State laws\n\xe2\x80\xa2 Local laws\n(including city &\ncounty\nregulations)\n\n\xe2\x80\xa2 National laws\n(including\nimport & export\nregulations)\n\xe2\x80\xa2 State or province\nlaw\n\xe2\x80\xa2 Local laws\n(including city &\ncounty\nregulations)\n\nInternational Laws\n\xe2\x80\xa2 Bilateral treaties\n\xe2\x80\xa2 Multilateral\ntreaties (e.g.\nGATT)\n\xe2\x80\xa2 UN Conventions\n(e.g. CISG)\n\xe2\x80\xa2 Regional trade\nblocs (e.g.\nUSMCA, EU,\nASEAN)\n\nInternational law consists of rules and principles that apply\nto the conduct of nations, international organizations, and\nindividuals across borders. There are two types of international\nlaw: public and private.\nPublic\n\ninternational\n\nlaw governs the relations among\n\ngovernments and international organizations. It includes the\nlaw of war, the acquisition of territory, and the settlement of\ndisputes among nations. Public international law also includes\nagreements governing property rights, trade, outer space, and\nnatural resources, such as the seas and mineral rights. For\nbusinesses, public international law is important because it\ndefines human rights, such as the prohibition against child\nlabor, slavery, and trafficking in people and stolen goods.\nPrivate international law applies to private parties engaged\nin international commercial and legal transactions. Essentially,\nprivate international law identifies what law applies to an\nagreement and how the parties will settle any disputes with\nparties in other nations.\n\nInternational Law | 90\n\n\x0cCounselor\xe2\x80\x99s Corner US nationals and businesses\nneed to understand that they are subject to the laws\nof the nations where they travel and operate. For\nexample, many US nationals do not understand that\nthey are restricted in what they can say and publish\nwithin China. The US Constitution\xe2\x80\x99s freedom of\nspeech does not apply when visiting or working in\nother nations, especially communist ones. It is worth\nthe time to understand the culture of the nation a\nbusiness wants to work in before investing too\nmuch time and resources into developing\noperations there. Culture is just as important as\nfinances when developing a business plan to\nexpand into another nation. If the culture is not one\nthat the business is comfortable with, then it should\nlook at business opportunities elsewhere.\n~Wei Z., attorney\n\n6.2 The Nature of International Law\nA sovereign state is a political entity that governs the affairs\nof its own territory without being subjected to an outside\nauthority. Nations are sovereign states. Sovereign states\nhave sovereign immunity, which is the principle that courts of\none nation lack the jurisdiction to hear cases against foreign\ngovernments. In the US, this principle is enacted in the Foreign\nSovereign Immunities Act (FSIA) which prohibits US courts\nfrom\n\nhearing\n\ncases\n\nagainst\n\nforeign\n\ngovernments.\n\nTwo\n\nexceptions are: (1) when the foreign government waives its\nright to immunity and agrees to the jurisdiction of the US court;\n91 | International Law\n\n\x0cand (2) when the foreign government is engaged in\ncommercial, not political, activity.\nIn domestic law, or law that is applicable within the nation\nwhere it is created, some authority has the power to create,\napply, and enforce a rule of law system. There is a legitimate\nlaw-creating authority at the \xe2\x80\x9ctop,\xe2\x80\x9d and the people to be\ngoverned at the \xe2\x80\x9cbottom.\xe2\x80\x9d This is a vertical structure of law,\nbecause there is some \xe2\x80\x9chigher\xe2\x80\x9d authority that imposes a rule\nof law on the people. In the United States, laws are made by\nthe legislative branch (statutory law), by the judicial branch\n(common law), and by the executive branch (executive orders,\nrules, and regulations). This authority is derived from the US\nConstitution.\nFigure 6.1 Vertical Nature of Domestic Law\n\nIt\xe2\x80\x99s important to note, however, that not all law can be\nconceived as a vertical structure. Some, such as international\nlaws, are best thought of as a horizontal structure. Treaties have\na horizontal structure because sovereign nations are parties\n\nInternational Law | 92\n\n\x0cto international treaties. Since each nation is sovereign, that\nmeans that one nation is not legally dominant over another.\nFigure 6.2 Horizontal Nature of International Law\n\nIf a party to a treaty has breached the agreement, enforcement\ncan be difficult because no overarching power \xe2\x80\x9cabove\xe2\x80\x9d the\nparties to a treaty exists. For this reason, many horizontal laws,\nlike treaties, contain provisions that require the parties to\nsubmit to a treaty-created dispute resolution panel or other\nneutral tribunal, such as the International Court of Justice (ICJ).\nAnother common challenge in international law is that the\nlaws are applicable only to parties who voluntarily choose to\nparticipate in them. This means that a sovereign nation cannot\ngenerally be compelled to submit to the authority of the\ninternational law if it chooses not to participate. Compare this\nwith domestic law. Everyone within the United States is subject\nto the jurisdiction of certain state and federal courts, whether\nthey voluntarily choose to submit to the jurisdiction or not. This\nis why fleeing criminals can legally be caught and brought to\njustice through extradition.\n\n6.3 Sources of International Law\nThere are two main sources of international law: customary\ninternational law and treaties. It is important for all companies\n\n93 | International Law\n\n\x0cto understand the laws that apply to their activities so they can\navoid criminal and civil liability.\n\nCustomary International Law\nA custom is a widely accepted way of doing something. Before\ntreaties and conventions started to become common during\nthe 1900s, custom was the primary way international law was\ncreated. Customary international law is a body of international\nrules that has become binding through the pattern of\nconsistent, long-standing behavior through a sense of legal\nobligation. For example, granting diplomatic immunity to\nvisiting heads of state is customary international law.\nHistorically, customary international law governed the rules of\nwar, treatment of prisoners of war, and human rights. After\nWorld War II, many areas of customary law became the basis\nfor UN Conventions. While customary international law still\nexists, the modern trend is to reduce legal obligations to\nwriting and have nations expressly agree to their terms.\n\nTreaties\nA treaty is an agreement between two or more nations\ngoverned by international law. In essence, a treaty is a contract\nbetween sovereign nations. A bilateral treaty is an agreement\nbetween two nations. A multilateral treaty is an agreement\nbetween three or more nations. A convention is a multilateral\ntreaty on a specific issue that concerns issues of worldwide\nimportance, such as human rights, property rights, and\ninternational trade rules. For businesses, one of the most\nimportant conventions is the UN Convention on Contracts for\n\nInternational Law | 94\n\n\x0cthe International Sale of Goods (CISG). This convention sets the\nglobal standard for international trade.\nTreaties are adopted when the parties agree to its final form.\nThen\n\nthe\n\ntreaty\n\nneeds\n\nto\n\nbe ratified\n\nby\n\nthe\n\nnations\xe2\x80\x99\n\ngovernments. To take effect in the US, treaties must be\napproved by two-thirds of the Senate. At that point, the treaty\nbecomes part of US law. Finally, a treaty enters into force when\nit becomes legally binding on the parties. This may be a\nspecific date identified in the treaty or when it is ratified by the\nparties.\nAlthough many treaties may impact businesses, a few are\nparticularly important to international trade.\n\nGATT\nThe General Agreement on Tariffs and Trade (GATT) is a\nmultilateral treaty to promote international trade by reducing\nor eliminating trade barriers, such as tariffs and quotas,\nbetween the member nations. GATT has been negotiated on\nand off since the 1940s as nations have sought to grow their\neconomies through global commerce. In 1995, GATT members\ncreated the World Trade Organization (WTO) to stimulate\ninternational commerce and resolve trade disputes.\nGATT and WTO are founded on three principles:\n1. Free trade. The major purpose of the treaty is to reduce\ntrade barriers to increase global trade.\n2. Most Favored Nation Status. Member nations agree to\ntreat every other member nation equally. If one nation\nreceives a special discount on customs duties, then the\ndiscount must be extended to all other member nations.\n3. National Treatment. Member nations agree to treat\n95 | International Law\n\n\x0cimported goods the same as domestic ones after they\nhave entered the nation. In other words, members cannot\ndiscriminate against foreign goods by imposing additional\ntaxes after being subject to import taxes and duties.\nThe WTO resolves trade disputes between member nations\nand has the power to impose trade sanctions for noncompliance with GATT. If a member nation refuses to comply\nwith a WTO ruling, affected members may retaliate by\nimposing punitive tariffs or other sanctions. For example, in\nthe famous \xe2\x80\x9cbanana battle,\xe2\x80\x9d the US and four Latin American\nnations filed a complaint with the WTO alleging that the\nEuropean Union (EU) placed unfair restrictions on imported\nbananas and showed favoritism to their former colonies by\nbuying bananas from them in violation of GATT. The WTO\nagreed and granted the US and the Latin American nations the\nright to impose sanctions on EU imports to their nations. The\nbanana battle ended in 2009 after 20 years of trade restrictions.\n\nCISG\nThe United\n\nNations\n\nConvention\n\non\n\nContracts\n\nfor\n\nthe\n\nInternational Sale of Goods (CISG) promotes international\ntrade by making sales law uniform and predictable across\ninternational boundaries. The US and most of its trading\npartners (except the United Kingdom) have adopted CISG,\nwhich results in the convention governing over two-thirds of\nthe world\xe2\x80\x99s trade. Some of its provisions include:\n\xe2\x80\xa2 CISG applies to contracts for the sale of commercial goods\nbetween merchants. It does not apply to the sale of goods\nto consumers for personal use.\n\xe2\x80\xa2 CISG applies automatically to contracts between parties\nlocated in different signatory nations. The convention does\nInternational Law | 96\n\n\x0cnot depend on nationality; it depends on location.\n\xe2\x80\xa2 Contract parties can opt out. Parties can contract to be\ngoverned by a nation\xe2\x80\x99s laws instead of CISG but they must\nexpressly state their intention to not be bound by CISG.\n\xe2\x80\xa2 CISG does not require a written contract.\n\xe2\x80\xa2 CISG requires parties to negotiate in good faith and to\nmodify contracts in the case of unforeseen circumstances.\n\xe2\x80\xa2 A buyer can avoid payment only after giving the seller\nnotice and an opportunity to remedy the problem.\n\nRegional Trade Agreements\nRegional trade agreements promote international commerce\nby reducing trade barriers among member nations that are\nlocated near each other. One of the most famous is the\nEuropean Union (EU) but more than half of international trade\nis covered by regional trade agreements throughout the world.\nAn important trade bloc agreement is the Association of South\nEast Asian Nations (ASEAN), which is a ten-nation trade bloc in\nSoutheast Asia. ASEAN + 3 includes the ASEAN nations, as well\nas China, Japan and South Korea.\nThe\n\nUS\n\nis\n\npart\n\nof\n\nthe\n\nUnited\n\nStates-Mexico-Canada\n\nAgreement (USMCA), which was formerly the North American\nFree Trade Agreement (NAFTA). USMCA reduces trade barriers\namong the three nations and updated NAFTA provisions,\nespecially as it relates to e-commerce, labor, and intellectual\nproperty\n\nrights.\n\nThese\n\nagreements\n\ncreate\n\ntremendous\n\nopportunities for businesses because they lower the costs\nassociated with importing and exporting within the region.\n\n97 | International Law\n\n\x0cTrade Regulations\nCompanies wishing to export or import products are subject to\nfederal trade regulations. To export simply means to transport\nproducts to another nation. Export controls prohibit or restrict\ncertain products from leaving a nation.\nCompanies wishing to import products are also subject to\nimport controls. Import controls take many forms including\ntariffs, quotas, bans and restrictions. The US Department of\nHomeland Security Customs and Border Protection Agency\n(CBA) has a primary role in import control administration and\nregulation. For example, it inspects imports to classify them\nand to establish their tariff schedule.\nTariffs are import taxes that apply to certain goods imported\nfrom other nations. They make the imported product more\nexpensive and keep the cost of domestic products attractive to\nconsumers. CBA customs officers classify the imported goods,\nwhich determines the applicable tariff. The importer is\nresponsible for complying with all import laws.\nQuotas are simply limits on the quantity of particular imported\ngoods. To protect domestic industries, a nation may limit the\nnumber of a competitor\xe2\x80\x99s goods that are sold within the nation.\nBans apply to goods that are illegal to be imported, because\nthey are dangerous to public safety, health, the environment,\nor national interests. For example, it is illegal to import items of\ncultural heritage from other nations without permission.\nAlong with the CBA, the US International Trade Commission\ninvestigates import injuries to the United States, such as\ndumping and subsidized imports. Dumping occurs when a\nforeign producer sells products for less than the cost of\nmanufacturing. Subsidized imports are produced overseas for\n\nInternational Law | 98\n\n\x0cwhich a government has provided financial assistance. When\ndumping or subsidized imports materially injure or threaten\nto injure domestic producers, the United States may impose\na countervailing duty for subsidized products or anti-dumping\nduty for dumped products. These duties, which are particular\ntypes of tariffs, reduce the negative impact that such practices\ncould have on US companies. Safeguards are limited duration\ngrowth restrictions that are imposed when domestic markets\nare threatened or injured from imports. This allows for\ndomestic markets to adjust to the surge from the import\nmarket. For example, the United States imposed safeguards\non Chinese textiles in response to actual or threatened market\ndisruption of the US textile industry.\n\n6.4 US Laws that Apply to US\nNationals Abroad\nExtraterritoriality is the power of a nation\xe2\x80\x99s laws to reach\nactivities outside of its physical borders. In other words, it is the\npower of a nation to impose its laws in other nations. Congress\nexpressly applies several important laws to US nationals\nworking abroad.\nUS citizens working for US companies overseas are protected\nby US federal employment laws, such as Title VII of the Civil\nRights Act and the Americans with Disabilities Act. This means\nthat US companies may not illegally discriminate against US\nemployees because those employees happen to work for the\ncompany on foreign soil rather than within the United States.\nBusiness practices abroad are also regulated by the US\ngovernment. For example, price-fixing conducted abroad by\nUS companies is a violation of the Sherman Antitrust Act.\nSimilarly, the Alien Torts Claims Act allows non-citizens to bring\n99 | International Law\n\n\x0csuit in US federal court against US businesses or citizens that\nhave committed torts or human rights violations in foreign\nnations.\n\nThe Foreign Corrupt Practices Act\nThe Foreign Corrupt Practices Act (FCPA) is an anti-corruption\nlaw that prohibits the payment of bribes by US companies and\ntheir employees to foreign officials. Violation of this law is a\ncriminal offense. It does, however, permit grease payments,\nor facilitating payments. Grease payments are only allowed to\nindividuals who are not decision makers. For example, a small\npayment to a clerk to process paperwork, after a project has\nalready been approved, is a grease payment.\nUS citizens are also prohibited from conducting transactions\nwith\n\nterrorists\n\nor\n\nterrorist\n\norganizations.\n\nConducting\n\ntransactions with prohibited persons, entities or businesses\ncan result in serious criminal violations, which carry significant\nfinancial penalties and long prison sentences.\n\n6.5 Concluding Thoughts\nTremendous opportunities exist for companies that wish to\noperate in international markets. However, the international\nlegal environment requires careful planning to avoid costly\nmistakes associated with violations of trade regulations, the\nformation of international contracts, and criminal and civil\nliability.\n\nInternational Law | 100\n\n\x0c7. Administrative Law\n7.1 Introduction\nLEARNING OBJECTIVES\n1. Understand the roles and functions of administrative\nagencies.\n2. Explore judicial review of agency actions.\n3. Learn how administrative agencies impact the daily\noperation of businesses.\nAn administrative agency is a governmental body with the\nauthority to implement and administer particular legislation.\nThey also are called government agencies or regulatory\nagencies.\nThe day-to-day operations of businesses across industries are\nshaped primarily by the actions of administrative agencies. This\nis because Congress and state legislatures often create\nagencies to regulate and enforce important legislation.\nAgencies\n\nexist\n\nat\n\nall\n\nlevels\n\nof\n\ngovernment\n\nand\n\nconsiderable power to achieve their regulatory objectives.\n\nCounselor\xe2\x80\x99s Corner The most important thing\nabout interacting with any government agency is\nnot to ignore the communication sent to you by\nthat agency. If an agency asks you for information,\nsend it. If the agency asks you to do something, or\n\n101 | Administrative Law\n\nhave\n\n\x0cprovide documentation, or to respond to a request,\ndo that thing, provide that documentation, and\nrespond to the request. The agency is not making\nthose requests aimlessly, or to cause you angst and\nfrustration. The agency is doing so because its own\nrules and regulations require it to gather more\ninformation, which the agency needs from you. Your\nreluctance or failure to respond will only cause\ndelay, or have negative consequences. So, ignore\nthose letters at your peril.\n\n~Sara C.,\n\nattorney\n\n7.2 Creation of Administrative\nAgencies\nAdministrative agencies are created by Congress or state\nlegislatures through an enabling act. An enabling act is a\nstatute that creates an administrative agency and determines\nthe scope of power granted to that agency. Some enabling\nacts are quite general and grant the agency a lot of discretion.\nOther enabling acts are more limited and identify the specific\ntype of power an agency has.\nWhile the legislative branch creates administrative agencies,\nthey are usually part of the executive branch because their\nprimary purpose is to enforce the law. Agencies in the\nexecutive branch are called executive agencies. At the federal\nlevel, these agencies are within the president\xe2\x80\x99s cabinet. The\npresident is granted the power to appoint and oversee the\nleadership of executive agencies, including replacing existing\nAdministrative Law | 102\n\n\x0cleadership when the president is sworn into office. A governor\nhas similar power over executive agencies at the state level.\nAn independent agency is an agency, commission, or board\nthat is not under the direction of the president or governor.\nCongress and and state legislatures create independent\nagencies when they want to insulate the work of the agencies\nfrom politics and to address concerns that go beyond the\nscope of ordinary legislation. These agencies are responsible\nfor keeping the government and economy running smoothly,\nespecially when different political parties come to power.\nExamples of independent agencies include the Federal Trade\nCommission and the Central Intelligence Agency.\nIndependent agencies are often run by boards or commissions\nmade up of five to seven members, who are from both major\npolitical parties, as well as political independents or smaller\npolitical\n\nparties.\n\nThe\n\nterm\n\nof\n\nboard\n\nmembers\n\nand\n\ncommissioners is usually four to nine years, with terms being\nstaggered to prevent complete turnover all at once.\nFigure 7.1 Differences Between Executive and Independent\nAgencies\n\n103 | Administrative Law\n\n\x0cCongress passed the Administrative Procedures Act (APA) to\nensure the rights of businesses and individuals are protected\nwhen interacting with federal agencies. The APA is a very\ncomplex statute that controls all aspects of agency activity to\nguarantee uniformity and fairness across agencies. For\nexample, the APA establishes the mechanisms for rulemaking,\nconducting adjudications, and giving notice to the public. The\nAPA also establishes the process for judicial review of agency\ndecisions. Most states have similar statutes to regulate state\nand local agencies.\nFigure 7.2 Organizational Chart of Federal Agencies\n\nAdministrative Law | 104\n\n\x0c7.3 Agency Functions\nAdministrative agencies carry out their purpose through the\nexercise of power in three ways that mirror the three branches\nof government:\n1. Agencies engage in rulemaking, which is a quasilegislative function;\n2. Agencies engage in enforcement, which is a quasiexecutive function; and\n3. Agencies engage in adjudication, which is a quasi-judicial\nfunction.\nFigure\n\n7.3\n\nRoles\n\nand\n\nAgencies\n\n105 | Administrative Law\n\nResponsibilities\n\nof\n\nAdministrative\n\n\x0cRulemaking\nThe enabling statute dictates the types of rules an agency can\nmake to implement and enforce the legislation for which it is\nresponsible. Generally, administrative rules are characterized as\ninternal, procedural, interpretive, and legislative.\nTypes of\nDescription\nRulemaking\nInternal\n\nPolicies and procedures adopted for in-house\noperations\n\nProcedural\n\nPolicies and procedures related to how the agency\nfunctions & interacts with businesses and individuals\n\nInterpretive\n\nGuidelines issued by the agency to businesses and\nindividuals about how to comply with the law\n\nLegislative\n\nRegulations that have the full force of law because\nthey are an extension of the underlying statute\n\nAdministrative Law | 106\n\n\x0cLegislative rulemaking may be formal or informal. Formal\nrulemaking is agency rulemaking that, when required by the\nenabling statute, must be on the record after an opportunity\nfor an agency hearing, and must comply with certain\nprocedures, such as allowing evidence and the crossexamination of witnesses. Formal rulemaking provides an\nopportunity to publicly and thoroughly debate the propriety of\na suggested rule. However, this process is very expensive and is\nsometimes subject to political delays.\nInformal rulemaking occurs when the agency publishes a\nproposed regulation and receives public comments on it, after\nwhich the regulation can take effect without the necessity of\na formal hearing on the record. Informal rulemaking is the\nmost common procedure followed by an agency when issuing\nsubstantive rules because it is less expensive and more\nefficient.\nAgencies will sometimes blend the the two types of\nrulemaking into a hybrid rulemaking approach. This type of\nrulemaking requires notice and a hearing on a proposed rule\nbut the hearing is not as extensive as in formal rulemaking and\ncross-examination of witnesses is not available.\n\nEnforcement\nAgencies are empowered to enforce administrative rules and\nthe underlying legislation identified in the agency\xe2\x80\x99s enabling\nact. Unlike law enforcement investigations, agencies do not\nneed probable cause to initiate an investigation. Generally,\nagencies are authorized to investigate simply to ensure the\nrules are being followed. For example, the Internal Revenue\nService may audit a business\xe2\x80\x99s taxes without any suspicion of\nwrongdoing.\n\n107 | Administrative Law\n\n\x0cAgencies are limited in their power to subpoena evidence in\nthe form of testimony from witnesses and in obtaining\ndocuments and evidence. To be lawful, an agency\xe2\x80\x99s subpoena\nmust:\n\xe2\x80\xa2 Establish that the purpose of the investigation is\nlegitimate;\n\xe2\x80\xa2 Establish that the agency has the power to conduct the\ninvestigation;\n\xe2\x80\xa2 Describe the requested information;\n\xe2\x80\xa2 Explain the relationship between the purpose of the\ninvestigation and the requested information; and\n\xe2\x80\xa2 Show that the requested information does not create an\nunreasonable burden on the business or individual in\npossession of it.\nBusinesses do not have all the Constitutional protections as\nindividuals\n\ndo,\n\nespecially\n\nwhen\n\nit\n\ncomes\n\nto\n\nagency\n\ninvestigations. In particular, a business cannot assert a Fifth\nAmendment\n\nright\n\nagainst\n\nself-incrimination\n\nto\n\nprevent\n\nagencies from obtaining business records. If an agency\nsubpoenas documents, a business is required to turn them\nover, even if doing so exposes the business and individuals to\npotential criminal liability.\n\nAdjudication\nAdjudication is the legal process of resolving a dispute. In an\nagency context, this is the trial-like procedure or hearing used\nby agencies to enforce their actions and determine whether a\nbusiness or individual has violated the law or regulations.\nAdjudication can be either formal or informal. Formal\nadjudication is like a trial and is usually overseen by an\n\nAdministrative Law | 108\n\n\x0cadministrative law judge (ALJ). The ALJ will decide what\nevidence is relevant and admissible, hear testimony, and\ndetermine the outcome of the dispute in a written finding. If\nappropriate, the ALJ also will determine a penalty.\nLike the judiciary, agencies have an internal appeal process for\nadjudication. If a party wants to appeal a hearing officer or ALJ\xe2\x80\x99s\ndecision, the case will be reviewed internally by the agency.\nOften, appeals boards will consist of three to five agency\nexperts who review the determination.\n\n7.4 Judicial Review of Agency Actions\nThe APA provides for judicial review of almost all agency\ndecisions. However, before going to court, a business or\nindividual must try to get the agency to reconsider its action.\nTo this end, two requirements must be satisfied:\n1. Administrative remedies must be exhausted; and\n2. The party must have standing.\nExhaustion of administrative remedies is the doctrine that, if\nan administrative remedy is provided by statute, a party must\nseek relief first from the agency before judicial relief is\navailable. The purpose of this doctrine is to ensure that courts\nwill not be burdened by cases in which judicial relief is\nunnecessary. Often courts cite the agency\xe2\x80\x99s subject matter\nexpertise as a reason to allow it to reconsider its action and fix\nerrors, especially common ones that may impact more than\njust the party involved in the hearing.\nFigure 7.4 Exhaustion of Administrative Remedies Flowchart\n\n109 | Administrative Law\n\n\x0cStanding is the requirement that only individuals and entities\nwith a personal stake in the outcome of a controversy may seek\njudicial review. Standing is discussed more in Chapter 3. With\nrespect to agency actions, this is often a litigated issue when\nadvocacy groups want to challenge an agency\xe2\x80\x99s decision but\nwere not a party to the agency\xe2\x80\x99s actions.\nBecause agencies have significant discretion in regulating\ntheir areas of expertise, judicial review of agency actions is\nlimited. A court will review an agency\xe2\x80\x99s actions in five\nsituations:\n\nAdministrative Law | 110\n\n\x0cBasis for Judicial\nReview\n\nDescription\n\nAgency exceeded\nits authority\n\nAgency acted beyond the authority given to it\nin the enabling act\n\nAgency\nincorrectly\ninterpreted the\nlaw\n\nAgency misunderstands or misapplies the law;\ncourts are the legal experts\n\nAgency made a\nprocedural error\n\nAgency failed to follow the APA or its own\nprocedural rules\n\nAgency violated\nthe Constitution\n\nAgency violated the Constitutional rights of\nbusinesses or individuals\n\nAgency made\narbitrary or\ncapricious\ndecision\n\nAgency\xe2\x80\x99s decision is neither based on the facts\nnor grounded in the law\n\n7.5 Public Access to Agency\nInformation\nAccountability\n\nand\n\ntransparency\n\nare\n\nconcerns\n\nwhen\n\ngovernmental entities have a lot of discretion and limited\njudicial oversight. To ensure that the government remains\nresponsive to the people as required by the Constitution,\nCongress has passed a series of laws to protect the rights of\nbusinesses and individuals.\nThe Freedom of Information Act (FOIA) was passed by\nCongress in 1966 to give a mechanism for private citizens to\nrequest information from the federal government. The central\npurpose of FOIA is to open up the workings of government\nto public scrutiny to keep the government accountable to the\npeople and electorate.\nThe process is simple. A business or individual sends a letter\nto the head of an agency requesting information regarding a\n111 | Administrative Law\n\n\x0cparticular subject. The agency then has ten days to respond.\nIf the agency denies the request, the party may either appeal\nthe decision within the agency or sue in federal court for the\ninformation.\nNot all information is subject to disclosure under FOIA. FOIA\nhas nine exceptions:\n\xe2\x80\xa2 National security and foreign policy;\n\xe2\x80\xa2 Internal personnel rules and practices of an agency;\n\xe2\x80\xa2 Information that Congress prohibits the disclosure of;\n\xe2\x80\xa2 Trade secrets and confidential commercial or financial\ninformation;\n\xe2\x80\xa2 Documents protected by the attorney-client privilege;\n\xe2\x80\xa2 Personnel and medical files that would constitute an\nunwarranted invasion of personal privacy;\n\xe2\x80\xa2 Some law enforcement information;\n\xe2\x80\xa2 Documents related to the regulation of financial\ninstitutions; and\n\xe2\x80\xa2 Geological and geophysical information and data,\nincluding well maps.\nThe media makes about ten percent of FOIA requests, which\nis part of investigative reporting. However, most requests come\nfrom\n\nbusinesses,\n\nexception\n\nattorneys,\n\napplies,\n\nthe\n\nand\n\nindividuals.\n\ngovernment\n\nmust\n\nUnless\n\ndisclose\n\nan\nthe\n\nrequested information. This has become a tool for businesses\nseeking advantage over their competition.\nFor example, AT&T received a federal grant to promote\ncommunications in school. AT&T self-reported to the Federal\nCommunications\n\nCommission\n\n(FCC)\n\nthat\n\nit\n\nmay\n\nhave\n\novercharged the government for its services. This resulted in an\ninvestigation into AT&T\xe2\x80\x99s services and billing practices. Several\nmonths after AT&T and the FCC reached a settlement in which\nAT&T reimbursed the FCC $500,000, a trade association\n\nAdministrative Law | 112\n\n\x0crepresenting some of AT&T\xe2\x80\x99s competitors made a FOIA request\nto the FCC for documents related to the investigation and\nsettlement. AT&T tried to block the request, arguing that it was\nan unwarranted invasion of personal privacy. In a unanimous\ndecision, the US Supreme Court held that corporations do not\nhave a personal privacy right like individuals do. As a result, the\nFCC disclosed the information to AT&T\xe2\x80\x99s competitors.\nOver the years, FOIA has been amended and supplemented\nthrough\n\ncomplementary\n\nlegislation.\n\nBusinesses\n\nand\n\nindividuals have the right to correct information that was\nsubmitted to an agency, as well as the right to specific reasons\nregarding any information that is withheld or redacted under\nFOIA. In addition, many agency meetings must be open to the\npublic.\nMost states have passed legislation similar to FOIA requiring\nstate and local governments to disclose information to the\npublic.\n\n7.6 Concluding Thoughts\nThe vast majority of governmental work is done through\nadministrative agencies. Given their functions, they are often\nreferred to as the \xe2\x80\x9cFourth Branch\xe2\x80\x9d of government. Agencies\nexist at all levels of government and have a lot of discretion\nin implementing and enforcing laws. Most businesses and\nindividuals have contact with the government through\nagencies so it is incredibly important to understand how they\nwork\n\nto\n\nbe\n\nsuccessful\n\nconsequences.\n\n113 | Administrative Law\n\nin\n\nbusiness\n\nand\n\navoid\n\nlegal\n\n\x0c8. Criminal Law\n8.1 Introduction\nLEARNING OBJECTIVES\n1. Understand what crime is and learn about common\nbusiness crimes.\n2. Compare and contrast the differences between criminal\nlaw and civil law.\n3. Understand the constitutional protections given to those\naccused of committing a crime.\n4. Explore the exceptions to the Fourth Amendment\xe2\x80\x99s\nwarrant requirement.\nA crime is a social harm that the law punishes. At the most\nbasic level, criminal statutes reflect the rules that must be\nfollowed for a civil society to function. Like individuals,\nbusinesses can be both victims and perpetrators of crime.\nCrime affects businesses both from outside and inside the\norganization. Criminal activity \xe2\x80\x9cfrom the outside\xe2\x80\x9d may include\nproperty damage, theft, shoplifting, corporate espionage,\nfraud, and arson. Threats \xe2\x80\x9cfrom the inside\xe2\x80\x9d may include crimes\nsuch as embezzlement, computer crimes, and fraud. Moreover,\nbusinesses must also protect themselves from the bad\njudgment and behavior of their employees. If an employee\nacting within the scope of employment commits a crime from\nwhich the business will benefit, then the business can be\nconvicted of the crime, too. Businesses may actively perpetrate\n\nCriminal Law | 114\n\n\x0ccrime, through a bad corporate culture or through organized\ncrime, such as money laundering.\n\nCounselor\xe2\x80\x99s Corner Criminal convictions result in\nmore than loss of liberty. Having a conviction on\nyour record can mean inability to obtain certain\njobs, to gain admission to college, to vote, and to\nrent or lease a home. Convictions affect a person\xe2\x80\x99s\nlife for much longer than the actual sentence\nimposed. Make sure you hire an attorney if you are\never faced with a criminal charge. Know your rights\nand understand the specific laws applicable to your\nfield. When in doubt, consult with an attorney,\naccountant, or other professional in your field.\n~Krista S., attorney\n\n8.2 The Nature of Criminal Law\nWhen crime occurs in the context of business, some people\nthink that no one is \xe2\x80\x9creally\xe2\x80\x9d injured. When an insurance\ncompany has to pay for a claim arising from a crime, the\ninsurance company is injured, as are the victim and society at\nlarge. Crime undermines confidence in the social order and\npublic safety. No crime is victimless.\nIn general, a crime requires someone to (1) commit a criminal\nact, known as actus reus, and (2) possess the required criminal\nstate of mind, or mens rea. Therefore, intent to commit a crime,\nwithout more, is not enough to convict someone. For example,\nif an accountant thinks about stealing money from her\ncompany but does not take any steps to do it, then no crime\n115 | Criminal Law\n\n\x0chas been committed. Similarly, if an accountant makes a\nmistake\n\nand\n\ntransfers\n\nmoney\n\ninappropriately\n\nbetween\n\naccounts, he has not committed fraud unless he had the\nrequired criminal state of mind.\nStrict liability crimes are an exception to the mens rea element.\nStrict liability crimes are acts that the legislature defines as\nsocial wrongs that do not need proof of the defendant\xe2\x80\x99s intent\nto complete the act. For example, speeding while driving a\nmotor vehicle, possession of child pornography, and sale of\ntobacco and alcohol to minors all carry criminal liability without\nthe government needing to prove the defendant\xe2\x80\x99s intent.\n\nCriminal Law versus Civil Law\nCriminal law differs from civil law in several important ways.\n\nCriminal Law | 116\n\n\x0cCriminal Law\n\nCivil Law\n\n\xe2\x80\xa2 An injury to the public\n\n\xe2\x80\xa2 A private injury or wrong\n\n\xe2\x80\xa2 Prosecuted by the\ngovernment\n\n\xe2\x80\xa2 Plaintiff sues defendant\n\n\xe2\x80\xa2 Attorney provided, if\ndefendant cannot afford one\n\n\xe2\x80\xa2 Parties must provide their\nown attorneys\n\n\xe2\x80\xa2 Burden of proof is beyond a\nreasonable doubt\n\n\xe2\x80\xa2 Burden of proof is usually\nthe preponderance of\nevidence\n\n\xe2\x80\xa2 Conviction may result in\nfines or loss of liberty\n\n\xe2\x80\xa2 Penalties are usually\nmonetary\n\nBecause crimes are public injuries, they are punishable by the\ngovernment. It is the government\xe2\x80\x99s responsibility to bring\ncharges against criminals. In fact, private citizens may not\nprosecute each other for crimes. When a crime has been\ncommitted, the government collects the evidence and files\ncharges against the defendant. When someone is charged\nwith committing a crime, he or she is charged by the\ngovernment in an indictment.\nOur civil tort system allows victims to bring a civil suit against\nsomeone for injuries inflicted upon them. Indeed, criminal laws\nand torts often have parallel causes of action. Sometimes these\nclaims have the same or similar names. For instance, a victim\nof fraud may bring a civil action for fraud and may also be a\nwitness for the government during the criminal trial for fraud.\n\n117 | Criminal Law\n\n\x0cBurden of Proof\nIn a criminal case, the defendant is presumed to be innocent\nunless he or she is proven guilty. This presumption of\ninnocence means that the government must prove the case\nagainst the defendant before it can impose punishment. If the\ngovernment cannot prove its case, then the person charged\nwith the crime must be acquitted. This means that the\ndefendant will be released, and he or she may not be tried\nfor that crime again. This important protection from double\njeopardy is guaranteed by the Fifth Amendment.\nThe prosecution has the burden to prove its case beyond a\nreasonable doubt. This means that the evidence must be so\ncompelling that no reasonable doubt exists as to the\ndefendant\xe2\x80\x99s guilt. The defendant does not have to prove\nanything, because the burden is on the government to prove\nits case. It is useful to think of the criminal standard of\nproof\xe2\x80\x94beyond a reasonable doubt\xe2\x80\x94as something like 95\npercent certainty, with 5 percent doubt. Perhaps there is some\ndoubt about the precise time of day or the victim\xe2\x80\x99s exact words\nto the defendant. However, there is no doubt about the\nessential elements of the crime, such as the defendant\xe2\x80\x99s\nidentity as the perpetrator of the crime, his or her mens rea,\nand the actus reus.\nFigure 8.1 Burden of Proof in Criminal Trials\n\nCriminal Law | 118\n\n\x0cCompare this to the standard of proof in a civil trial, which\nrequires\n\nthe\n\nplaintiff\n\nto\n\nprove\n\nthe\n\ncase\n\nonly\n\nby\n\na preponderance of the evidence. This means that the\nevidence to support the plaintiff\xe2\x80\x99s civil case is greater than the\nevidence that does not. Preponderance of the evidence could\nmean 51 percent in favor of the plaintiff\xe2\x80\x99s case, and 49 percent\nin doubt. Therefore, it is much more difficult to prosecute a\ncriminal defendant than to bring a successful civil claim. Since\na criminal action and a civil action may be brought against a\ndefendant for the same incident, these differences in burdens\nof proof can result in verdicts that seem, at first glance, to\ncontradict each other. For example, O.J. Simpson was acquitted\nof murder in a criminal trial because the government did not\nprove to the jury that he committed the crimes beyond a\nreasonable doubt. However, a different jury found O.J. Simpson\nliable for wrongful death in a subsequent civil action.\nFigure 8.2 Burden of Proof in Civil Trials\n\n119 | Criminal Law\n\n\x0cThis extra burden reflects the fact that the defendant in a\ncriminal case stands to lose much more than a defendant in a\ncivil case. Although no one wants to lose assets in a civil case,\nthe loss of liberty through imprisonment is a more significant\nloss. Therefore, more protections are given to a criminal\ndefendant than are given to defendants in civil proceedings.\nBecause so much is at stake in a criminal case, our\nConstitutional due process requirements are very high for\ndefendants in criminal proceedings.\nDue process procedures vary depending on the type of penalty\nthat can be levied against someone. For example, in a civil\ncase, the due process requirements might simply be notice\nand an opportunity to be heard. If the government intends to\nrevoke a professional license, then the defendant might receive\nnotice by way of a letter, and the opportunity to be heard might\nexist by way of written appeal. In a criminal case, however, the\ndue process requirements are higher. For example, a criminal\ndefendant is entitled to confront all witnesses against him or\nher, and to see the evidence the prosecution intends to\nCriminal Law | 120\n\n\x0cintroduce at trial. More protections must be in place because\na criminal case carries the potential for the most serious\npenalties.\n\nClassification of Crimes\nFelonies versus Misdemeanors\nCrimes\n\nare\n\ngenerally\n\nclassified\n\nas\n\neither\n\nfelonies\n\nor\n\nmisdemeanors. Felonies are serious crimes punishable by a\nyear or more in prison. These type of crimes include fraud,\narson, homicide, and most other crimes that are mentioned\nin news headlines. Misdemeanors are less serious crimes that\nare often punishable by fines, probation or time served in jail\npending conviction. Examples of misdemeanors include\ntrespassing, vandalism, and failure to report for jury duty.\n\nWhite-Collar Crime Versus Blue-Collar Crime\nWhite-collar crime is a term used to describe nonviolent\ncrimes committed by people in their professional capacity, or\nby organizations. These crimes are committed for financial\ngain, often through deception. White-collar crimes are not\ntypical street crimes, like burglary or robbery, and they are not\npersonal crimes, like murder or rape. White-collar criminals\nfrequently commit their crimes on the job, in broad daylight,\nwhile sitting at a desk. For example, Bernie Madoff was\nsentenced to 150 years in prison for stealing $20 billion in a\nPonzi scheme that had $65 billion in fabricated gains.\nBlue-collar crime is a generic term used to describe crimes\nthat are more traditional street crimes. In business, property\n\n121 | Criminal Law\n\n\x0ccrimes (rather than crimes against people) are a primary\nconcern. A property crime is a crime involving damage to\nproperty, while a person crime is a crime involving injury to a\nperson\xe2\x80\x99s body. Examples of blue-collar crime that often affect\nbusinesses include shoplifting, vandalism and destruction of\nproperty.\n\n8.3 Constitutional Rights and\nDefenses\nA person accused of a crime has rights guaranteed by the\nUS Constitution to ensure the federal government does not\nunfairly prosecute them. The Bill of Rights\xe2\x80\x93especially the\nFourth, Fifth, Sixth, and Eighth Amendments\xe2\x80\x93list the rights of\ncriminal defendants. The Fourteenth Amendment makes\nthese rights applicable to defendants accused of crimes by\nstate governments. In addition, most states have constitutions\nthat have similar protections.\n\nFourth Amendment\nFigure 8.3 Language of the Fourth Amendment\n\nCriminal Law | 122\n\n\x0cThe Fourth Amendment prohibits illegal searches and seizures.\nIf evidence is obtained in violation of the Fourth Amendment,\nit cannot be used against the defendant in a court of law. For\nFourth Amendment requirements to be met, law enforcement\nofficers (the Executive Branch) must obtain a search warrant\nfrom a judge (the Judicial Branch) to search a specific area\nor person for specific items. A search warrant is issued only\nwhen a judge determines that probable cause exists. Probable\ncause exists when the known facts and circumstances would\nlead a reasonable person to believe that an item sought by the\nwarrant is contraband, is stolen, or is evidence of a crime.\nIf a valid search warrant is issued, then law enforcement may\nsearch the area identified in the warrant for the named item(s)\nor person. Even if there was no warrant, the items found may\nstill be admissible as evidence. This is because several\nexceptions to the requirements for a search warrant exist to\nhelp law enforcement protect the public and stop crimes as\nthey occur.\n\n123 | Criminal Law\n\n\x0cWarrant\nException\n\nExample\n\n\xe2\x80\xa2 Plain View\n\nOfficer is lawfully in store parking lot and sees\nstolen goods for sale in store window. The\nofficer can seize the items without a warrant.\n\n\xe2\x80\xa2 Crime in\nProcess\n\nOfficer sees man running down the street with\na purse while witnesses are yelling that he\nstole the purse from a woman on the sidewalk.\nOfficer can seize the man and purse without a\nwarrant.\n\n\xe2\x80\xa2 Destruction of\nEvidence\n\nOfficer responds to suspected drug deal and\nhears toilet flushing repeatedly and quickly.\nOfficer may enter bathroom and seize drugs.\n\n\xe2\x80\xa2 Emergency/\nOfficer responds to a situation where someone\nExigent\nmay be injured. Officer may enter premises to\nCircumstances locate and help injured person.\n\n\xe2\x80\xa2 Consent\n\nOfficer may ask permission to search area that\na person owns or controls. If the individual says\n\xe2\x80\x9cyes,\xe2\x80\x9d then officer can lawfully search.\n\n\xe2\x80\xa2 Officer Safety\n\nOfficer may do a protective sweep of a\nsuspect\xe2\x80\x99s clothes and immediate area for\nweapons and contraband within the suspect\xe2\x80\x99s\nreach to protect the officer\xe2\x80\x99s physical safety.\n\n\xe2\x80\xa2 Incident to a\nLawful Arrest\n\nOnce someone is placed under arrest, an\nofficer may search them for weapons and\ncontraband. Officers will also do an inventory\nsearch upon arrival at the jail.\n\nTwo other common exceptions are the automobile exception\nand stop and frisk exception. The automobile exception\nmeans that the passenger compartment of an automobile\nmay be searched if the car has been lawfully stopped. When a\npolice officer approaches a stopped car at night and shines a\nlight into the interior of the car, the car has been searched. No\nwarrant is required. If the police officer spots something that\nis incriminating, it may be seized without a warrant. Similarly,\nif someone is stopped lawfully, that person may be frisked\n\nCriminal Law | 124\n\n\x0cwithout a warrant. This is the stop and frisk exception to the\nwarrant requirement. Both of these exceptions are based on\nofficer safety, but are often labeled based on the circumstances\nof the search.\nIn the business context, it is also important to note that some\nadministrative agencies may conduct warrantless searches of\nclosely regulated businesses, such as junkyards, where stolen\ncars may be disassembled for parts that can be sold.\n\nFifth Amendment\nFigure 8.4 Language of the Fifth Amendment\n\nThe Fifth Amendment guarantees four important rights:\n1. The right to avoid self-incrimination;\n2. The right to due process so that all court proceedings are\nfundamentally fair;\n3. The right to be indicted by a grand jury for capital offenses\nand infamous crimes; and\n125 | Criminal Law\n\n\x0c4. The right to be free from double jeopardy.\nThe Fifth Amendment guarantees that people can choose to\nremain silent. No one can be compelled to testify against\nhimself or herself or to make self-incriminating statements. If\na person does not want to cooperate with the government\xe2\x80\x99s\ninvestigation and prosecution of a crime, he or she does not\nhave to. During trial, the prosecution cannot comment on a\ndefendant\xe2\x80\x99s silence and it cannot be used as evidence of guilt\nagainst the defendant.\nThe prohibition against double jeopardy means that a person\ncannot be tried twice for the same offense by the same\ngovernmental body. This prevents the government from\nharassing individuals with endless prosecutions until they find\nthe \xe2\x80\x9cright\xe2\x80\x9d jury that is willing to convict. It also requires the\ngovernment to do its job well the first time it prosecutes a case.\n\nSixth Amendment\nFigure 8.5 Language of the Sixth Amendment\n\nCriminal Law | 126\n\n\x0cThe Sixth Amendment entitles a criminal defendant to:\n1. A speedy trial;\n2. A trial by jury;\n3. A public trial;\n4. An attorney; and\n5. The right to confront witnesses.\nThe\n\npurpose\n\nof\n\nthe\n\nSixth\n\nAmendment\n\nis\n\nto\n\nensure\n\ntransparency in criminal proceedings so the government\ncannot selectively prosecute dissidents or employ unfair\ntactics. Defendants are entitled to an attorney during any\nphase of a criminal proceeding where there is a possibility of\nincarceration. This means that if a defendant cannot afford\nan attorney, then one is appointed for him or her at the\ngovernment\xe2\x80\x99s expense.\n\nEighth Amendment\nFigure 8.6 Language of the Eighth Amendment\n\n127 | Criminal Law\n\n\x0cThe\n\nEighth\n\nAmendment\n\nprohibits\n\ncruel\n\nand\n\nunusual\n\npunishment and excessive fines and bail. Simply put, the\nEighth Amendment is an anti-torture amendment. It also\nprohibits jails from being used against the poor as was\ncommonly practiced in Europe at the time the Constitution\nwas written.\n\nDefenses\nUnder the exclusionary rule, any evidence the government\nacquires illegally may not be used at trial. This rule prevents\ngovernmental misconduct during the investigation of crimes.\nThe theory is simple: if law enforcement and prosecutors know\nthat illegally obtained evidence cannot be used in court, they\nwill not be tempted to make improper searches or engage in\nother illegal behavior. The exclusionary rule is one of the most\npowerful limits on the police power of the government.\nBecause the exclusionary rule is intended to prevent law\nenforcement from intentionally overstepping its authority, an\nexception exists to the rule for when the police act in good\nfaith. Therefore, the exclusionary rule does not protect\nindividuals and businesses from all governmental errors.\nInstead, it prevents intentional misconduct.\nIf someone is subject to a custodial interrogation, he or she\nmust first be informed of their Miranda rights. These rights are\nusually stated as:\nYou have the right to remain silent. Anything that you\nsay can and will be used against you in a court of law.\nYou have the right to an attorney. If you cannot afford an\nattorney, one will be provided to you by the state. Do you\nunderstand your rights?\n\nCriminal Law | 128\n\n\x0cThe purpose of the Miranda warnings is to ensure that people\nunderstand their constitutional rights so they make informed\ndecisions about whether to speak with law enforcement.\nEntrapment is another defense available to people accused of\ncrimes. Entrapment means that the criminal intent originated\nwith the police, and therefore the mens rea of the crime cannot\nbe placed on the defendant. Essentially, the rule against\nentrapment limits the ability of the police to play the role of\ncriminals during undercover investigations. For example, if the\npolice provide a drug dealer with the opportunity to sell drugs\nto an undercover agent, there is no defense of entrapment\nbecause the dealer had the mens rea to commit a crime\nregardless of the identity of the buyer. However, if the police\nknock on someone\xe2\x80\x99s door who is not known to be a drug dealer\nand continues to demand drugs until the person cannot resist\nand sells the police drugs, then entrapment occurs.\n\n8.4 Common Business Crimes\nEach jurisdiction has the power to define what a crime is.\nTherefore, criminal laws can vary between states and federal\ngovernments. However, there are some common crimes that\naffect businesses across jurisdictions.\nFraud is the use of deception to acquire money or property.\nSecurities\n\nfraud is when someone uses deception to\n\ncircumvent the regulations or statutes interpreted by the US\nSecurities and Exchange Commission (SEC) to acquire money\nor property. Goldman Sachs was charged with securities fraud\nwhen it misrepresented material facts to investors to gain\nfinancially.\nFinancial institution fraud is fraud against banks and other\n\n129 | Criminal Law\n\n\x0csimilar institutions, such as credit unions. The IRS investigates\nfinancial institution fraud. Cases of financial institution fraud\ncan involve people who commit money laundering and those\nwho falsify tax documents, or profit and loss statements, to\ngain funding from banks.\nA Ponzi scheme is a fraudulent pyramid scheme, where\ninnocent people pay in to participate. Those at the top of the\npyramid may receive something that appears to be a return\non their investment (ROI), but those at the bottom do not.\nThose who operate Ponzi schemes generally solicit investors,\nand those who invest in such schemes are expecting a\nlegitimate ROI. However, the head of the Ponzi scheme keeps\nhis early investors happy by bringing in new investors, whose\nmoney he gives to the old investors as their ROI. This allows the\nPonzi scheme to continue, because it appears from the outside\nthat investors are receiving a legitimate ROI. The problem is\nthat the capital contributions eventually disappear, since they\nare never invested but are simply used by the head for his own\npurposes, including paying investors with fake ROI payments\nas necessary. Pyramids will eventually collapse under their own\nunsustainable structure. Bernie Madoff was convicted of\nrunning the largest known Ponzi scheme that defrauded\ninvestors of approximately $65 billion.\nEmbezzlement occurs when someone takes property that was\nin his or her possession lawfully and then converts it to his\nor her own use. Embezzlement often happens by people who\nare in a position of trust over the assets of another person.\nThis includes financial advisors, brokers, accountants, lawyers,\nand guardians. Embezzlement strategies can involve forgery,\nwhich is counterfeiting a document or someone else\xe2\x80\x99s\nsignature.\nEmbezzlement differs from larceny, because larceny requires\nthe trespassory taking of property with the intent to deprive\n\nCriminal Law | 130\n\n\x0cthe owner of the property. In other words, in a larceny, the thief\nis not supposed to have possession of the property to begin\nwith. For example, larceny includes shoplifting and basic theft\nof personal property.\nIt is illegal to make false statements or engage in a cover up\nduring dealings with the federal government. Making False\nStatements is a crime that is often easier to prove against\na defendant than a more complex crime that is being\ninvestigated. For example, Martha Stewart was investigated for\ninsider trading. Although the insider trading charges were\ndismissed, Martha Stewart was convicted by a jury of making\nfalse statements because she lied to officers during the\ninvestigation. As a result, she served five months in prison.\n\nRICO\nThe Racketeer Influenced and Corrupt Organizations Act\n(RICO) is a federal statute that was passed to prevent gangsters\nfrom taking money earned illegally and investing it in\nlegitimate businesses. Although RICO was written to target\ntraditional organized crime, less than 10 percent of RICO cases\nfiled have been against the mafia. Instead, 75 percent of RICO\ncases involve business fraud.\nA racket is a dishonest or fraudulent scheme, which usually is\nan organized criminal activity. The two most common rackets\nare protection rackets and fencing rackets. In a protection\nracket, a criminal offers to protect the victim from violence\nor destruction of property. If the victim refuses to pay for\nprotection, then the criminal will engage in violence against\nthe victim or destroy his or her property. In a fencing racket, a\ncriminal will steal property from a victim then offer to resell it\n\n131 | Criminal Law\n\n\x0cto them. The victim must pay for the return of his or her own\nproperty.\nRICO punishes those engaged in three or more racketeering\nactivities over a ten-year period when funds from those\nactivities were used to maintain, operate, or acquire a\nlegitimate\n\nbusiness.\n\nembezzlement,\n\nmail\n\nRacketeering\nfraud,\n\nwire\n\nactivities\nfraud,\n\ninclude\n\nloan-sharking,\n\nbookmaking, money laundering, counterfeiting, smuggling,\nblackmailing, arson, and other similar crimes. RICO is now used\nagainst insurance companies, stock brokerages, tobacco\ncompanies, banks, and other large commercial enterprises. If\nconvicted, a defendant can be punished with large fines and a\nprison sentence of up to twenty years.\nRICO also has a civil provision allowing a competitor to file\nRICO charges, which come with triple damages if the suit is\nsuccessful. In other words, a civil plaintiff can recover a\njudgment for three times the harm actually suffered, as well as\nattorneys\xe2\x80\x99 fees.\nArt Cohen vs. Donald J. Trump was a civil RICO class action\nlawsuit filed in 2013, accusing Donald Trump of fraudulently\nmisrepresenting the nature of Trump University. Within weeks\nof winning the presidential election in 2016, Trump settled this\ncase and two others for $25 million in damages to the plaintiffs.\nMany states also have organized crime statutes. State penalties\noften are much more severe under the organized crime\nstatutes than they would be if the accused worked alone. For\nthis reason, businesses and individuals need to be careful to\nprotect themselves from another\xe2\x80\x99s wrongful conduct.\n\nCriminal Law | 132\n\n\x0c8.5 Concluding Thoughts\nCrime has an enormous impact on society, including business.\nCrime is a very important consideration in the business world.\nBusinesses can be both victims and perpetrators of crime.\nAlthough jurisdictions may define crimes differently, there are\nsome types of crime that businesses often face, including\nfraud, embezzlement, and larceny. Successful businesses must\nbe vigilant to protect themselves from those who wish to harm\nthem, both from inside and out.\nCrime is a public injury. Criminal law can be classified both\nby the nature of the punishment and the type of offense it is.\nCriminal law differs from civil law in important ways, including\nwho brings the claim, the burden of proof, due process, and\npenalties. The most important distinction is the elevated\nburden of proof in criminal cases. The prosecution must prove\nthat a defendant committed a crime beyond a reasonable\ndoubt.\nThose who are accused of committing a crime are protected\nby the US Constitution. Important constitutional protections\ninclude the prohibition against illegal searches and seizures,\nself-incrimination, and cruel and unusual punishment. If the\ngovernment obtains evidence illegally, it cannot use it against\na defendant in a criminal trial. Criminal defendants have the\nright to a public and speedy trial, an attorney, and to remain\nsilent.\n\n133 | Criminal Law\n\n\x0c9. Torts\n9.1 Introduction\nLEARNING OBJECTIVES\n1. Define torts.\n2. Understand intentional torts, and how to defend against\nan accusation of one.\n3. Explore negligence.\n4. Explain strict liability and how product liability affects\nmanufacturers.\nA tort can be understood as a civil wrong to a person or\nproperty other than breach of contract. A tort is any legally\nrecognizable injury arising from the conduct (or sometimes\nfailure to act) of persons or corporations. There are several key\ndifferences between torts and contracts, which are also\ndifferent than crimes:\n\nTorts | 134\n\n\x0cContract\n\nTort\n\nCrime\n\nObligation\n\nThe parties\nagree to a\ncontract;\nwhich imposes\nduties on\nthem\n\nCivil law\nimposes duties\n\nLegislatures\npass laws\nprohibiting\ncertain\nconduct\n\nEnforcement\n\nParty to\ncontract or\nbeneficiary\nsues for breach\nof contract\n\nInjured party\nsues for tort\nclaims\n\nGovernment\nprosecutes\n\nMonetary\ndamages;\ninjunction\n\nCriminal\nconviction\nmay include\nfine,\nimprisonment,\n& restitution\n\nConsequences\n\nMonetary\ndamages\n\nSome conduct can be both a crime and a tort. If Allie punches\nBentley without provocation, then Allie has committed both\nthe tort of battery and the crime of battery. In the tort case,\nBentley could sue Allie in civil court for money damages\n(typically for his medical bills). That case would be tried based\non the civil burden of proof\xe2\x80\x94preponderance of the evidence.\nThat same action, however, could result in Allie being charged\nwith criminal battery. If convicted beyond a reasonable doubt,\nAllie may have to pay a fine or go to jail.\nThe standard of proof in a criminal case (beyond a reasonable\ndoubt) is far higher than the standard of proof in a civil case (a\npreponderance of evidence). Therefore, victims of crimes often\nwait to bring related tort claims against a defendant until after\nthe criminal trial is over. If the defendant is convicted of a crime,\nit is easier and less expensive to prove liability at a civil trial.\nTorts can be broadly categorized into three categories,\ndepending on the level of intent demonstrated by the\ntortfeasor (the person committing the tort). If the tortfeasor\nacted with intent to cause the damage or harm, then\n\n135 | Torts\n\n\x0can intentional tort has occurred. If the tortfeasor didn\xe2\x80\x99t act\nintentionally but failed to act as a reasonable person,\nthen negligence occurs. Finally, strict liability occurs where\nthe tortfeasor is held responsible regardless of intent.\nFigure 9.1 Tort Liability Diagram\n\nCounselor\xe2\x80\x99s Corner Not every injury or harm gives\nrise to a legal claim. You can\xe2\x80\x99t sue someone just\nbecause your feelings are hurt or something bad\nhappened. Even though you may have been\nthrough something harmful, if the law doesn\xe2\x80\x99t\nrecognize the injury as something you can recover\nfor, you don\xe2\x80\x99t have a legal claim. Lawsuits are meant\nto address really bad injuries or really bad behavior.\nMany things that drive us crazy when dealing with\nother people are things that we just have to learn to\n\nTorts | 136\n\n\x0cdeal with. Or resolve in another forum. ~Heather C.,\nattorney\n\n9.2 Intentional Torts\nIn an intentional tort, the tortfeasor intends the consequences\nof his or her act, or knew with substantial certainty that certain\nconsequences would result. This intent can be transferred. For\nexample, if someone swings a baseball bat at someone else but\nthe person ducks and the bat hits a third person, the person hit\nis the victim of a tort even if the person swinging the bat had\nno intention of hitting the person actually injured.\nIt is useful to think of torts based on the type of rights being\nprotected.\n\n137 | Torts\n\n\x0cTheory of Liability\n\nDescription\n\nInterference with\nPersonal Freedom\nAssault\n\nCausing the apprehension or fear of\nimmediate harmful or offensive contact\n\nBattery\n\nApplication of force that results in\nharmful or offensive contact with a\nperson\xe2\x80\x99s body\n\nFalse Imprisonment\n\nIntentional confinement or restrain of a\nperson\xe2\x80\x99s movements without justification\nor consent\n\nIntentional Infliction of\nEmotional Distress\n\nIntentionally or recklessly causing\nanother person severe emotional distress\nthrough extreme or outrageous acts\n\nInterference with\nProperty Rights\nTrespass to Land\n\nUnauthorized entry onto land that is\nvisibly enclosed & owned by another\n\nTrespass to Personal\nProperty\n\nTaking or harming another\xe2\x80\x99s personal\nproperty without permission\n\nConversion\n\nWrongful possession or disposition of\nproperty as if it were one\xe2\x80\x99s own with the\nintent to do so permanently\n\nNuisance\n\nCondition or situation that interferes with\nthe use or enjoyment of property\n\nInterference with\nEconomic Relations\nDisparagement\n\nFalse & injurious statement that\ndiscredits or detracts from the reputation\nof another\xe2\x80\x99s property, product or\nbusiness\n\nInterference with\nContractual Relations\n\nIntentional inducement of a party to\nbreak an existing contract\n\nInterference with\nProspective Advantage\n\nIntentional interference with a potential\nbusiness relationship\n\nMisappropriation\n\nUsing another\xe2\x80\x99s property dishonestly for\none\xe2\x80\x99s own use\n\nWrongful\nCommunications\nDefamation\n\nHarming the reputation of another by\nmaking a false statement\n\nTorts | 138\n\n\x0cSlander\n\nSpoken defamation\n\nLibel\n\nWritten defamation\nViolating someone\xe2\x80\x99s right to be left alone\nor to restrict public access to confidential\ninformation through:\n\nInvasion of Privacy\n\nFraud\n\n\xe2\x80\xa2 appropriating the person\xe2\x80\x99s name or\nlikeness;\n\xe2\x80\xa2 invasion of physical solitude;\n\xe2\x80\xa2 publicly disclosing private facts; or\n\xe2\x80\xa2 false light\nIntentional misstatement of a material\nfact that is relied upon by a third party\n\nInterference with Personal Freedom\nAssault is the threat of force on another that causes that\nperson to have a reasonable apprehension or fear of immediate\nharmful or offensive contact. Actual fear or physical injuries\nare not required for assault. It is also not necessary for the\ntortfeasor to intend to cause apprehension or fear. If someone\npoints a realistic-looking toy pistol at a stranger and says \xe2\x80\x9cgive\nme all your money\xe2\x80\x9d as a joke, it is still assault if a reasonable\nperson would have had apprehension or fear in that situation.\nThe intentional element of assault exists here, because the\ntortfeasor intended to point the realistic-looking toy at the\nstranger.\nBattery is the application of force to another that results in\nharmful or offensive conduct. It includes any non-consensual\ntouching, even if physical injuries are not present. In battery,\nthe contact or touching does not have to be to the person.\nGrabbing someone\xe2\x80\x99s clothing or possessions they are holding\nis battery. Notice that assault and battery are not always\npresent together. Assault can occur without physically\ntouching the victim. Similarly, a surgeon who performs\n139 | Torts\n\n\x0cunwanted surgery or inappropriately touches a patient who is\nsedated has committed battery but not assault because the\npatient did not feel fear or apprehension.\nWhen someone is sued for assault or battery, several defenses\nare available. The first is consent. Boxers have consented to\nbeing battered when competing. Self-defense and defense of\nothers also may be available defenses, as long as the selfdefense is proportionate to the initial force.\nFalse imprisonment occurs when someone intentionally\nconfines or restrains another person\xe2\x80\x99s movement or activities\nwithout justification. The protected interest is the right to travel\nand move freely without impediment. This tort requires actual\nand present confinement. False imprisonment is challenging\nfor retailers and other businesses that interact regularly with\nthe public, such as hotels and restaurants. The shopkeeper\xe2\x80\x99s\nprivilege allows businesses to detain suspected thieves until\nlaw enforcement arrives. The detention must be reasonable,\nhowever. Store employees must not use excessive force in\ndetaining the suspect, and the justification, manner, and time\nof the detention must be reasonable.\nIntentional infliction of emotional distress occurs when a\ntortfeasor intentionally or recklessly causes another person\nsevere emotional distress through extreme and outrageous\nacts. A plaintiff has to prove the defendant\xe2\x80\x99s actions would be\noutrageous to a reasonable member of the community. The\nstandard is objective. It is not enough for the plaintiff to believe\nthe defendant acted outrageously.\nAlthough the standard for outrageous conduct is objective,\nthe measurement is made against the particular sensitivities\nof the plaintiff. Exploiting a known sensitivity in a child, the\nelderly, or pregnant women can constitute intentional infliction\nof emotional distress. Businesses must be careful when\nhandling sensitive employment situations to avoid potential\nTorts | 140\n\n\x0cliability. This is especially true when firing or laying off\nemployees. Such actions must be taken with care and civility.\nSimilarly, bill collectors and foreclosure agencies must be\ncareful not to harass, intimidate, or threaten people.\n\nInterference with Property Rights\nIntentional torts can also be committed against property.\nTrespass to land occurs when someone enters onto, above,\nor below the surface of land that is visibly enclosed without\nthe owner\xe2\x80\x99s permission. The trespass can be momentary or\nfleeting. Soot, smoke, noise, odor, or even a flying arrow or\nbullet can all become the basis for trespass. These can also\nbe the basis for nuisance claims. Nuisance is a condition or\nsituation that interferes with the use or enjoyment of property.\nNuisance claims can be public (applying to community areas\nsuch as parks or the environment) or private (applying to\nprivately owned property such as houses).\nTrespass can be innocent or willful. An innocent trespass occurs\nwhen someone enters another\xe2\x80\x99s property by mistake or when\nthey believe they have permission but do not. Willful trespass\noccurs when someone intentionally enters another\xe2\x80\x99s property\nknowing they do not have permission to be there.\nThere are times when trespass is justified. Someone may have\na license to trespass, such as a meter reader or utility repair\ntechnician. There may also be times when it may be necessary\nto trespass\xe2\x80\x94for example, to rescue someone during an\nemergency.\nSome states do not require the land to be visibly enclosed to be\nprotected from trespass. Therefore, residential homes in urban\nand suburban areas do not always need a fence around the\nproperty to be protected from trespass.\n141 | Torts\n\n\x0cTrespass to personal property is the unlawful taking or\nharming of another\xe2\x80\x99s personal property without the owner\xe2\x80\x99s\npermission. The tort of conversion is the wrongful possession\nor disposition of property as if it were one\xe2\x80\x99s own with the intent\nto do so permanently. It is the civil equivalent to the crime of\ntheft. An employer who refuses to pay an employee for work\ncommits conversion. Similarly, conversion occurs when a\nbusiness returns personal property to the wrong customer.\n\nInterference with Economic Relations\nTorts can also take place against goods or products instead\nof people. Disparagement is a false and injurious statement\nthat discredits or detracts from the reputation of another\xe2\x80\x99s\nproperty, product, or business. To recover, the injured party\nmust prove that the statement caused a third party to take\nsome action resulting in economic loss to the plaintiff. In other\nwords, the victim of the statement must prove that it lost\ncustomers or goodwill as a result of the false statement made\nabout its business or products. These types of false statements\nare considered unfair competition and, therefore, are unlawful.\nSimilarly, unfair competition can also be in the form of\ninterfering with a competitor\xe2\x80\x99s contracts. Tortious interference\nwith\n\ncontractual\n\nrelations\n\nprohibits\n\nthe\n\nintentional\n\ninterference with an existing valid and enforceable contract by\nintentionally inducing one of the parties to break the contract,\ncausing damage to the relationship between the contracting\nparties. This occurs when a business tries to break up a\ncompetitor\xe2\x80\x99s contract with vendors, suppliers, or customers in\nan effort to harm them.\nThere are four elements to prove intentional interference with\ncontractual relations:\n\nTorts | 142\n\n\x0c1. A contract exists between the plaintiff and a third party;\n2. Defendant knew of the contract;\n3. Defendant improperly induced the third party to breach\nthe contract or made performance of the contract\nimpossible; and\n4. Plaintiff was injured.\nSimilarly, tortious interference with prospective advantage\nis an intentional, damaging intrusion on another\xe2\x80\x99s potential\nbusiness relationship, such as the opportunity to obtain\ncustomers or employment. Fair competition does not give rise\nto this tort. However, if a business engages in fraud,\nintimidation, or threats to drive away potential customers from\nits competitors, then it is liable. Tortious interference with\nprospective advantage applies to conduct before a contract\nexists.\nMisappropriation occurs when a person or business uses\nsomeone else\xe2\x80\x99s property dishonestly for one\xe2\x80\x99s own use.\nMisappropriation is a very broad tort because it covers any\nlikeness or identifying characteristic, as well as property such\nas patents, copyrights, and trademarks. It also applies to a\nbusiness\xe2\x80\x99s name and goodwill.\n\nWrongful Communications\nAnother intentional tort is defamation, which is the act of\nharming the reputation of another by making a false\nstatement\n\nto\n\na\n\nthird\n\nparty.\n\nSpoken\n\ndefamation\n\nis\n\nconsidered slander, while written defamation is libel. To be\nliable for defamation, the words must be made to a third party,\nwhich may include emails, text messages, and social media.\nThe First Amendment provides strong protection for news\norganizations, and courts have held that public figures must\n\n143 | Torts\n\n\x0cshow actual malice before they can win a defamation lawsuit.\nThis means celebrities and famous individuals must prove the\nmedia knew that it was publishing false information, or that it\npublished the information with reckless disregard for the truth.\nTruth is a complete defense to defamation.\nThe invasion of the right of privacy is essentially the violation\nof a person\xe2\x80\x99s right to be left alone and to restrict public access\nto personal information, such as tax returns and medical\nrecords. There are four forms of this tort:\nForm of Invasion of\nPrivacy\n\nDescription\n\n1. Appropriating a\nperson\xe2\x80\x99s name or\nlikeness\n\nUsing someone\xe2\x80\x99s name, photograph, or\nother identifying characteristic for\ncommercial purposes without permission\n\n2. Invasion of physical\nsolitude\n\nWindow peeping, eavesdropping, using\ndrones to video private areas, going\nthrough garage to find confidential\ninformation, etc.\n\n3. Public disclosure of\nprivate facts\n\nDisclosure of a private citizen\xe2\x80\x99s finances,\nmedical conditions, or personal\nrelationships through a public medium\nsuch as social media\n\n4. False light\n\nUsing publicity to place a person in false\nlight in the public eye, such as\nobjectionable hobbies or attributing\nbeliefs and opinions to the person that he\nor she does not hold\n\nFraud is the intentional misstatement of a material fact that is\nrelied upon by a third party to the detriment of the targeted\nparty. It requires the tortfeasor to misrepresent facts (not\nopinions) with knowledge that they are false or with reckless\ndisregard for the truth. An \xe2\x80\x9cinnocent\xe2\x80\x9d misrepresentation is not\nenough\xe2\x80\x94the defendant must know he or she is lying. Fraud\ncan arise in any number of business situations, such as lying\non a r\xc3\xa9sum\xc3\xa9 to gain employment, lying on a credit application\nto obtain credit, or in product marketing. Here, there is a fine\nline between puffery, or seller\xe2\x80\x99s talk, and an actual lie. If an\nTorts | 144\n\n\x0cadvertisement claims that a particular car gets a certain gas\nmileage or meets emissions standards, then fraud occurs if\nthose statements are untrue. Conversely, an advertisement\nthat promises \xe2\x80\x9cunparalleled luxury\xe2\x80\x9d is only puffery since it is\nopinion.\n\n9.3 Negligence\nEveryone has the duty to act reasonably and to exercise a\nreasonable amount of care in their dealings and interactions\nwith others. Breach of that duty, which causes injury, is\nnegligence. Negligence is distinguished from intentional torts\nbecause there is a lack of intent to cause harm.\nThe definition of negligence is purposefully broad. Negligence\nis the failure to exercise the standard of care that a reasonably\nprudent person would have exercised in a similar situation. This\nlegal standard is to protect people against unreasonable risk of\nharm.\nTo succeed on a negligence claim, a plaintiff must prove five\nelements:\n1. The defendant owed a duty of care to the plaintiff;\n2. The defendant breached that duty;\n3. The defendant\xe2\x80\x99s conduct was the actual cause of the\nplaintiff\xe2\x80\x99s injuries;\n4. The defendant\xe2\x80\x99s conduct was the proximate cause of the\nplaintiff\xe2\x80\x99s injuries; and\n5. The plaintiff was damaged.\n\n145 | Torts\n\n\x0cDuty of Care\nFirst, the plaintiff has to demonstrate that the defendant owed\nit a duty of care. The general rule is that people are free to\nact any way they want, as long as they do not harm others.\nThis means strangers are generally not responsible for caring\nfor each other unless a special relationship exists. For example,\nparents owe their children a duty of care and doctors owe their\npatients a duty of care because of their underlying relationship.\nIn a business context, businesses owe a duty of care to their\ncustomers and managers owe a duty of care to their\nemployees. Some business relationships involve a fiduciary\nduty, which is a duty to act with the utmost faith, trust, and\ncandor towards another. Doctors, lawyers, accountants, and\ncorporate officers all have fiduciary duties towards their\npatients, clients, and shareholders.\nIt is important to understand that businesses and individuals\nowe a general duty to the community as a whole. Drivers owe\nother drivers and pedestrians a duty of care not to cause\naccidents. However, drivers are not required to report accidents\nor to stop and help others when they are not involved because\nthey do not owe a duty of care to strangers.\nBusinesses have a duty to warn and protect customers from\ncrimes committed by other customers. When a business\nknows about, or should know about, a high likelihood of crime\noccurring, then the business must warn or take steps to protect\nits customers. These businesses include bars frequented by\nbiker gangs, hotels where frequent sexual assaults occur, and\nany business with escalating violence on their premises.\nBusinesses also owe a duty to exercise a reasonable degree of\ncare to protect the public from foreseeable risks that the owner\nknew or should have known about. There are many foreseeable\nways for customers to be injured in retail stores, including\nTorts | 146\n\n\x0cobjects falling from shelves, spilled liquids, and icy entryways.\nIf a store knows about a hazardous condition, or should have\nknown about it, then the store must quickly warn customers\nand remedy the situation.\n\nBreach of Duty of Care\nOnce a duty has been established, plaintiffs have to prove that\nthe defendant breached that duty. A breach is demonstrated\nby showing the defendant failed to act reasonably. It is\nimportant to keep in mind that the reasonable person is an\nobjective standard. The reasonable person is never sleepdeprived, angry, or intoxicated. He or she is reasonably careful\nand considers consequences carefully before acting. A jury\ndoes not put themselves in the shoes of the defendant to\ndetermine what they would have done in that situation. Nor\ndo they take into account the defendant\xe2\x80\x99s subjective situation,\nsuch as being intoxicated or sleep-deprived at the time.\nIn practical terms, the presence of injury or harm is usually\nenough to satisfy the \xe2\x80\x9cbreach of duty\xe2\x80\x9d requirement. Often the\nharm is the evidence of the breach because it would not have\noccurred if the defendant had acted as they should.\nBreach of the duty of care can be both an action (such as\ncausing a car accident) or it can be a failure to act (such as\nnot clearing ice from the sidewalk). These are fact-specific\ndeterminations because what a reasonable person would do in\na given situation varies.\nThere are two special doctrines that establish breach of duty\nof care in limited circumstances. The first, res ipsa loquitur,\nmeans \xe2\x80\x9cthe thing speaks for itself\xe2\x80\x9d in Latin and holds that a\nbreach of a party\xe2\x80\x99s duty of care may be inferred from the events\nthat occurred. It is used in cases where:\n147 | Torts\n\n\x0c1. The injury would not have occurred unless someone was\nnegligent;\n2. The defendant had exclusive control over the property\ncausing injury; and\n3. The plaintiff had no role in causing the harm.\nFor example, if a patient discovers surgical equipment inside\nhis or her body after surgery, the patient does not have to\nprove which person in the operating room negligently left the\nequipment. Instead, the plaintiff can sue the surgeon under\nthe res ipsa loquitur doctrine because the surgeon is in charge\nof the surgery room. When res ipsa loquitur is raised, the\nburden shifts to the defendant to prove that he or she did not\ncause the harm.\nFigure 9.2 X-Ray Image of Scissors Left Inside a Patient\n\nThe second doctrine is negligence per se. Legislatures\nsometimes pass laws defining negligence under certain\ncircumstances. If a defendant violates the statute or ordinance,\nthen the defendant is legally negligent. To recover under this\ntheory, a plaintiff has to prove:\n1. The defendant broke the law;\n2. The plaintiff is in the class of people intended to be\nprotected by the law; and\nTorts | 148\n\n\x0c3. The violation of the law caused plaintiff\xe2\x80\x99s injuries.\nNegligence per se is often argued in car accidents where the\ndefendant is ticketed for reckless driving by the police, as well\nas dog bite cases where the victim has physical injuries. When\ndefending against negligence per se claims, defendants may\nargue:\n1. They were unable to comply with the law through\nreasonable care;\n2. It was an emergency situation not caused by them; or\n3. Complying with the law would have presented a greater\nrisk of harm.\n\nActual Cause\nThe third element of negligence is actual causation, which is\nalso known as but-for causation. This form of causation is fairly\neasy to prove. But for the defendant\xe2\x80\x99s actions, would the\nplaintiff have been injured? If yes, then but-for causation is\nproven. For example, if a customer slips on ice on a store\xe2\x80\x99s\nproperty, would the plaintiff been injured but for the store\xe2\x80\x99s\nfailure to remove the ice? This is the form of causation that\nmost people describe in their daily interactions. Because the\nstore did not remove the ice, the customer slipped and was\ninjured.\n\nProximate Cause\nThe second form of causation asks whether the defendant\xe2\x80\x99s\nactions were the proximate cause of the plaintiff\xe2\x80\x99s injury.\nSometimes the chain of events results in the injury being too\n\n149 | Torts\n\n\x0cremote from the defendant\xe2\x80\x99s conduct to be legally recoverable.\nIn other words, proximate cause means that the act or\nomission must be related closely enough to the injury to justify\nimposing legal liability. Proximate cause places a limit on a\ndefendant\xe2\x80\x99s responsibility to immediate (or foreseeable) harm.\nThis ensures that no intervening causes of the plaintiff\xe2\x80\x99s injuries\nexist.\nA customer slips on ice on a store\xe2\x80\x99s property and breaks a leg.\nOn the way to the hospital in an ambulance, there is a car\naccident and the customer is killed. Although the customer\nwould not have been in the ambulance if she had not fallen\non the store\xe2\x80\x99s property, the store would not be responsible in a\nwrongful death claim. The car accident is an intervening event\nthat breaks the causal chain. Put another way, the car accident\nwas not a foreseeable consequence of the store\xe2\x80\x99s failure to\nremove ice on its premises.\nProximate cause prevents actual causation to be taken to a\nlogical but extreme conclusion. At some point, the law has to\nbreak the chain of causation to hold parties to a reasonable\namount of liability for their actions.\n\nDamages\nThe final element in negligence is legally recognizable injuries,\nor damages. If someone walks on a discarded banana peel and\ndoes not slip, then no tort occurs. Only when someone has\nbeen injured are damages awarded.\nThere are two types of damages awarded in tort law. The first,\ncompensatory damages, seek to compensate the plaintiff for\nhis or her injuries. Compensatory damages can be awarded for\nmedical injuries, economic injuries (such as loss of property or\nincome), and pain and suffering. They can also be awarded for\nTorts | 150\n\n\x0cpast, present, and future losses. While medical and economic\ndamages can be calculated using available standards, it is far\nmore difficult to assign a monetary value to pain and suffering.\nJuries often use the severity and duration of the injury and its\nimpact on the plaintiff\xe2\x80\x99s life to calculate damages.\nThe second type of damages is punitive damages, which are\nintended to deter the defendant from engaging in similar\nconduct in the future. The idea behind punitive damages is\nthat compensatory damages may be inadequate to deter\nfuture bad conduct, so additional damages are necessary to\nensure the defendant corrects its ways. Punitive damages are\navailable in cases where the defendant acted with willful and\nwanton negligence, a higher level of negligence than ordinary\nnegligence. There are constitutional limits to the award of\npunitive damages.\n\nDefenses to Negligence Claims\nA defendant being sued for negligence has two main defenses:\n(1) assumption of risk by the plaintiff; and (2) comparative\nnegligence.\n\nAssumption of Risk\nThe first defense is assumption of risk. If the plaintiff knowingly\nand voluntarily assumes the risk of participating in a dangerous\nactivity, then the defendant is not liable for injuries incurred.\nHowever, a plaintiff can only assume known risks. A skier\nassumes the known risks of downhill skiing, including falling,\navalanches, and skiing in poor conditions. However, a skier who\nis injured from a defective chair lift does not assume the risk of\ninjury as a result of a manufacturing defect.\n151 | Torts\n\n\x0cA related doctrine, the open and obvious doctrine, is used to\ndefend against lawsuits by persons injured while on someone\nelse\xe2\x80\x99s property. For example, if there is a spill on a store\xe2\x80\x99s floor\nand\n\nthe\n\nstore\n\nowner\n\nhas\n\nput\n\nup\n\na\n\nsign\n\nthat\n\nsays\n\n\xe2\x80\x9cCaution\xe2\x80\x94Slippery Floor,\xe2\x80\x9d yet someone decides to run through\nthe spill anyway, then that person would lose a negligence\nlawsuit because the spill was open and obvious.\nBoth the assumption of risk and open and obvious defenses\nare not available to the defendant who caused a dangerous\nsituation in the first place.\n\nComparative Negligence\nThe second defense to negligence is when the plaintiff\xe2\x80\x99s own\nnegligence contributed to his or her injuries. Most jurisdictions,\nincluding Colorado, follow the comparative negligence rule.\nUnder this rule, the jury determines the percentage of fault\nof all the parties for the plaintiff\xe2\x80\x99s injuries. If the jury finds the\nplaintiff responsible for some of his or her own injuries, then\nany compensatory damages are reduced by that percentage.\nFor example, if a customer is 40 percent at fault for his injuries,\nthen the compensatory damage award will be reduced by 40\npercent. The reasoning for this rule is to hold people and\nbusinesses accountable for their own negligence.\nFigure\n\n9.3\n\nRecovery\n\nof\n\nDamages\n\nunder\n\nComparative\n\nNegligence\n\nTorts | 152\n\n\x0cThis rule applies only to compensatory damages, and not\npunitive damages. Because punitive damages are meant to\ndeter the defendant from committing future bad acts, the\npurpose would be undercut if the amount of punitive damages\nwas reduced, too.\n\n9.4 Strict Liability\nIntentional torts require some level of intent to be committed,\nsuch as the intent to batter someone. Negligence torts require\ncarelessness or neglect. Some torts require neither intent nor\ncarelessness. In strict liability, it is irrelevant how carefully the\ndefendant acted. If someone is harmed in a situation where\n\n153 | Torts\n\n\x0cstrict liability applies, then the defendant is liable regardless of\nlack of intent.\nStrict liability applies when restaurants and bars serve alcohol\nto minors or visibly intoxicated persons. This is dangerous\nbecause there is a high risk that drunk patrons will injure\nothers if they drive. Sale of tobacco and firearms to minors\nare also strict liability crimes, as well as possession of child\npornography.\n\nUltrahazardous Activity\nAn ultrahazardous activity is an undertaking that cannot be\nperformed safely even if reasonable care is used while\nperforming it, and it does not ordinarily happen in the\ncommunity. Ultrahazardous activities include using dynamite,\ntransporting dangerous chemicals, keeping wild animals, and\nusing nuclear and radioactive materials. Some states have\npassed laws defining offshore drilling for oil and gas as an\nultrahazardous activity as well.\nDefendants engaged in ultrahazardous activities are almost\nalways liable for resulting harm. Plaintiffs do not have to prove\nduty of care or breach of duty of care. The \xe2\x80\x9creasonable person\xe2\x80\x9d\ntest is also irrelevant, as well as the issue of whether the harm\nwas foreseeable.\n\nProduct Liability\nProduct liability cases address situations in which products,\nnot people, cause injury. Plaintiffs can raise either negligence\nor strict liability claims for injuries caused by products. There\n\nTorts | 154\n\n\x0care three main product liability theories: design defect,\nmanufacturing defects, and failure to warn.\nDesign defects occur when the foreseeable risk of harm can be\nreduced or avoided by the adoption of a reasonable alternative\ndesign. In other words, the manufacturer poorly designed a\nproduct that caused injuries which could have been avoided.\nThe law does not require products to be perfect. Litigation in\nthese cases centers on what is a foreseeable risk and whether\nthere was a reasonable alternative. As a result, plaintiffs must\nshow that an alternative design was reasonable.\nFor example, Takata manufactured airbags that were installed\nby most major car manufacturers. After many airbags failed\nto deploy in car accidents, leading to severe injury and death,\nTakata recalled its airbags. Takata is strictly liable for injuries\ncaused by its defective design.\nManufacturing defects occur when a product fails to conform\nto the manufacturer\xe2\x80\x99s design for the product. In other words,\nthe product may have been designed adequately but the\nmanufacturer allowed a dangerous product to leave the plant.\nThese claims often involve allegations of failure to adequately\ninspect products before distribution.\nFor example, a light bulb factory is strictly liable for\nmanufacturing a batch of faulty bulbs that explode when\nturned on due to some glitch in the production process.\nFailure to warn occurs when the defect is not in the product\nitself but in the instructions (or lack of them). The plaintiff\nargues that the manufacturer failed to warn users about the\ndangers of normal use or a foreseeable misuse. However, there\nis no duty to warn about obvious dangers.\n\n155 | Torts\n\n\x0cDefenses to Product Liability\nThere are several defenses to product liability claims.\nFirst, strict liability applies only to commercial sellers. If an\nindividual sells her car to another person, she would not be\nstrictly liable for selling an unreasonably dangerous product if\nit had Takata airbags.\nSecond, plaintiff\xe2\x80\x99s assumption of risk can be a defense. The\nuser must know of the risk of harm and voluntarily assume\nthat risk. Someone cutting carrots with a sharp knife voluntarily\nassumes the risk of being cut by the knife. However, if the knife\nblade unexpectedly detaches from the knife handle because of\na design or production defect, no assumption of risk occurs.\nThird, product misuse is another defense to strict product\nliability. If the consumer misuses the product in a way that is\nunforeseeable by the manufacturer, then strict liability does\nnot apply. Modifying a lawn mower to operate as a go-kart, for\ninstance, is product misuse.\nA final related defense is known as the commonly known\ndanger doctrine. If a manufacturer can convince a jury that\nthe plaintiff\xe2\x80\x99s injury resulted from a commonly known danger,\nthen the defendant may escape liability.\n\n9.5 Concluding Thoughts\nTort law significantly impacts businesses, regardless of\nindustry. Businesses must not engage in activities with the\nintention to harm employees, customers, and the public. They\nalso must act reasonably to avoid injuries caused by their\nnegligence. Similarly, manufacturers can be strictly liable for\n\nTorts | 156\n\n\x0cdesign defects, manufacturing defects, and failure to warn\nconsumers. Because many businesses are seen to have \xe2\x80\x9cdeep\npockets,\xe2\x80\x9d they are often targeted by plaintiffs when injured by\ntheir products and services.\nIntentional torts occur when the tortfeasor intends the\nconsequences of his or her act or knew with substantial\ncertainty what the consequences would be. Businesses are\naffected by intentional torts and need to be careful not to\ncommit them against their employees, customers, and\nmembers of the public. It is useful to categorize intentional\ntorts based on the types of rights being protected, such as\npreventing injuries to persons, property or privacy.\nNegligence imposes a duty on all persons to act reasonably\nand to exercise due care in dealing and interacting with others.\nNegligence has five elements. First, the plaintiff must\ndemonstrate the defendant owed the plaintiff a duty of care.\nSecond, there must be a breach of that duty. A breach occurs\nwhen the defendant fails to act like a reasonable person. The\nplaintiff must also demonstrate that the defendant caused the\nplaintiff\xe2\x80\x99s injuries. Both causation-in-fact and proximate\ncausation\n\nmust\n\nbe\n\nproven.\n\nFinally,\n\nthe\n\nplaintiff\n\nmust\n\ndemonstrate legally recognizable injuries, which include past,\npresent, and future economic, medical, and pain and suffering\ndamages. Defendants can raise several affirmative defenses\nto negligence, including assumption of risk and comparative\nnegligence.\nIn areas where strict liability applies, the defendant is liable\nno matter how carefully it tried to prevent harm. Carrying out\nultrahazardous activities results in strict liability for defendants.\nAnother area where strict liability applies is in the serving of\nalcohol to minors or visibly intoxicated persons. A large area\nof strict liability applies to the manufacture, distribution, and\nsale of unreasonably dangerous products. Products can be\n\n157 | Torts\n\n\x0cunreasonably dangerous because of a production defect,\ndesign\n\ndefect,\n\nor\n\nboth.\n\nA\n\nproduct\xe2\x80\x99s\n\nwarnings\n\nand\n\ndocumentation are a part of a product\xe2\x80\x99s design, and therefore\ninadequate warnings can be a basis for strict product liability.\nAssumption of risk, product misuse, and commonly known\ndangers are all defenses to strict product liability.\n\nTorts | 158\n\n\x0c10. Contracts\n10.1 Introduction\nLEARNING OBJECTIVES\n1. Explain what constitutes a contract.\n2. Understand how a contract is formed.\n3. Know the defenses to performance of a contract.\n4. Understand breach of contract and its consequences.\n5. Identify remedies for breach of contract.\nAlthough businesses tend to use the terms \xe2\x80\x9cagreement\xe2\x80\x9d and\n\xe2\x80\x9ccontract\xe2\x80\x9d interchangeably, legally the terms have very\ndifferent meanings. An agreement is a mutual understanding\nbetween two or more parties about their rights and duties\ntoward each other. A contract is a legally enforceable\nagreement between two or more parties. All contracts are\nagreements, but not all agreements are contracts.\nWhen contracts are broken, or breached, the injured party can\nseek damages. In contracts, this usually means an amount that\nwould make that party whole again.\nGenerally speaking, contracts are a form of private law,\nbecause the terms of the contract are binding on the parties\nto the contract but not anyone else. Parties may enter into\ncontracts for whatever they wish and under any terms that\nthey agree on. In other words, parties may assent to\nagreements even if those agreements represent bad bargains.\nContracts may restrict parties\xe2\x80\x99 future activity. For example, a\n\n159 | Contracts\n\n\x0cnon-compete clause in an employment contract may be\nenforceable\n\nin\n\nthe\n\nfuture\n\nagainst\n\nan\n\nemployee\n\nafter\n\ntermination of employment.\nHowever, contracts that are illegal or against public policy are\nnot enforceable.\nContract law performs three significant economic functions:\n1. It helps individuals and businesses exchange goods and\nservices efficiently.\n2. It reduces the costs of economic transactions because\nparties do not need to negotiate a variety of rules and\nterms with each separate transaction.\n3. It alerts the parties to problems that have arisen in the\npast, making it easier to avoid potential pitfalls.\n\nCounselor\xe2\x80\x99s Corner We live in a world of contracts,\nwhich are the bread and butter of business\ntransactions. However, many consumers,\nemployees, and small businesses are afraid to read\nand understand contracts. That fear allows others to\ntake advantage of them. Take the time to read\ncontracts provided to you. Ask questions about\nanything you don\xe2\x80\x99t understand before you sign.\nHave the courage to revise and edit contracts to\nensure your interests are protected. Or even write\nyour own. It\xe2\x80\x99s not hard and the more you do it, the\nmore confidence you will have to negotiate\nbusiness transactions and protect your interests.\n~Darnell T., attorney\n\nContracts | 160\n\n\x0c10.2 Contract Elements\nThere are three required elements of a contract: offer,\nacceptance, and consideration. It is important to note that\nsome states and legal scholars expand this list to include\nwhether the subject matter is legal, whether the parties have\ncapacity to enter into a contract, and whether the law requires\nthe contract to be in writing to be enforceable. However, these\nare best understood as defenses to contract formation,\nespecially in light of the fact that the only elements that all\nstates agree on are offer, acceptance, and consideration.\n\nOffer\nAll contracts start when an individual or business proposes\na deal. It might involve buying or selling goods, performing\nservices, or making an exchange. An offer is a conditional\npromise to do or refrain from doing something now or in the\nfuture. In other words, it is willingness to enter into a contract.\nOffers can be formal or informal. In some industries, such as\nretail and restaurants, offers are often posted on menus, signs,\nand advertisements. For example, a sign hanging above a cash\nregister listing menu items and their prices is the restaurant\xe2\x80\x99s\noffer to sell customers those items at those prices.\nThere are not a lot of legal requirements about what an offer\nmust contain, but there are some things that cannot be a legal\noffer:\n\n161 | Contracts\n\n\x0cType of\nInvalid Offers\n\nDefinition\n\nExample\n\nIllusory\nPromise\n\nNo offer exists because\nthere is no duty to\nperform\n\n\xe2\x80\x9cIf I decide to buy a new\ncar, I\xe2\x80\x99ll give you my old\none.\xe2\x80\x9d\n\nPre-existing\nDuty\n\nA party cannot leverage\nan existing duty to get\nmore out of someone\nelse\n\n\xe2\x80\x9cI agree to teach you\nbusiness law for $100\neven though you have\nalready paid tuition for\nthe course.\xe2\x80\x9d\n\nForbearance\n\nAn offer cannot be a\npromise not to pursue a\nlegal claim that is\nknown to be invalid\n(Note: if the claim is\nvalid, then forbearance\nmay be a valid offer)\n\n\xe2\x80\x9cI know the accident was\ncompletely my fault but I\npromise not to sue you.\xe2\x80\x9d\n\nPast\nAn offer cannot be\nConsideration based on past actions\n\nI paint your house. Two\nmonths later you say that\nyou will pay me $500 for\ndoing it. If you change\nyour mind and decide\nnot to pay me, I cannot\nenforce your promise\nbecause it was in\nconsideration of a past\nevent.\n\nOnce made, offers can be terminated in a number of ways. An\noffer that has been properly communicated continues to exist\nuntil it:\n1. Is rejected;\n2. Is replaced by a counteroffer;\n3. Lapses or expires;\n4. Is revoked; or\n5. Is terminated by operation of law.\nUnless it states a specific time, an offer remains open for a\nreasonable time. A lapsed offer is an offer that is no longer\nvalid because a reasonable time to accept it has expired. An\nexpired coupon is an example of a lapsed offer.\n\nContracts | 162\n\n\x0cAcceptance\nTo constitute an agreement, there must be an acceptance of\nthe offer. Legally, acceptance is an implied or express act that\nshows willingness to be bound by the terms of an offer. To be\neffective, both parties must understand and agree to be bound\nby the contract.\nAcceptance\n\ncan\n\nbe\n\nboth\n\nexpress\n\nor\n\nimplied.\n\nExpress\n\nacceptance occurs when a party states that they accept the\noffer. Acceptance may be implied based on the parties\xe2\x80\x99\nconduct. For example, a retailer offers to sell a product to\nconsumers for the price listed on the shelf. A consumer may\naccept that offer by handing the cashier the item and money\nto pay for it. The consumer does not need to say anything\nto complete the transaction. But the consumer must\ndo something to accept. Silence, without more (such as\nhanding over payment), is not acceptance. This is because\nsilence may be evidence that the consumer either does not\nknow about the offer or has rejected it.\nA common problem in the business community is knowing\nwhat constitutes acceptance and what is negotiation. If an\nacceptance changes, adds, or modifies terms of the offer, it is\na counter-offer and no contract is formed. The original party\nmay decide to accept, reject, or propose another offer as a\nresult. Although this sounds straightforward, with today\xe2\x80\x99s fastpaced communications, parties may respond to part of an\noffer, negotiate various parts of the contract simultaneously,\nor agree to terms in installments. As a result, there may be\nconfusion about what the full terms of a contract are.\nOffer and acceptance form mutual assent, which is also called\n\xe2\x80\x9cmeeting of the minds.\xe2\x80\x9d This is the parties\xe2\x80\x99 intention to enter\ninto a binding contract on the terms they agreed upon. If\nparties do not agree on the essential terms, then there can be\n163 | Contracts\n\n\x0cno meeting of the minds to enter into a contract. This is the\nbasis for many of the defenses to contract formation.\n\nConsideration\nConsideration is the bargained-for exchange of something of\nvalue that shows the parties intend to be bound by the\ncontract. There are two elements to consideration:\n1. Something of value\n2. Is exchanged between the parties.\nThe \xe2\x80\x9csomething\xe2\x80\x9d that is promised or delivered must be a legal\ndetriment. A legal detriment is giving up a legal or property\nright.\nConsideration may be concurrent or a promise to perform in\nthe future. However, it cannot be \xe2\x80\x9cpast consideration\xe2\x80\x9d based\non something that has occurred before the formation of the\ncurrent contract. In other words, an act or promise made\nbefore the current contract is not adequate consideration\nbecause it was not given in exchange for the current promise.\nWhen bargained-for consideration is not present, a court may\nvalidate a promise based on promissory estoppel. Promissory\nestoppel is the principle that a promise made without\nconsideration may nonetheless be enforced to prevent\ninjustice if the promisor should have reasonably expected the\npromisee to rely on the promise, and the promisee actually\nrelied on the promise to his or her detriment. Promissory\nestoppel is an equitable doctrine used as a substitute for\nconsideration that allows the imposition of contractual liability\nto prevent unfairness.\nTo establish promissory estoppel, a party must show:\n\nContracts | 164\n\n\x0c1. A definite promise;\n2. The party making the promise should have expected that\nthe other party would rely on the promise;\n3. A reasonable person would have relied on the promise;\n4. The party relied on the promise and it resulted in a\nsubstantial detriment; and\n5. Basic justice and fairness require that the promise be\nenforced.\n\n10.3 Types of Contracts\nBilateral and Unilateral Contracts\nIn a bilateral contract, both parties make a promise of\nperformance. These contracts are also called mutual or\nreciprocal contracts. Bilateral contracts are the most common\nform of contracts. They include ordering food in a restaurant,\nbuying gas for vehicles, purchasing goods and services, etc.\nA unilateral contract, on the other hand, is a contract where\none party makes a promise that the other party can accept only\nby doing something. For example, a business offers a reward\nfor information leading to the arrest of a thief. A person cannot\ncollect the reward money by promising to give information\xe2\x80\x93he\nor she must perform under the contract by providing the\ninformation.\n\nExpress and Implied Contracts\nAn express contract is a contract in words (orally or in writing)\nin which the terms are spelled out directly. The parties to an\n\n165 | Contracts\n\n\x0cexpress contract, whether written or oral, clearly intend to\nmake a legally enforceable agreement. For example, an\nagreement to buy a car for $1,000 and to take title next Monday\nis an express contract.\nAn implied contract is a contract that is inferred from the\nparties\xe2\x80\x99 actions. Although no discussion of terms took place,\nan implied contract exists if it is clear from the conduct of the\nparties that they have an agreement. A delicatessen patron\nwho asks for a \xe2\x80\x9cturkey sandwich to go\xe2\x80\x9d has made a contract\nand is obligated to pay when the sandwich is made. By\nordering the food, the patron is implicitly agreeing to the price,\nwhether posted or not.\n\nQuasi-contract: Contract Implied in Law\nBoth express and implied contracts embody an actual\nagreement of the parties. A quasi-contract, by contrast, is an\nobligation imposed by law to avoid unjust enrichment of one\nperson at the expense of another. In fact, a quasi-contract is\nnot a contract at all. It is a judicial remedy in which the court\ndecides what a contract should look like between the parties to\nprevent injustice. For example, a carpenter mistakenly believes\na homeowner hired him to repair her porch, when it was\nactually the neighbor who hired him. One morning the\ncarpenter arrives and begins work. Rather than stop him, the\nhomeowner lets him proceed, excited to get her porch fixed\nfor free. Although no contract exists because there was no\noffer, acceptance or consideration, the law will imply a contract\nbetween the carpenter and homeowner for the value of the\nwork.\n\nContracts | 166\n\n\x0cEnforceability\nA contract that is fully enforceable and reflects the parties\xe2\x80\x99\nintent is valid. Conversely, an unenforceable contract is a\ncontract where the parties intend to form a valid bargain but\nthe court declares that it cannot be enforced for legal reasons.\nFor example, Ramesh owes Jai money, but Jai has waited too\nlong to collect it and the statute of limitations has run out. The\ncontract for repayment is unenforceable and Jai is out of luck\nunless Ramesh makes a new promise to pay or actually pays\npart of the debt.\nAn agreement that is lacking one of the legal elements of a\ncontract is void because it never was a contract. In other words,\nit is not legally enforceable because it is not a contract at all. An\nagreement that is illegal is also void. For example, a promise to\ncommit a crime in return for payment is void because neither\nside can enforce the agreement in court.\nBy contrast, a voidable contract is a contract that can be\nannulled. It is a contract that is unenforceable by one party but\nenforceable by the other. For example, a minor may \xe2\x80\x9cavoid\xe2\x80\x9d a\ncontract with an adult; meaning the adult may not enforce the\ncontract against the minor if the minor refuses to carry out\nthe bargain. The adult must comply if the minor wishes the\ncontract to be performed. A contract may be voidable by both\nparties if they are both minors. Usually, the parties to a voidable\ncontract are entitled to be restored to their original position.\nA voidable contract remains a valid contract until it is voided.\nThus, a contract with a minor remains in force unless the minor\ndecides he does not wish to be bound by it. When minors\nbecome adults, they have two choices:\n1. Ratify the contract\xe2\x80\x93that is, agree to be bound by it; or\n2. Disaffirm the contract\xe2\x80\x93that is, disavow or avoid it.\n167 | Contracts\n\n\x0cRatification may be explicit or implicit. For example, by\ncontinuing to make payments or retaining goods for an\nunreasonable period of time, a party may ratify the contract. If\na party has not disaffirmed the contract while still a minor, she\nmay do so within a reasonable time after becoming an adult.\n\nDegree of Completion\nAn executory contract is a contract that has yet to be\ncompleted. Most executory contracts are enforceable. If some,\nbut not all, of the terms of the contract have been performed,\nthe contract is called partially executed. A contract that has\nbeen completed or carried out fully by both parties is called an\nexecuted contract.\n\n10.4 Performance and Breach of\nContract\nPerformance simply means undertaking the legal duties\nimposed by the terms of the contract.\nBut how do we know whether the contract terms have been\nperformed? Sometimes it\xe2\x80\x99s easy to determine. For instance,\nif someone offers to sell his scooter for four hundred dollars,\na purchaser agrees, and they exchange the scooter for the\nmoney, then the contract has been fully performed. A contract\nwas formed, the parties performed their obligations under it\n(known as complete performance), and they are subsequently\ndischarged from further duties arising under the contract.\nComplete performance results in an executed contract.\nWhen a party fails to perform under the terms of the contract\n\nContracts | 168\n\n\x0cwithout a legally justifiable reason, the party is in breach of\ncontract. Not all breach of contract situations give rise to\nlitigation. Some breaches are minor and may be overlooked by\nparties, especially if there is a long-term business relationship\nbetween them. Others may be major and give rise to\nsignificant issues between the parties.\nIn a service contract, the standard used to judge performance\nis substantial performance. This means that the performing\nparty acted in good faith and conveyed enough benefit to the\nother party under the contract that any breach may be\nremedied by money damages. A material breach in a service\ncontract occurs when a party has not substantially performed\nunder the terms of the contract. A minor breach occurs when\nthe party has substantially performed but has not strictly\nperformed.\nPerformance to the standard of personal satisfaction can be\nenforced if the contract expressly requires it. This means that\ncontract performance is evaluated subjectively, either by one\nparty to the contract or by a third-party beneficiary specified\nin the contract. If the subject of the contract is something for\nwhich approval is dependent on someone\xe2\x80\x99s subjective opinion,\nlike personal taste, then assessment can be made on a\nsubjective standard providing this standard is clearly specified\nin\n\nthe\n\ncontract.\n\nThese\n\ncontracts\n\noften\n\noccur\n\nin\n\nthe\n\nentertainment industry, as well as the building of custom\nhomes.\n\nConditions\nA condition is an act or event (other than the lapse of time) that\nmust occur before performance under a contract becomes\ndue. Conditions determine when a party must perform.\n\n169 | Contracts\n\n\x0cType of\nCondition\n\nDescription\n\nCondition\nprecedent\n\nA condition must occur before a party\xe2\x80\x99s performance\nis required\n\nConcurrent\ncondition\n\nEach party\xe2\x80\x99s performance is dependent on the other\nparty\xe2\x80\x99s performance\n\nSubsequent\ncondition\n\nA condition follows the duty to perform that\ncompletely eliminates or discharges a duty to\nperform\n\nConstructive Equitable doctrine that serves as an implied-in-law\ncondition\ncondition to prevent injustice\n\nA condition precedent is an act or event that must occur\nbefore a duty of immediate performance of a promise arises.\nFor example, an inspection of property is a condition precedent\nto the sale of a home.\nA concurrent condition occurs when mutually dependent\nconditions must be performed at the same time by the parties.\nFor example, delivery of goods and payment in a cash sale are\nconcurrent conditions.\nA subsequent condition is an event that discharges a duty of\nperformance that becomes absolute. They are rare and tend\nto occur in the insurance industry. For example, an insurance\ncompany may require notice within thirty days of a claim. The\ninsurance company does not have a duty to pay until the\ninsured gives notice. Notice is the subsequent condition that\ntriggers the insurance company\xe2\x80\x99s performance.\nA constructive condition is a condition contained in an\nessential contractual term that, though omitted by the parties\nfrom their agreement, a court has supplied as being\nreasonable in the circumstances. It is an equitable doctrine\nthat serves to imply conditions to prevent injustice.\n\nContracts | 170\n\n\x0c10.5 Defenses to Contracts\nA party may have a valid reason for breaching, or not\nperforming, a contract. These reasons are known as defenses to\ncontract. Many of the defenses to contracts go to the heart of\nwhether an agreement ever existed. In other words, if a party\ndoes not voluntarily consent or there was no \xe2\x80\x9cmeeting of the\nminds,\xe2\x80\x9d then a valid contract was never formed.\n\nIllegality\nIllegal contracts are unenforceable because they are void.\nThere are two common types of illegalities: (1) statutory\nviolations, and (2) violations of public policy. An example of a\nstatutory violation is where a company in the US wants to avoid\nimport regulations and quotas by purchasing Cuban cigars\nthrough an intermediary in Mexico. If the US buyer pays the\nMexican intermediary for the cigars but does not receive them,\nthe buyer cannot sue the intermediary for breach of contract.\nThe law will not provide a remedy to someone who intends to\nviolate the law.\nExamples of violations of public policy often occur in an\nemployment context. An employer that tries to bind its\nemployees to unreasonable non-compete agreements violates\nthe public policy of freedom to work. Another common\nexample is contracts with professionals who do not maintain\na current license in their field. If they are not legally licensed\nfor the work they perform, they are not entitled to payment\nfor their services. Here, the public policy is that the law does\nnot want to encourage a black market for services outside of\ngovernment regulation.\n\n171 | Contracts\n\n\x0cIncapacity\nIf someone lacks mental capacity to understand the terms of\nthe agreement, there cannot be a true meeting of the minds to\nform a contract. Capacity is the mental state of mind sufficient\nto understand that a contract is made and its legal\nconsequences.\nIncapacity can be permanent, such as from mental illness,\nphysical illness, or insanity. Incapacity may also be temporary,\nsuch as being intoxicated, under the influence of drugs, or\nunderage (i.e. under eighteen years old).\n\nUndue Influence\nUndue influence occurs when one party overpowers the free\nwill of another by use of superior power or influence. In other\nwords, it is unfair persuasion. Undue influence is not a normal\nlevel of persuasion. Rather, it occurs when a party agrees to\na contract that they would not have otherwise consented to\nwithout the unreasonable pressure of the other party. For\nexample, an elderly person who is isolated from others due\nto poor health and living conditions may be lonely and eager\nfor company. If a caretaker exerted influence over the elder to\nthe extent that he or she could no longer exercise free will,\nthen undue influence occurs. Contracts and transactions in\nwhich elders transfer most or all of their wealth to others are\nfrequently reviewed for undue influence.\n\nDuress\nDuress occurs when there is a threat to a person, family or\n\nContracts | 172\n\n\x0cproperty. Economic pressure may constitute duress if it is\nwrongful and oppressive. Cases involving duress often occur in\nemergency situations. For example, when someone is required\nto sign legal paperwork in an emergency room before\nreceiving medical treatment for themselves or their children.\nIf a person enters into a contract under duress, he or she is able\nto get out of the contract after the emergency situation is over.\nDuress essentially overcomes a person\xe2\x80\x99s free will to voluntarily\nchoose to enter into the contract.\n\nUnconscionability\nUnconscionability\n\noccurs\n\nwhen\n\nthe\n\ncontract\n\ncontains\n\nmarkedly unfair terms against the party with less bargaining\npower or sophistication than the party who created the terms\nand induced the other party to sign it. Common cases involving\nunconscionability\n\nclaims\n\noccur\n\nwhen\n\none\n\nparty\n\nis\n\nan\n\nexperienced business dealer, while the other party is an\naverage consumer. If the business dealer uses a very small font\nand inserts terms into the contract in a way that intentionally\nmisleads the consumer into signing on unfair terms, then the\ncontract may be deemed unconscionable.\n\nStatute of Frauds\nThe Statute of Frauds requires certain contracts to be in\nwriting and signed to be enforceable. The Statute of Frauds\noriginated in England in 1677 to prevent fraud when one party\ntries to claim a contract existed when it did not. The Statute of\nFrauds requires a written contract for:\n1. Real property interests;\n173 | Contracts\n\n\x0c2. Marriage;\n3. Payment of another\xe2\x80\x99s debt;\n4. Contracts that cannot be completely performed within\none year;\n5. Contracts for the sale of goods of five hundred dollars or\nmore; and\n6. Acting as another\xe2\x80\x99s executor/administrator.\n\nStatute of Limitations\nThe statute of limitations is an affirmative defense that can be\nraised by a defendant to argue that a lawsuit is being brought\ntoo late. This means that if a dispute arises under a contract,\nthen the plaintiff must bring a lawsuit concerning that dispute\nwithin a certain time period. States have different statutes of\nlimitations. If a contract has a choice of law provision, then that\nstate\xe2\x80\x99s statute of limitations will apply to disputes related to the\ncontract.\n\nMistake\nIn the context of contracts, a mistake is the situation in which\nthe parties did not mean the same thing or when one or both\nparties formed untrue conclusions about the subject matter of\nthe contract. In other words, a mistake is an erroneous belief.\nMutual mistake refers to something that is a mistake by both\nparties that relates to an essential term of the contract. For\nexample, a contract to buy property that is not actually owned\nby the seller would be a mutual mistake, if the seller believed in\ngood faith that he owned the property. When mutual mistakes\noccur, either party may rescind the contract.\n\nContracts | 174\n\n\x0cUnilateral mistake occurs when only one party is laboring\nunder a mistake. Mistake does not mean bad bargaining.\nCourts will not step in to save parties from bad bargaining\nabsent evidence of undue influence or unconscionability. In\ngeneral, parties cannot rescind the contract when unilateral\nmistakes occur except when the mistake makes the contract\nunconscionable, the error is apparent to the other party, or\nwhen significant mathematical errors occur.\nFigure 10.1 Types of Mistakes Affecting Contracts and Their\nRemedies\n\nMisrepresentation and Fraud\nMisrepresentation and fraud are also defenses to contract.\nMisrepresentation is when a party makes a false statement\nthat induces the other party to enter into the contract. Fraud\nis a closely related concept, and it simply means that one party\n\n175 | Contracts\n\n\x0chas used deception to acquire money or property. Fraud may\nalso be a basis for criminal charges, depending on the\ncircumstances leading to the contract.\n\nCommercial impracticability\nCommercial impracticability is a defense that can be used\nwhen fulfilling a contract has become extraordinarily difficult\nor unfair for one party. For example, a sales contract relating\nto the sale of goods destroyed by a natural disaster would fall\nunder this defense. It becomes impossible for the seller to\ndeliver goods that no longer exist, and would be unfair to\nenforce damages against the seller for breach of contract. This\nis also called frustration of purpose or impossibility in some\njurisdictions.\n\nBankruptcy\nSometimes a party to a contract files for bankruptcy\nprotection. The bankruptcy court will determine which debts\nthe bankrupt party must pay and which are dischargeable.\nContract obligations are suspended temporarily through the\nbankruptcy court\xe2\x80\x99s automatic stay. In other words, the debt\ndoes not have to be paid during the course of the bankruptcy.\nAt the conclusion of the bankruptcy, if the contract obligation is\ndetermined to be a dischargeable debt, then the debt will not\nhave to be paid.\n\nContracts | 176\n\n\x0c10.6 Assignment, Delegation, and\nThird Party Beneficiaries\nContracts are by law assignable and delegable. This means\nthat the rights conveyed by the contract may be transferred to\nanother party by assignment, unless an express restriction on\nassignment exists within the contract, or unless an assignment\nviolates public policy. Likewise, the duties imposed on a party\nmay be transferred to another party by delegation, unless the\ncontract expressly restricts delegation, there is a substantial\ninterest in personal performance by the original party to the\ncontract, or if delegation would violate public policy.\nAs a general rule, a party may assign contract rights without\nthe consent of the other party. This is common in the\nconstruction industry where a general contractor may assign\nrights and delegate duties to subcontractors for specific work\nthat needs to be performed under the main contract. For\nexample, the general contractor may delegate the duty to\nperform electrical work to an electrician, as well as assign the\nright to be paid for the work performed.\nIn delegation and assignment, the original contracting party is\nnot \xe2\x80\x9coff the hook\xe2\x80\x9d if it transfers its duties or rights to another\nparty. For instance, a subtenant assumed the rights and duties\nimposed on the original tenant in a lease. If the subletting\ntenant does not pay the rent, the original tenant is still liable.\nThe way to excuse oneself from legal liability under a contract\nis through novation. Novation is essentially a new contract that\ntransfers all rights and duties to a new party to the contract\nand releases the previous party from any further obligation. It\nis the procedure in which one party is dismissed completely\nfrom the contract because a third party is substituted. In this\nsituation, the dismissed party no longer has any liability under\n\n177 | Contracts\n\n\x0cthe original contract. To be effective, all parties must agree to\nthe novation.\n\nThird Party Beneficiaries\nAssignment and delegation under a contract should not be\nconfused with rights of third party beneficiaries. A third party\nbeneficiary is someone who is not a party to the contract but\nstands to benefit from it. Life insurance policies are a classic\nexample of contracts with third party beneficiaries. The\ninsurance company and the insured are parties to the contract.\nBut the person who receives payment upon the death of the\ninsured is the third party beneficiary.\nThird party beneficiaries can either be intended or incidental.\nAn intended beneficiary is someone who the parties intend to\nreceive the benefit of the contract. For example, the named\nbeneficiary of a life insurance policy. The beneficiary does not\nneed to know about the contract to have his or her rights vest.\nAn incidental beneficiary is someone who benefits from a\ncontract but was not intended by the parties to benefit. For\nexample, if a business pays for a professional to landscape its\nproperty, the neighbors are incidental beneficiaries to the\nlandscaping contract. They benefit from the improved\nappearance and property values, but the business did not enter\nthe contract with an intent to benefit them. Incidental\nbeneficiaries do not have a legally enforceable interest in the\ncontract.\n\nContracts | 178\n\n\x0c10.7 Parol Evidence Rule\nCourts often must interpret the meaning of a contract. When\nthe contract is written, courts will look within the \xe2\x80\x9cfour corners\xe2\x80\x9d\nof the document and apply the contract as written. The Parol\nEvidence Rule is the principle that a writing intended by the\nparties to be a final embodiment of their agreement cannot\nbe modified by evidence that adds to, varies, or contradicts\nthe writing. This rule usually prevents a party from introducing\nevidence of negotiations that occurred before or while the\nagreement was being reduced to its final written form.\nHowever, there are several important exceptions that allow oral\nstatements to be admitted:\n1. Subsequent modifications;\n2. Evidence of intentional misrepresentations by a party;\n3. Correcting errors in drafting;\n4. Clarifying ambiguities and filling in gaps; and\n5. Supplements to a partially integrated contract.\nAs a result of the parol evidence rule, businesses should do\ntheir due diligence to ensure any written contracts fully and\nadequately include the essential terms of their agreement.\n\n10.8 Remedies\nThe four main remedies for breach of contract are damages,\nspecific performance, rescission, and restitution. The purpose\nof contract remedies is to compensate the non-breaching\nparty for the losses suffered. In other words, remedies must put\nthe non-breaching party in the position it would have been if\nthere had been no breach.\n179 | Contracts\n\n\x0cDamages\nDamages are the money paid by one party to another to\ndischarge a legal liability.\nTypes of\nMonetary\nDamages\n\nPurpose\n\nCompensatory\n\nTo make the non-breaching party \xe2\x80\x9cwhole\xe2\x80\x9d as if\nbreach did not occur\n\nConsequential\n\nTo cover indirect but foreseeable losses flowing\nfrom the breach\n\nIncidental\n\nTo cover direct losses flowing from the breach & to\navoid further loss\n\nNominal\n\nTo recognize legal breach although no actual\ndamages resulted\n\nPunitive\n\nTo punish and deter future wrongful behavior;\nonly available if breach itself is a tort\n\nLiquidated\n\nTo allow parties to determine value of contract in\ncase of breach\n\nCompensatory Damages\nCompensatory damages are paid to compensate the nonbreaching party for the loss suffered as a result of the breach. It\nis the general category of damages awarded to make the party\nwhole. Compensatory damages include out-of-pocket losses\nand costs associated with the loss of the bargain. They are the\nprimary damages in contract breach cases and are a direct,\nforeseeable result of the breach of contract.\n\nContracts | 180\n\n\x0cConsequential Damages\nA basic principle of contract law is that a person injured by\nbreach of contract is not entitled to compensation unless the\nbreaching party, at the time the contract was made, had\nreason to foresee the loss as a probable result of the breach.\nConsequential\n\ndamages are damages that flow as a\n\nforeseeable but indirect result of the breach of contract. For\nexample, a roofer takes longer to fix a leaky roof than specified\nin a contract. The delay results in a retailer remaining closed for\nan additional week until the roof is repaired. The loss of sales\nfrom that week are consequential damages.\nConsequential damages often include:\n\xe2\x80\xa2 Loss of profits due to the interruption of normal business\npractices;\n\xe2\x80\xa2 Loss of customers due to delays or cancellations; and\n\xe2\x80\xa2 Cost of replacement goods or services.\n\nIncidental Damages\nIncidental damages are damages that are paid to the nonbreaching party in an attempt to avoid further loss on account\nof the breach. These damages include additional costs incurred\nby the non-breaching party after the breach in a reasonable\nattempt to avoid further loss, even if that attempt was\nunsuccessful.\nFor example, an electrician contracts to install light fixtures in\na warehouse within seven days. The electrician enters into a\npurchase agreement with a supplier to buy the fixtures which\nare to be delivered within three days. On the fifth day, the\n\n181 | Contracts\n\n\x0csupplier notifies the electrician that it cannot fill the order,\nbreaching the contract. Because he cannot fulfill his contract\nwith another supplier in time, the electrician breaches his\ncontract with the warehouse and has to refund the warehouse\nits money. The losses incurred by the electrician to the\nwarehouse are a direct result of the supplier\xe2\x80\x99s breach of\ncontract, and are incidental damages.\nIncidental costs often include:\n\xe2\x80\xa2 Inspection of items;\n\xe2\x80\xa2 Transportation or care of items;\n\xe2\x80\xa2 Expenses or commissions incurred in connection with\nincident or delay of items; and\n\xe2\x80\xa2 Storing of defective items until the supplier can retrieve\nthem.\nThe\n\ndifference\n\nbetween\n\nincidental\n\nand\n\nconsequential\n\ndamages is the cause of the expense or loss. Incidental\ndamages are the direct result of one party\xe2\x80\x99s breach of contract.\nConsequential damages are more indirect, being incurred not\nas a result of the breach itself, but due to the end result of the\nbreach.\n\nNominal Damages\nIf the breach of contract caused no actual loss, the nonbreaching party may be awarded nominal damages. Nominal\ndamages are a token amount of money paid when the breach\nhas caused no actual loss. Nominal damages are often\nawarded symbolically by juries when they find legal liability\nbut believe the breach was minor or could have been\naccommodated in another way. For example, a buyer could\n\nContracts | 182\n\n\x0chave purchased the same commodity at the same price\nwithout spending any extra time or money.\n\nPunitive Damages\nPunitive damages are awarded to a non-breaching party in\nexcess of any loss suffered to punish the breaching party.\nPunitive damages are awarded when the defendant acted\nwillfully and maliciously, and the purpose is to deter similar\nfuture bad conduct. Punitive damages are not usually available\nfor breach of contract claims, unless the breach of contract\nitself constitutes a tort. In other words, punitive damages may\nbe available when the contract breach itself is fraudulent or\nmalicious. Punitive damages have been awarded against\ninsurance companies that have refused to honor disability\npayments and that have acted in bad faith in denying\nlegitimate claims.\n\nLiquidated Damages\nLiquidated damages are damages agreed upon by parties to\na contract to be paid in the event of a breach. Because the\nparties are often in the best position to know the value of their\ncontract, they can negotiate a fixed sum or method to\ncalculate damages in the event of a breach. To be enforceable,\nliquidated damage provisions must apply equally to all parties,\nbe negotiated fairly at the time the contract is executed, and\nmust bear a reasonable relation to the probable damage in\ncase of a breach.\n\nEquitable Remedies for Breach of\n183 | Contracts\n\n\x0cContract\nEquitable remedies involve a request for relief that does not\ninclude money damages. Equitable remedies are useful for\nwhen money does not provide adequate relief to the nonbreaching party.\nEquitable\nRemedy\n\nPurpose\n\nThe object of the\ncontract is unique &\nSpecific\nthe loss cannot be\nPerformance\neasily compensated\nthrough money\n\nDescription\n\nParty must perform under\nterms of contract\n\nRescission\n\nContract was executed\nbased on mutual\nmistake or fraud\n\nParties are put back into\nposition they were in\nbefore contract was made\n\nRestitution\n\nParties must return\nany benefit received\n\nBenefit or item unjustly\nobtained is returned\n\nSpecific Performance\nSpecific performance is a judicial order directing a party to\ndeliver the exact property (real or personal) under the terms\nof a contract. Specific performance is an alternative remedy\nto damages and may be issued at the discretion of the court.\nSpecific performance is granted when money damages are not\nan adequate remedy. For example, sale of specific real property\n(real estate is always unique), artwork, antiques, and heirlooms.\nTo warrant specific performance, a contract must be clear,\ndefinite, complete, and free from fraud and duress.\nSpecific performance is generally not available for service\ncontracts. This is because ordering someone to perform a\ncontract against their will is a type of involuntary servitude\n\nContracts | 184\n\n\x0cbanned by the Thirteenth Amendment of the US Constitution.\nHowever,\n\ncourts\n\nhave\n\noccasionally\n\nentered\n\ninjunctions\n\nprohibiting entertainers from performing at alternative venues\nuntil they perform at the venue under their original contract.\nThese cases are in response to unethical forum shopping in the\nentertainment industry, and are very limited in nature.\n\nRescission\nRescission occurs when one party seeks to undo a contract\nand return to the position it was in before the contract was\nmade. Rescission often occurs when fraud and mutual mistake\noccur and enforcing the contract would be unjust. Rescission\nmay also be available when one party materially breaches the\ncontract to such an extent that requiring the other party to\nperform would be unjust.\nA party seeking rescission must notify the other party within a\nreasonable time after discovery of the facts that are the basis\nfor rescission. The reason is that restoring the parties to their\npre-contractual positions is easiest before too much time and\nperformance has passed. Failure to rescind a contract in a\ntimely manner may be held to affirm the contract or waive a\nbreach of contract.\n\nRestitution\nRestitution is restoring property to the original owners. In other\nwords, parties must return any benefit received under the\ncontract. Therefore, only to the extent that the injured party\nconferred a benefit on the other party may the injured party\nbe awarded restitution. Restitution often follows rescission of a\ncontract. The purpose of restitution is to prevent a party from\n185 | Contracts\n\n\x0cbeing unjustly enriched when a contract has been legally\nannulled.\n\n10.9 Concluding Thoughts\nContracts are a fundamental part of business. It is important\nto understand how contracts are formed, performed, and\nexecuted in order to be successful. This understanding also\nincludes understanding what performance is required, what\ndefenses are available when someone breaches a contract, and\nwhat remedies are available in the event of a breach.\n\nContracts | 186\n\n\x0c11. Sales Contracts\n11.1 Introduction\nLEARNING OBJECTIVES\n1. Explore the differences between the Uniform Commercial\nCode and common law contract principles.\n2. Understand important provisions of the Uniform\nCommercial Code and how they apply to merchants who\nsell goods.\n3. Learn when the Uniform Commercial Code applies to\nmixed contracts.\nOne of the drawbacks of federalism is that states can\nimplement different laws. This was a serious problem as the\nUS economy grew beyond local and state-based industries to\neconomies of scale during the Twentieth Century because it\nhampered economic growth. In response, business leaders\ndemanded consistent laws to facilitate trade across the nation,\nespecially for the sale of goods across state lines.\nThe Uniform Commercial Code (UCC) is a proposed set of laws\ndeveloped by legal experts and business leaders to govern\ncommercial transactions, including sale of goods, secured\ntransactions, and negotiable instruments. The UCC was\ncreated in 1952 and its advocates lobbied the states and\nterritories to adopt it. The UCC has been adopted in some form\nby all fifty states, the District of Columbia, and US territories.\nInterestingly, it is the only \xe2\x80\x9cnational\xe2\x80\x9d law not enacted by\nCongress.\n\n187 | Sales Contracts\n\n\x0cThis chapter will focus on important provisions that relate to\nsales contracts that have been adopted by most, if not all,\nstates.\n\nCounselor\xe2\x80\x99s Corner When writing something for\nwork, I offer the following advice. First, take time to\nreview and edit your writing. You will be surprised at\nthe number of typos that can be discovered when\nyou give your work fresh eyes. Don\xe2\x80\x99t be afraid to\nreach out to others to review your work as\nwell. Excellence in writing will help to convey your\nmessage clearly and credibly. Second, write with\nhonesty. If your reader doubts the sincerity of your\nwork, the message you are trying to convey will be\nlost. The strongest advocates I have encountered are\nthe most honest ones. Third, be clear and\nconcise. Tell your reader a story but give them the\ninformation they need in an organized fashion.\n~Tiffany M., attorney\n\n11.2 Scope of the UCC\nThe UCC deals with commercial transactions from start to\nfinish. The power of the UCC is that if the parties do not have a\ncontract with express terms, then the UCC \xe2\x80\x9cfills the gaps\xe2\x80\x9d with\nlegal requirements. For example, if the parties do not negotiate\nthe terms of delivery, then the UCC states where and when\ndelivery should occur. This is incredibly beneficial to businesses\nbecause it provides legal certainty and consistency across\njurisdictions.\n\nIf\n\nparties\n\nhave\n\na\n\ndispute,\n\nor\n\nunforeseen\n\nSales Contracts | 188\n\n\x0ccircumstances result in a breach of contract, the parties can\nresolve the problem without having to litigate the issue in\ncourt. This saves businesses a lot of time, money and resources,\nas well as helps them maintain good working relationships.\nThe UCC also addresses four important problems that\nmerchants struggled with under the common law:\n\n189 | Sales Contracts\n\n\x0cProblem\n\nContract\nFormation\n\nRequired\nWriting\n\nCommon\nLaw\n\nUCC\n\nExample\n\nMirror Image\nRule: Offer\nmust be\nfollowed by\nacceptance\nshowing\nmeeting of\nthe minds on\nall essential\nterms\n\nContract can\nbe made in\nany manner\nthat shows\nagreement\nand some\nterms,\nincluding\nprice and time\nof delivery,\nmay be left\nopen (\xc2\xa72-204\n& \xc2\xa72-305)\n\nJimena writes Ahn\nthat she needs a\nnew computer. Ahn\ndelivers the\ncomputer and\nJimena starts to use\nit. Under the\ncommon law, there\nis no contract\nbecause price was\nnot discussed.\nUnder the UCC a\ncontract exists for a\nreasonable price.\n\nAll essential\nterms must\nbe in writing\n\nAny writing\nthat intends\nto be a\ncontract is\nenforceable;\n\xe2\x80\x9cmerchant\xe2\x80\x9d\nexception can\ncreate a\ncontract\nagainst party\nthat does not\nobject to\nwriting within\nten days\n(\xc2\xa72-201)\n\nHome Depot sends\na purchase order to\na wholesaler. The\nwholesaler receives\nthe order but does\nnot respond. Under\nthe common law, no\ncontract exists.\nUnder the UCC, a\ncontract exists after\nten days that Home\nDepot may enforce\nagainst the\nwholesaler.\n\nSales Contracts | 190\n\n\x0cAdditional\nTerms\n\nAn\nacceptance\nwith any\nadditional\nterms is a\ncounteroffer\n\nTo be valid, a\nmodification\nmust be\nModification\nsupported by\nnew\nconsideration\n\nAdditional\nand different\nterms are not\nnecessarily\ncounteroffers,\nmay just be\npart of\nnegotiation\nprocess\n(\xc2\xa72-207)\n\nA florist sends a\npreprinted order\nform to buy specific\nsupplies from a\nmanufacturer for a\nstated price. The\nmanufacturer\nresponds with its\nown preprinted\nform accepting the\norder but adding\nthe term that\nunpaid balances\nincur interest.\nUnder the common\nlaw, the additional\nterm is a\ncounteroffer and no\ncontract is formed\nuntil the florist\naccepts it. Under\nthe UCC, there is a\nvalid contract that\nincludes the interest\nterm.\n\nA\nmodification\ndoes not need\nto be\nsupported by\nnew\nconsideration\n(\xc2\xa72-209)\n\nFred Farmer agrees\nto sell produce to\nAponi for her\nrestaurant. They\nagree to all essential\nterms, including\ngoods, price, and\ndelivery. The next\nday a hurricane\nfloods the interstate\ndoubling the\ndelivery costs. Fred\ncalls Aponi who\nagrees to pay half of\nthe increased cost.\nUnder the common\nlaw, the\nmodification is void.\nUnder the UCC, the\nmodification is\nenforceable.\n\nA common problem is determining when the UCC applies. The\nUCC does not apply to contracts related to the sale of land,\nintangible personal property, construction, or for services. The\nUCC applies to the sale of goods, which the Code defines as\n191 | Sales Contracts\n\n\x0cany moveable physical object except for money and securities.\nIn other words, goods are tangible personal property.\nFigure 11.1 Determination of when the UCC Applies to Sales\nTransactions\n\nMixed contracts are for both the sale of goods and services. For\nexample, a contract for the sale of a dishwasher that includes\nthe service of installation is a mixed contract. The UCC only\napplies to mixed contracts when the primary purpose of the\ncontract is the sale of goods. In the dishwasher example, the\nUCC applies because installation would not occur without the\nsale of the dishwasher.\nThe UCC also does not apply if none of the parties are a\nmerchant. In other words, the sale of goods between\nindividuals is governed by the common law. If a sales\ntransaction involves a merchant, then the UCC usually applies.\nA merchant is someone who routinely deals in the goods\ninvolved in the transaction or who, by his or her occupation,\n\nSales Contracts | 192\n\n\x0cholds himself or herself out as having special knowledge with\nrespect to the goods. Suppliers of services are not merchants.\nThe UCC provides merchants with rules that facilitate their\nbusiness needs. For example, contract formation is more\ninformal and flexible than under the common law. However,\nthe UCC often holds merchants to a higher standard of\nconduct than non-merchants. Merchants are required to act in\ngood faith and to observe reasonable commercial standards of\nfair dealing.\n\n11.3 Sales Contract Formation\nThe common law expects parties to form a contract by making\nan offer, with an acceptance that mirrors the offer and includes\nall material terms. Modern business transactions, however,\nfrequently do not follow that pattern. As a result, UCC \xc2\xa72-204\nprovides that a contract may be formed in any manner that\nshows the parties reached an agreement.\nThe terms of sales contracts are supplied by three sources:\n1. The express agreement of the parties;\n2. Course of dealing, usage of trade, and course of\nperformance; and\n3. The UCC.\n\nExpress Agreement\nThe general rule is that parties are free to make their own sales\ncontract. When parties agree on terms\xe2\x80\x93especially for quality,\nquantity, price, delivery and payment\xe2\x80\x93those terms control over\n\n193 | Sales Contracts\n\n\x0cUCC provisions. The parties\xe2\x80\x99 freedom to contract, however, is\nnot limitless. Parties cannot disclaim their obligation of good\nfaith, diligence, and due care. Similarly, liquidated damages\nprovisions must be based on the value of the contract and\ncannot be a penalty for breach of contract. Further, limitations\non consequential damages cannot be unconscionable.\n\nCourse of Dealing, Usage of Trade &\nCourse of Performance\nThe parties\xe2\x80\x99 agreement may be based on their actions. Course\nof dealing is an established pattern of prior conduct between\nthe parties to a particular transaction. If a dispute arises, the\nparties\xe2\x80\x99 course of dealing can be used as evidence of how they\nintended to carry out the transaction. In other words, the\ncurrent contract is interpreted based on past contracts.\nCourse of performance relates to the conduct of the parties\nunder the contract in question after its formation. It occurs\nwhen a contract involves repeated performance and looks at\nhow the parties have acted when performing this particular\ncontract, not contracts in the past.\nUsage of trade is a practice or custom in a particular trade\nused so frequently that it justifies the expectation that it will be\nfollowed in the current transaction. It is industry standards and\ncustoms related to a particular industry.\n\nUCC Provisions\nWhen sales contracts do not have all the necessary terms, the\nUCC \xe2\x80\x9cfills in the gaps\xe2\x80\x9d of the contract. The most important UCC\n\nSales Contracts | 194\n\n\x0cgap-filler provisions relate to price, quantity, delivery, and time\nof performance.\nFigure 11.2 UCC Gap-Filler Provisions\n\n195 | Sales Contracts\n\n\x0cProvision Subject\n\n\xc2\xa72-305\n\nPrice\n\nDescription\nPrice can be left open to be fixed at later\ntime;\nReasonable price determined upon delivery\n\xe2\x80\x9cOutput\xe2\x80\x9d and \xe2\x80\x9cRequirement\xe2\x80\x9d amounts can\nbe determined at a later time;\n\n\xc2\xa72-306\n\nNo quantity that is unreasonably\nQuantity disproportionate to the estimate will be\nenforced;\nReasonable amount in keeping with normal\nor prior comparable output or requirements\nis implied\n\n\xc2\xa72-507\n& \xc2\xa72-308\n\nDelivery\n\nDelivery occurs at seller\xe2\x80\x99s place of business\nunless contract provides otherwise\n\n\xc2\xa72-309\n\nTime\n\nReasonable time for performance\n\nWhen these sources of contract terms are in conflict, the UCC\napplies the following hierarchy:\n1. Express terms;\n2. Course of performance;\n3. Course of dealing;\n4. Usage of trade; and\n5. UCC gap-filler provisions.\nThe logic is that the parties are free to contract the terms they\nwould like. In absence of an express agreement, the parties\xe2\x80\x99\nconduct shows their intent. In practical terms, usage of trade\nand UCC provisions often go hand-in-hand. For example, what\nconstitutes \xe2\x80\x9creasonable time\xe2\x80\x9d for performance is often based\non relevant industry standards. Although the UCC identifies a\nhierarchy, in practice it is not rigidly applied by the courts when\ndetermining usage of trade and UCC provisions.\n\nSales Contracts | 196\n\n\x0cAdditional and Different Terms\nUnder UCC \xc2\xa72-207, an acceptance that adds or alters terms\nwill often create a contract. Unlike the common law that treats\nmodifications as a counter-offer, the UCC has a more flexible\nconcept of acceptance. This is to address the \xe2\x80\x9cbattle of the\nforms\xe2\x80\x9d that happens when merchants buy and sell goods with\npre-printed forms. Frequently buyers use pre-printed forms to\nplace an order that are then acknowledged by the seller on its\nown pre-printed forms. These forms typically contain language\nfavorable to the party sending it and rarely agree.\nSection 2-207 still requires the parties to intend to create a\ncontract. If the differing forms show that the parties never\nreached an agreement, then no contract exists.\nHowever, if the acceptance contains an additional term, then\na contract is usually formed. An additional term is a proposed\ncontract term that addresses issues not included in the offer.\nAdditional terms expand the offer to cover more essential\nterms to ensure a meeting of the minds.\nIf both parties are merchants, the additional terms usually\nbecome part of the contract unless:\n1. The offer states that it cannot be accepted with additional\nor different terms;\n2. The additional terms materially alter the offer; or\n3. The party making the offer promptly rejects the additional\nterms.\nA different term is a proposed contract term that contradicts\nthe term(s) in the offer. Under the UCC, different terms cancel\neach other out. In most states, different terms are replaced by\nUCC gap-filler provisions.\n\n197 | Sales Contracts\n\n\x0c11.4 Performance\nA seller is expected to deliver what the buyer ordered.\nConforming goods meet contractual specifications and satisfy\nperformance requirements. Non-conforming goods are goods\nthat fail to meet contractual specifications, allowing the buyer\nto reject the goods or to revoke acceptance.\nA buyer has the right to inspect the goods before paying or\naccepting them. A buyer may also reject non-conforming\ngoods by notifying the seller within a reasonable time.\nIf a buyer rejects the goods, the seller has the right to cure,\nwhich is the right to deliver conforming goods before the\ncontract deadline. The UCC also allows the right to cure after\nthe contract deadline in some situations. If the seller delivers\nconforming goods, then it is entitled to full payment under the\ncontract.\nIf the seller breaches the contract, the buyer is entitled to\ncover. Cover is obtaining reasonable substitute goods because\nanother party failed to perform under a contract. If the seller\nobtains reasonable substitute goods, the seller is entitled to the\ndifference between the contract price and its cover price, plus\nincidental and consequential damages, minus expenses saved.\nIf the buyer breaches the contract, the seller may refuse to\ndeliver the goods. If a buyer refuses to accept or pay for goods\nwithout justification, the seller may resell them to another\nparty. When the resale is commercially reasonable, the seller\nmay recover the difference between the resale price and the\ncontract price, plus incidental damages, minus expenses\nsaved.\nIf the buyer has accepted the goods and refuses to pay, or if the\ngoods are conforming but resale is impossible, the seller may\n\nSales Contracts | 198\n\n\x0csue the buyer for the contract price. This is common when the\nbuyer orders goods with unique specifications.\n\n11.5 Warranties\nA warranty is a contractual assurance that goods will meet a\ncertain standard. An express warranty is a guarantee, created\nby the words or actions of the seller, that goods will meet\ncertain standards. Under the UCC, a seller may create an\nexpress warranty in three ways:\n1. With an affirmation of a fact or a promise;\n2. With a description of the goods; or\n3. With a sample or model.\nTo constitute a warranty, the seller\xe2\x80\x99s words or actions must be\npart of the basis of the bargain. For example, if a salesperson\nsays that a car\xe2\x80\x99s timing belt was just replaced and will not\nneed to be replaced for another 100,000 miles, and the buyer\nrelied on that statement when deciding to buy the car, then\nthe salesperson\xe2\x80\x99s statement becomes an express warranty.\nAn implied warranty is a guarantee created by the UCC and\nimposed on the seller of goods. There are two main implied\nwarranties: merchantability and fitness for a particular\npurpose.\nThe implied warranty of merchantability is a warranty that\nthe goods are fit for the ordinary purposes for which they are\nused. To disclaim this warranty, a merchant must use the term\n\xe2\x80\x9cmerchantability.\xe2\x80\x9d The novel or unusual use of goods is not\nprotected by this warranty. If a buyer uses goods for something\nother than their intended purpose, the warranty does not\napply.\n\n199 | Sales Contracts\n\n\x0cThe implied warranty of fitness for a particular purpose is a\nwarranty that the property is suitable for the buyer\xe2\x80\x99s special\npurpose. For the warranty to apply, the seller must know what\nthe buyer\xe2\x80\x99s purpose is and the buyer must rely on the seller\xe2\x80\x99s\njudgment that the goods meet the buyer\xe2\x80\x99s needs.\n\n11.6 Concluding Thoughts\nThe UCC is a national law that was proposed by legal experts\nand business leaders to address the need for consistent laws\nrelated to the sale of goods across state lines. The UCC also\napplies to secured transactions and negotiable instruments,\nwhich are areas beyond the scope of this book. For individuals\nand businesses who buy or sell goods with merchants, it is\nimportant to understand how the UCC fills in gaps with terms\nthat are not expressly contained in a contract, as well as to\nunderstand applicable warranties. The flexibility of the UCC\nfacilitates business by making commercial transactions more\nconsistent and predictable.\n\nSales Contracts | 200\n\n\x0c12. Writing Contracts\n12.1 Writing Contracts\nLEARNING OBJECTIVES\n1. Learn how to write valid contracts.\n2. Understand strategies for drafting contracts.\nKnowing how to write legally enforceable contracts that\nprotect their interests is a vital skill for businesses. In fact, most\ncontracts are not written by attorneys. Individuals and\nbusinesses write contracts without legal help because they are\ntrying to save time, money, and tension with others. However,\nhiring an attorney to write or review a contract to protect\npersonal or business interests is sometimes necessary and\nworthwhile.\nThere are no magic words that a contract must have to be\nenforceable. Some are short and informal, while others are long\nand formal. No one style, format, or approach will always serve\nthe parties\xe2\x80\x99 needs. The only legal requirement that contracts\nmust have are the elements of a contract: offer, acceptance,\nand consideration. This chapter offers some guidelines for\nbusiness people to consider when writing their own contracts.\n\nCounselor\xe2\x80\x99s Corner It has been said that a poorly\n\n201 | Writing Contracts\n\n\x0cdrafted contract will work if everyone gets the\nbenefit of their bargain. This may be true, but it does\nnot excuse sloppy drafting. Address all essential\nmatters, clearly, succinctly, and at once. Nonessential terms, inconsistent use of defined terms,\nand repetition create fertile ground for disputes. You\ncannot control how the other party will perform.\nHowever, you put yourself in the best position\npossible by ensuring that the intent, obligations and\nrights of all parties are stated clearly and\nunambiguously. ~Kathy K., attorney\n\n12.2 Structure of Contracts\nWritten contracts can be organized in many different ways.\nHowever, having a structure can help keep information\norganized, clear, and easy to find. The best contracts have clear\nheadings that accurately describe what is contained in that\nsection. Using emphasis, such as bold and underlining, work\nbetter than italics alone for capturing the reader\xe2\x80\x99s eye.\nIn general, contracts often contain a structure like this:\n1. Title\n2. Introduction of Parties and Purpose\n3. Definitions of Material Terms\n4. Covenants and Promises of Performance\n5. Conditions\n6. Breach and Its Consequences\n\nWriting Contracts | 202\n\n\x0c7. Representations and Warranties\n8. Standard (often called \xe2\x80\x9cBoilerplate\xe2\x80\x9d) Provisions\n\xe2\x97\xa6 Procedure to Modify Contract\n\xe2\x97\xa6 Rights of Assignment and Delegation\n\xe2\x97\xa6 Alternative Dispute Resolution\n\xe2\x97\xa6 Choice of Law and Forum\n\xe2\x97\xa6 Integration\n\xe2\x97\xa6 Severability\n\xe2\x97\xa6 Exculpatory Clause\n\xe2\x97\xa6 Force Majeure\n\xe2\x97\xa6 Attorney Fees\n9. Signature Block\nNot all contracts will contain all these elements and provisions.\nThe parties\xe2\x80\x99 needs and the purpose of the contract drive the\nstructure of the document.\n\nTitle\nContracts have a title, often in bold or CAPITAL letters, at the\ntop of the page. Titles should be as descriptive as possible.\n\xe2\x80\x9cContract\xe2\x80\x9d or \xe2\x80\x9cAgreement\xe2\x80\x9d are not useful because they require\nthe reader to read through the contract to know what it is\nabout. The best contracts capture the nature of the document\nin the title. For example, \xe2\x80\x9cEmployment Agreement Between\nJane Doe and Stanford University.\xe2\x80\x9d\n\nIntroduction of Parties and Purpose\nThe introduction should name the parties and describe the\n\n203 | Writing Contracts\n\n\x0cnature of the contract. If background information is useful in\nexplaining the parties\xe2\x80\x99 interests and objectives, then it should\nbe included here.\n\nDefinitions of Material Terms\nMost business contracts contain some definitions, unless the\nsubject matter and parties are clear. Definitions are useful\nbecause it is an area readers can reference to ensure\ncompliance with the contract. For example, did the seller\nprovide the specific goods as defined by the contract?\nDefinitions are not necessary for every term, though. If not\ndefined, legal terms are given their legal meaning. And\nordinary words are given their common, ordinary meaning.\nTherefore, businesses should define the material terms of the\ntransaction: goods, services, quantity, quality, price, etc.\nDefinitions that are specific to the industry are also helpful to\ninclude.\n\nCovenants and Promises of Performance\nA covenant is a formal promise to perform. This is the section\nof the contract where the parties state exactly how they will\nperform the contract. Buyer will pay a specific amount for the\ngoods or service. Seller will deliver a specific item at a particular\nlocation.\nTo ensure clarity, the best contracts use active verbs in this\nsection. For example, \xe2\x80\x9cBuyer will pay Seller ten dollars.\xe2\x80\x9d It is\nclear who will be paying whom, and how much is owed. Passive\nvoice injects ambiguity, which can be problematic. For\nexample, \xe2\x80\x9cSeller shall be paid ten dollars.\xe2\x80\x9d Will Buyer pay Seller\n\nWriting Contracts | 204\n\n\x0cthe money or will someone else tender payment? If payment is\nnot made, is Buyer in breach of contract?\n\nConditions\nAs discussed in Chapter 10, conditions are things that must\noccur before performance is due. Usually conditions must be\nexpressly stated in a contract to be legally enforceable. The\nbest contracts identify any conditions and delineate a timeline\nfor when performance is due after the condition is met. For\nexample, if an inspection of a property is a condition precedent\nof purchasing it, how long after the inspection is completed\nmust the buyer perform?\n\nBreach and Its Consequences\nTo constitute a violation of the contract, a breach must be\nmaterial. A material breach is a substantial breach of contract\nthat excuses aggrieved parties from further performance and\naffords them the right to sue for damages.\nIn contracts that require performance over a period of time,\nor payments in installments, it is helpful to define what\nconstitutes a material breach. This clarifies when the nonbreaching party can seek a remedy. The best contracts\nanticipate reasons for breach and identify consequences for\nthem.\n\nAcceleration Clause\nAn acceleration clause makes all future payments due\n\n205 | Writing Contracts\n\n\x0cimmediately under the contract. Acceleration clauses often\nexists in contracts where periodic payments occur. For\nexample, a contract to purchase a vehicle may require\npayment of all remaining money owed under the contract if\nthe buyer misses a monthly payment. This allows the business\nthat sold the vehicle or the bank that issued the loan to sue\nfor breach of contract once, rather than filing a new lawsuit for\neach month.\n\nLiquidated Damages\nA liquidated damages clause allows parties to determine the\namount of damages in the event of a material breach. Agreeing\nto the value of the contract before any breach occurs often\nsaves time and money should the case be litigated. To be\nenforceable, the liquidated damages must apply to all parties\nequally, and be based on the value of the contract rather than\nact as a penalty.\n\nRepresentations and Warranties\nRepresentations are statements of fact made to induce\nsomeone to enter into a contract. Common representations by\nbusinesses include:\n\xe2\x80\xa2 They are properly licensed;\n\xe2\x80\xa2 They are insured;\n\xe2\x80\xa2 Their financial statements are accurate;\n\xe2\x80\xa2 They own all relevant assets;\n\xe2\x80\xa2 They have legal authority to enter into contracts.\nWarranties in a contract are express promises that guarantee\n\nWriting Contracts | 206\n\n\x0csomething in furtherance of the contract by one of the parties.\nFor example, a seller warrants that the object being sold is as\nrepresented or promised.\nWarranties differ from representations in four ways:\n1. A warranty is an essential part of a contract, while a\nrepresentation is usually only a collateral inducement;\n2. A warranty is written in a contract; while a representation\nmay be written or oral;\n3. A warranty is conclusively presumed to be material, while\na representation must be proven to be material by the\nparty claiming breach; and\n4. A warranty must be strictly complied with, while a\nrepresentation must be substantially true.\nPlease note that express contract warranties are different from\nimplied warranties under the Uniform Commercial Code (UCC).\nA party may disavow implied warranties under the UCC\nthrough a written contract.\n\nModification\nOften with contracts that require an extended period for\nperformance, modification becomes a concern. What happens\nif prices or deadlines need to be altered? Does that require a\nnew contract or can the existing contract be modified? Good\ncontracts often include a procedure for how to modify a\ncontract. This may be as informal as writing changes directly\non the original contract with the parties\xe2\x80\x99 initials and date. Or it\ncould be through a formal addendum procedure.\nRegardless of the chosen procedure, it is a best practice for\nbusinesses to discuss modification procedures when entering\n\n207 | Writing Contracts\n\n\x0cinto a contract. If the procedure is clear, less friction occurs\nwhen a party seeks modification.\n\nAssignment and Delegation\nIn general, parties are free to assign and delegate their rights\nand duties under a contract. Parties can limit those rights or\nthey can request notice if an assignment or delegation occurs.\nThis is a provision that is often not needed unless a party has a\nconcern about assignment, such as in the insurance industry.\n\nAlternative Dispute Resolution\nAs discussed in Chapter 4, many businesses want to reduce\ntheir risk of litigation by participating in alternative dispute\nresolution (ADR). Mandatory arbitration clauses are common\nin consumer and employment contracts. Before including an\nADR provision in a contract, parties should be fully comfortable\nwith the option that they choose. If a party agrees to mediation\nor arbitration, a court will enforce that choice even if the parties\nchange their mind.\n\nChoice of Law and Forum\nChoice of law provisions determine which state\xe2\x80\x99s laws will be\nused to interpret the contract. Choice of forum provisions\ndetermine the state in which any litigation will take place.\nThis provision is often unnecessary for contracts involving\nindividuals and entities in the same state. If the parties do not\nselect that state law or location for litigation, the courts look to:\n\nWriting Contracts | 208\n\n\x0c1. Where the contract was signed;\n2. Where the contract is performed;\n3. Where the parties are residents; and\n4. The court\xe2\x80\x99s jurisdictional rules.\n\nIntegration\nAn integration clause is a provision stating that the contract\nrepresents the parties\xe2\x80\x99 complete and final agreement and\nsupersedes all informal understandings and oral agreements\nrelating to the subject matter of the contract. In other words, it\nis the agreement.\nThe purpose of an integration clause is to prevent the parties\nfrom later claiming that they agreed to additional or different\nterms than what the contract states. This means that any\nstatements made before the parties signed the contract are\nnot part of the contract and they will not be used to interpret\nthe meaning of the contract.\n\nSeverability\nA severability clause is a provision that keeps the remaining\nprovisions of a contract in force if any portion of the contract\nis declared unenforceable by the court. It is also known as a\nsavings clause because it \xe2\x80\x9csaves\xe2\x80\x9d the whole contract from\nbeing declared unenforceable.\nFor example, if a non-compete clause in an employment\ncontract is declared unenforceable by a court, then the rest of\nthe employment contract remains in effect.\n\n209 | Writing Contracts\n\n\x0cExculpatory Clause\nAn exculpatory clause is a provision relieving a party from any\nliability resulting from a negligent or wrongful act. They are\noften employed when the risk of injury exists. Exculpatory\nclauses cannot limit liability when a party acts with gross\nnegligence, commits an intentional tort, or when public policy\nor state laws prohibit them. Exculpatory clauses have been\nstruck down by courts in some cases where parties to a\ncontract have greatly unequal bargaining power, especially\nwhen the party with greater power acts unethically or with\ngross negligence.\n\nForce Majeure\nA force majeure clause is a provision allocating risk to a certain\nparty if performance becomes impossible as a result of an\nevent that the parties could not have anticipated or controlled.\nForce majeure events are big, disruptive events such as natural\ndisasters, war, terrorist attacks, and fires.\nFor example, if the subject matter of an international sales\ncontract is destroyed by a hurricane, does the buyer or seller\nlose the money in the sale?\n\nAttorney Fees\nBusiness contracts often have an attorney fees clause that\nentitles a party successful in litigation over the contract to be\nreimbursed its attorney fees. This clause often has the effect of\nlimiting frivolous lawsuits because it becomes more expensive\n\nWriting Contracts | 210\n\n\x0cfor parties to litigate weaker claims. It may also give leverage to\na winning party to prevent or end appeals of a court judgment.\nCourts will usually enforce an attorney fees provision in a\ncontract. However, courts review attorney fee awards for\nreasonableness. Therefore, the amount of fees usually must be\ndeemed reasonable by a court or arbitrator before a party can\ncollect under a contract.\n\n12.3 Common Mistakes\nFour of the most common mistakes when writing a contract\nare not understanding the content, vagueness, ambiguity, and\ntypographical errors.\n\nNot Understanding the Content\nOne common mistake is using free online resources without\nensuring that they are appropriate for the circumstances. Just\nbecause it sounds official, a document generated by a\ncomputer algorithm may not be helpful. Better to read the\ncontract and ensure that it accurately reflects the parties\xe2\x80\x99\nagreement.\nCourts presume that parties have read a contract before\nsigning it. Any mistakes in drafting go against the party who\nwrote the contract. In other words, if the contract is unclear,\nthe party who did not write it gets the benefit of the doubt.\nThe idea is that the party who wrote it should have done a\nbetter job, and the party who read and signed it should not be\npenalized as a result of someone else\xe2\x80\x99s error. When writing a\ncontract, better to keep it simple and clear.\n\n211 | Writing Contracts\n\n\x0cIt is also important to exclude provisions that are irrelevant to\nthe contract. Contracts that are too long and contain irrelevant\nand contradictory terms are hard to understand. The best\ncontracts are used as a reference between the parties during\nthe period of performance. If a contract is too broad, too\nconfusing, or contains too much irrelevant information, it\nhinders the effectiveness of the document.\n\nVagueness\nIn the context of contracts, vagueness means the language is\nimprecise, uncertain, and not clearly expressed. Vagueness is\nproblematic because it could mean that the parties did not\nhave a meeting of the minds because they were not talking\nabout the same things.\nSome business people think that keeping the contract\n\xe2\x80\x9cgeneral\xe2\x80\x9d will facilitate a business transaction and that the\ndetails can be worked out later. However, if the parties are not\nin agreement up front, it is uncommon that things will work\nout smoothly later.\nAnother risk with vagueness is that it is not clear how a court\nwill interpret the contract. If there are two or more reasonable\ninterpretations, it is possible that the court will decide another\ninterpretation is more reasonable. Again, mistakes in drafting\nare held against the drafter so if a court concludes that the\nvague term was a mistake, then it is hard to win in litigation.\n\nAmbiguity\nIn contracts, ambiguity means an uncertainty of meaning or\nintention. Ambiguities can be either patent or latent. A patent\n\nWriting Contracts | 212\n\n\x0cambiguity is where the language of the contract itself creates\nuncertainty because it is contradictory. For example, a contract\nstates two different sale prices.\nA latent ambiguity exists where the uncertainty arises during\nthe performance of the contract. For example, the contract\nstates that goods will ship via a carrier that has a common\nname and could be referring to different carriers.\n\nTypographical Errors\nTypographical errors are common in contracts. Some are\nharmless, some are embarrassing, and others are harmful.\nAlthough some typos are easy to ignore because they do not\ncarry legal consequences, some can be fatal to the agreement.\nMinor errors are called scrivener\xe2\x80\x99s errors. The scrivener\xe2\x80\x99s error\ndoctrine permits typographical errors in a written contract to\nbe corrected when clear and convincing evidence exists that\nthe mistake does not reflect the intent of the parties.\nHowever, errors related to dates, price, quantity, legal names\nof individuals and entities, and property descriptions (such as\naddresses and lot numbers) may not qualify as scrivener\xe2\x80\x99s\nerrors. Such errors may be fatal to the contract or may be\nenforced with adverse consequences against one of the\nparties.\n\n12.4 Tips for Writing a Contract\nRegardless of the purpose of the contract, some tips for writing\ngood contracts include:\n\n213 | Writing Contracts\n\n\x0cNaming the Parties\nBe sure to use the correct name of the business entity or\nindividual who is a party to the contract. This may seem\nobvious, but people often write the name of a representative of\nthe entity rather than the legal name of the entity.\nFor sole proprietorships, it is appropriate to identify the party\nas Ling Chen doing business as Chen Bookkeeping. If the\nbusiness is a Limited Liability Company (LLC), identifying an\nindividual in the contract by name may remove any personal\nliability protection that a LLC provides. Similar issues may arise\nwith a partnership if each individual is identified as a party to\nthe contract.\nExcept for sole proprietors who do not have a separate business\nname, use the business entity\xe2\x80\x99s name and not a personal name\nas a party to the contract. Otherwise, parties may lose the\nbenefit of limited liability. There may also be tax consequences.\n\nDefine the Scope of the Work\nClearly define the scope of work or service being provided, and\nthe proposed timeline to complete the work. Be specific. For\nexample, instead of a broad \xe2\x80\x9crenovate the kitchen,\xe2\x80\x9d provide\ndetails of the cabinet designs, counter tops, and other\nmaterials and work to be provided.\nIf applicable, a time frame for each phase of the project is\nuseful, along with procedures to follow if there are delays. This\nis especially helpful when delays occur as a result of a supply\nshortage or a third party. Breach of contract may not always\nbe the fault of the parties. Having procedures in place in the\n\nWriting Contracts | 214\n\n\x0ccase of delay often saves business relationships when things go\nwrong.\n\nSpecify Time and Amounts of Payments\nEntering an hourly rate and projected time for completion, or\nthe total amount of payment for a project, may be insufficient.\nDepending on the nature of the goods or services, the contract\nshould include:\n\xe2\x80\xa2 Who is paying whom;\n\xe2\x80\xa2 How much is being paid;\n\xe2\x80\xa2 The method of payment (such as check, cashier\xe2\x80\x99s check or\nbank transfer);\n\xe2\x80\xa2 Any portion of fees to be paid upfront;\n\xe2\x80\xa2 Any fees to be paid at project milestones;\n\xe2\x80\xa2 Payment for work completed if contract is canceled;\n\xe2\x80\xa2 Any late fees; and\n\xe2\x80\xa2 Hourly/per diem rate for time due to delays caused by the\nother party.\n\nTermination Clause\nFew contracts go on forever, so including an end date for the\nagreement or procedures for a party to cancel the contract are\nhelpful. For example, parties often want to end the agreement\nif the other party fails to pay or misses too many important\ndeadlines.\nTermination procedures should be as specific as possible and\ninclude how much notice needs to be given, the type of notice\nrequired, and whether there is a time period where the other\nparty may cure the deficiency.\n215 | Writing Contracts\n\n\x0cTermination clauses should anticipate termination by all\nparties and address the parties\xe2\x80\x99 rights based on which party\nrequests termination and why.\n\nSign and Date the Contract\nThe signature block should name the business entity, then\nunder the signature, the name and title of the person signing.\nFigure 12.1 Signature Block Example\n\nFor example, Ahmad\xe2\x80\x99s Construction, LLC By: __________ Khalid\nAhmad, President\nEach person signing the contract should date it next to his or\nher signature.\nFor partnerships, only general partners can sign a contract on\n\nWriting Contracts | 216\n\n\x0cthe partnership\xe2\x80\x99s behalf. For corporations, the president or\nchief executive officer is presumed to have authority to sign.\nFor an organization or association, a board president would\nhave authority, but it may require a vote of the governing board\nto approve the contract.\n\nMinor Changes\nMinor changes can be made directly to the contract. Both\nparties need to initial and date beside the changes to show\nthat both parties agree to the change.\nThis is common when people buy property and the amount\nheld in escrow changes (usually based on interest accrued)\nfrom the time the contract was prepared to the time it was\nsigned.\n\nLegal Terms\nCourts interpret legal terms to have their legal meaning,\nregardless of the parties\xe2\x80\x99 intent. Avoid using legal terminology\nunless all parties fully understand the legal definition and how\nit will be applied by the court. Again, simple and clear language\nis more effective than confusing legal jargon.\n\nAllow for Flexibility\nContracts are usually the result of negotiation and the majority\nof them never end up in court. Contracts cannot cover every\npossible future situation but serve as a working document for\nthe parties\xe2\x80\x99 business relationship. When writing contracts, it is\n\n217 | Writing Contracts\n\n\x0cbest to think of them as an agreement between parties that\nneed some flexibility for the transaction(s) to take place. Life is\ndynamic and the best contracts give structure without being\ntoo rigid.\n\n12.5 Concluding Thoughts\nWriting valid contracts is an essential skill to be successful in\nbusiness. Most contracts are not written by attorneys but they\nare critical to capturing an agreement between parties.\nSuccessful business people see contracts not just as a way to\nprotect their interests, but also as a document that governs\ntheir business relationships with others. A well-written contract\ncan be used throughout a transaction to guide the parties in\ntheir interactions and responsibilities.\n\nWriting Contracts | 218\n\n\x0c13. Employment Law\n13.1 Introduction\nLEARNING OBJECTIVES\n1. Understand the principle of employment at will and the\nexceptions to the doctrine.\n2. Learn important employment laws that affect businesses\nacross industries.\n3. Examine the laws that govern the relationship between\nemployers and employees who belong to a union.\nUntil the early Twentieth Century, there were not many laws\nthat regulated the employer-employee relationship. The belief\nwas that the free market system would ensure that employers\ntreat employees fairly or else they would not be able to attract\nand keep good workers. However, the reality of the Industrial\nRevolution\n\nproved\n\nthat\n\nthe\n\ntraditional\n\nemployment\n\nrelationship favored the interests of the employers at the\nexpense of workers, including children. As a result, Congress\nand state legislatures started passing employment and labor\nlaws to protect the interests of employees. Today, employment\nlaw is a very robust area of the law that impacts businesses\nacross industries.\n\nCounselor\xe2\x80\x99s Corner As working remotely is the\nnorm now for many employees who formerly went\n\n219 | Employment Law\n\n\x0cin to work each day, debates have arisen regarding\nwhere employees are more productive\xe2\x80\x94at home or\nback at the office? According to data gathered by\nvarious sources, most workers are more productive\nat home, including both those who enjoy and prefer\nthis arrangement, and those who\xe2\x80\x99d rather be in the\noffice. According to data gathered by\nRescueTime, remote workers had a 4% increase in\naverage daily time spent on their core work and an\n18% decrease in time spent on communication,\ncompared with employees in the office. Translated,\nworking from home for many means spending\nmore time on meaningful work and less time on\ncommunication, all without the commute. The\nlatest Census data indicates that the average\ncommute for Americans is 27 minutes each way, so\nalmost an hour a day roundtrip. These data raise\ninteresting questions about what the workplace will\nlook like when it is safe for most workers to return to\nthe office. ~Denise K., attorney\n\n13.2 Employment At Will\nIn general, employees are free to quit a job at any time for any\nreason, with or without notice. Similarly, employers are free to\nend a worker\xe2\x80\x99s employment at any time for any reason, with or\nwithout notice. This principle is called employment at will. This\ndoctrine is based on the concept that employment is a form\nof an implied contractual relationship. Therefore, as long as\nboth parties want to continue their contract to work together,\nEmployment Law | 220\n\n\x0cthe law presumes they will. When one party does not want to\ncontinue, then they may end their working relationship.\nThere are five major exceptions to the employment at will\ndoctrine:\n1. Contract;\n2. Good cause;\n3. Discrimination against an employee based on\nmembership in a protected class;\n4. Violation of public policy; and\n5. Whistleblowing.\nFigure 13.1 Exceptions to the Employment at Will Doctrine\n\n221 | Employment Law\n\n\x0cContract\nEmployers and employees may modify the employment at will\ndoctrine through contract. In addition to formal, written\nemployment\n\ncontracts,\n\ncourts\n\nhave\n\nalso\n\nenforced\n\noral\n\npromises made during the hiring process. Promises made to\njob applicants are generally enforceable, even when the\npromises are not approved by the employer\xe2\x80\x99s executives or\nupper management. Therefore, it is important when hiring\nemployees that companies do not make promises that can\nbe reasonably interpreted to be guaranteed employment or\nemployment for a certain period of time.\nEmployee handbooks also may create implied contracts that\nmodify the employment at will doctrine. Often handbooks\nstate that the company follows a progressive discipline policy\nand that employees may only be fired for \xe2\x80\x9cjust cause\xe2\x80\x9d or after\nreceiving warnings, notice, hearing, or other procedures.\nPolicies such as this create an implied contract that require\nbusinesses to follow the progressive discipline policy before\nterminating a worker\xe2\x80\x99s employment, in absence of good cause.\n\nGood Cause\nThe definition of \xe2\x80\x9cgood cause\xe2\x80\x9d for terminating the employment\nof a worker varies from state to state. And businesses often\ndefine \xe2\x80\x9cgood cause\xe2\x80\x9d in their policies. However, most states\nrecognize the following as good cause to fire an employee\nwithout going through progressive discipline first:\n\xe2\x80\xa2 Theft;\n\xe2\x80\xa2 Fraud;\n\xe2\x80\xa2 Damage to company property;\n\xe2\x80\xa2 Being under the influence of illegal drugs or alcohol at\nEmployment Law | 222\n\n\x0cwork;\n\xe2\x80\xa2 Fighting;\n\xe2\x80\xa2 Threats against other employees or customers;\n\xe2\x80\xa2 Domestic violence;\n\xe2\x80\xa2 Having weapons on premises;\n\xe2\x80\xa2 Unethical behavior; and\n\xe2\x80\xa2 Willful or malicious misbehavior.\nPoor performance also constitutes good cause for firing an\nemployee. Employers need to be careful, however, to\ndocument\n\nthe\n\nperformance\n\nissues\n\nand\n\nto\n\nengage\n\nin\n\nprogressive discipline when appropriate. If an employee has\nnot been counseled that their performance is unsatisfactory,\nthen the employee is more likely to bring a charge of wrongful\ndischarge against the employer. Courts are more likely to rule\nthat poor performance constitutes good cause when an\nemployee has notice of the performance issue(s) and has a\nreasonable opportunity to fix them.\n\nDiscrimination Against a Protected Class\nMember\nAnti-discrimination laws make it illegal to take adverse actions\nagainst a member of a protected class based on their\nmembership in the class. A protected class is a group of people\nwho are protected by laws that prohibit discrimination based\non a personal characteristic, such as race, color, religion,\ngender, national origin, age or disability.\nAs discussed in Chapter 14, adverse actions include failure to\nhire, failure to promote, demotion, and termination of\nemployment. That is not to say that someone who is a member\nof a protected class may never be fired. Rather, it is illegal to\n\n223 | Employment Law\n\n\x0cfire them because of their race, color, religion, gender, national\norigin, age or disability.\n\nViolation of Public Policy\nThe public policy exception occurs when an employee is fired\nfor:\n\xe2\x80\xa2 Refusing to perform an action that violates a law or public\npolicy; or\n\xe2\x80\xa2 For exercising a legal right or advancing a public policy.\nIn other words, an employee can\xe2\x80\x99t be fired for refusing to do\nsomething illegal or doing something legal that the employer\ndoes not want done. For example, an employee cannot be fired\nfor not falsifying reports, for refusing to testify falsely in court,\nfor filing a workers\xe2\x80\x99 compensation claim, or for serving on a jury.\n\nWhistleblowing\nA whistleblower is an employee who reports the employer\xe2\x80\x99s\nillegal behavior to a governmental or law enforcement agency.\nMany different laws have whistleblower provisions that\nencourage people who have knowledge of illegal activity to\nreport it without fear of retribution or losing their jobs.\nWhistleblower protections apply to good faith reports of\nwrongdoing, even if it turns out that the activity is not illegal.\nHowever, whistleblower protection does not usually protect\nemployees who make reports that they either know, or should\nhave known, do not include illegal activity.\n\nEmployment Law | 224\n\n\x0c13.3 Common Employment Law Torts\nEmployees may assert various tort claims against their\nemployers. Tort claims are often decided on the basis of\ngeneralized duties of care rather than specific types of conduct\nprohibited by law. Tort claims vary state to state but most states\nrecognize the following claims between employers and\nemployees:\n\xe2\x80\xa2 Negligent hiring, retention, and supervision;\n\xe2\x80\xa2 Negligent investigation;\n\xe2\x80\xa2 Negligent infliction of emotional distress;\n\xe2\x80\xa2 Intentional infliction of emotional distress (also called\noutrageous conduct);\n\xe2\x80\xa2 Tortious interference with contract and/or prospective\nbusiness advantage;\n\xe2\x80\xa2 Defamation (libel and slander);\n\xe2\x80\xa2 Invasion of privacy; and\n\xe2\x80\xa2 Fraud.\nTorts are discussed in more detail in Chapter 9. However, it is\nimportant for businesses to understand that they owe their\nemployees and managers a duty of care. If they violate that\nduty, then they may be subject to legal liability.\n\n13.4 Wage and Hour Laws\nThe Fair Labor Standards Act (FLSA) is a federal law that was\npassed in 1938 that nationalized standards for pay, record\nkeeping and child labor for businesses with two or more\nemployees that engage in interstate commerce. The FLSA\nprohibits \xe2\x80\x9coppressive child labor,\xe2\x80\x9d which means that children\n\n225 | Employment Law\n\n\x0cunder fourteen cannot work unless it is a family business,\nbabysitting, newspaper delivery, entertainment, or agriculture.\nFourteen and fifteen year olds are permitted to work limited\nhours after school in nonhazardous jobs, such as retail and\nrestaurants. Sixteen and seventeen year olds may work\nunlimited hours in nonhazardous jobs.\nFigure 13.2 FLSA Facts\n\nThe FLSA also provides for a national minimum wage and a\nstandard forty hour work week. Under the FLSA, an employee\nwho works more than forty hours is entitled to overtime pay.\nHowever, the Act provides exemptions to the overtime\nrequirement. Employees who earn more than a certain\namount and perform specific types of work are not entitled to\novertime pay.\nExempt Categories to Overtime Pay under the FLSA\n\xe2\x80\xa2\n\xe2\x80\xa2\n\xe2\x80\xa2\n\xe2\x80\xa2\n\xe2\x80\xa2\n\nExecutive\nAdministrative\nProfessional\nOutside sales\nComputer workers\n\nEmployment Law | 226\n\n\x0cFigure 13.3 Overtime under the FLSA\n\nThe Department of Labor (DOL) is charged with enforcing the\nFLSA and other federal wage and hour laws. As a general rule,\nfederal wage and hour laws do not preempt state and local\nlaws. Therefore, employers must comply with federal, state, and\nlocal laws regarding employees\xe2\x80\x99 wages. Many state and local\ngovernments have set a higher minimum wage than is\n\n227 | Employment Law\n\n\x0crequired federally. Therefore, businesses must ensure that they\ncomply with all wage and hour laws applicable to them.\n\n13.5 Family Medical Leave Act\nThe Family Medical Leave Act of 1993 (FMLA) is a federal law\nthat guarantees employees up to twelve weeks of unpaid leave\neach year for childbirth, adoption, or a serious health condition\nof their own or their immediate family member. Under the\nFMLA, a qualifying family member is a spouse, child, or parent.\nSiblings, grandchildren, and in-laws are not usually qualifying\nfamily members. The FMLA applies to businesses with at least\nfifty workers that engage in interstate commerce.\nFigure 13.4 FMLA\n\nAn employee must work for the company for at least one year\nbefore being eligible to take leave under the FMLA. The Act\nrequires that employees who take leave be allowed to return to\nthe same or equivalent job with the same pay and benefits.\nWhat constitutes a \xe2\x80\x9cserious health condition\xe2\x80\x9d is a heavily\nlitigated issue. In general, a serious health condition requires\n\nEmployment Law | 228\n\n\x0ccontinued treatment by a health provider and results in at least\nthree days of incapacitation. Sometimes this aligns with\nrecognized disabilities but it does not always. Also, a condition\nsuch as migraines may incapacitate people to varying degrees.\nTo avoid legal liability, businesses should request appropriate\ndocumentation from medical providers rather than relying on\na subjective determination of what constitutes serious health\nconditions.\n\n13.6 Occupational Safety and Health\nAct\nIn a heavily industrialized society, workplace safety is a major\nconcern. To that end, Congress passed the Occupational Safety\nand Health Act (OSHA) in 1970. The Act requires employers to\nprovide a workplace that is free from recognized hazards likely\nto cause death or serious physical harm to employees.\nEmployers must comply with specific health and safety\nstandards for their industry. For example, standards for\nrestaurants differ from standards for health care providers or\nthose for the mining industry. Employers must also keep\nrecords of all workplace injuries and accidents, and under some\ncircumstances\n\nmust\n\nautomatically\n\nreport\n\nthem\n\nto\n\nthe\n\ngovernment. Employees may also report violations.\nThe Occupational Safety and Health Administration (also\nknown as OSHA) is an agency within the Department of Labor\nthat is responsible for enforcing the Act. The Agency may\ninspect workplaces to ensure they are safe and impose fines for\nviolations of the Act. The Act also provides for criminal penalties\nwhen the violations are willful.\nFigure 13.5 Common OSHA Violations\n229 | Employment Law\n\n\x0cStates and local governments also have a variety of health and\nsafety laws and regulations. Therefore, businesses must ensure\nthat they comply with all laws applicable to them.\n\n13.7 Employee Retirement Income\nSecurity Act\nIn 1974, Congress passed the Employee Retirement Income\nSecurity Act (ERISA) to regulate employer-sponsored pension\nplans. ERISA requires employers disclose a large amount of\ninformation regarding the funding and vesting of pension\nplans. This Act was in response to fraudulent handling of\npension plans that deprived employees of savings at the time\nof their retirement.\nERISA also applies to employer-sponsored medical, disability,\nand welfare benefit programs. Although the Act does not\nrequire employers to provide these types of benefits to their\nemployees, if employers choose to do so, ERISA regulates what\ntypes of information employees are entitled to, along with their\nenforcement rights under the plans.\n\nEmployment Law | 230\n\n\x0cFigure 13.6 ERISA Areas of Regulation\n\n13.8 Workers\xe2\x80\x99 Compensation Laws\nWorkers\xe2\x80\x99 compensation laws provide payment to employees\nfor injuries incurred at work. In essence, workers\xe2\x80\x99 compensation\nis a type of no-fault insurance system that every state has. The\nintent of these laws is to provide quick and efficient delivery\nof disability and medical benefits to injured workers at a\nreasonable cost to employers.\nFigure 13.7 Workers\xe2\x80\x99 Compensation\n\n231 | Employment Law\n\n\x0cWorkers\xe2\x80\x99 compensation is the exclusive remedy for injury\nclaims. In other words, if an employee makes a workers\xe2\x80\x99\ncompensation claim, he or she may not sue the employer for\nhis or her injury. The amounts provided for medical expenses\nand lost wages are often lower than an employee may receive\nin a successful lawsuit. However, the employee benefits from\nreceiving payment upfront and does not have to risk the\nuncertain outcome of a lawsuit or pay attorney fees associated\nwith litigation.\nThere are two exceptions to the exclusive remedy doctrine:\n1. Intentional actions resulting in harm; and\n2. Product liability claims against a manufacturer of a\ndefective product.\nState law varies with respect to types of workers who are\nexcluded from coverage, as well as types and amount of\ncompensation. All states cover medical costs, rehabilitation\ncosts, and lost wages and benefits as a result of the injury.\nIn general, an employee may recover workers\xe2\x80\x99 compensation\nbenefits when:\n1. The employer has complied with the state\xe2\x80\x99s legal\nEmployment Law | 232\n\n\x0crequirements;\n2. The employee was acting in the course of his or her\nemployment when injured;\n3. The injury was proximately caused by his or her\nemployment (i.e. the injury was not caused by off work\nactivities); and\n4. The employee did not intentionally injure himself or\nherself.\nAn employer may not retaliate against an employee who files a\nworkers\xe2\x80\x99 compensation claim.\n\n13.9 Unemployment Compensation\nEvery\n\nstate\n\nprovides\n\nan\n\nunemployment\n\ncompensation\n\ninsurance program that is funded by a tax paid by employers.\nTo draw from the program, an employee must:\n\xe2\x80\xa2 Have worked for the employer for a certain amount of\ntime;\n\xe2\x80\xa2 Not have quit without good cause;\n\xe2\x80\xa2 Not have been fired for egregious behavior;\n\xe2\x80\xa2 Be capable of work; and\n\xe2\x80\xa2 Actively look for a new job.\nUnemployment compensation is meant to help workers who\nare subject to lay offs and reductions in force while they look\nfor new employment. It is generally not available to employees\nwho voluntarily leave a job and want to continue receiving\nincome from their former employer.\nStates have different formulas for calculating unemployment\ncompensation, but in general benefits are a percentage of past\nearnings and are available for a limited period of time.\n233 | Employment Law\n\n\x0c13.10 Labor Relations\nLabor law affects the working relationship of employees who\nare represented by a union in their workplace. A union is an\norganization formed to negotiate with employers, on behalf\nof workers collectively, about job-related issues such as salary,\nbenefits, hours, and working conditions. Labor law essentially\ncreates a framework for employers, employees, and unions to\ncreate a contract unique to that business for the purpose of\nregulating\n\nthe\n\nemployment\n\nrelationship\n\nand\n\nresolving\n\ndisputes.\n\nNational Labor Relations Act\nThe first unions in the United States were formed after the Civil\nWar and began to flourish during the Industrial Revolution.\nIn 1935, Congress enacted the National Labor Relations Act\n(NLRA) to provide workers three important rights:\n1. The right to organize;\n2. The right to collectively bargain; and\n3. The right to strike.\nThe NLRA also prohibits employers and unions from engaging\nin unfair labor practices. Unfair labor practices by employers\ninclude:\n\xe2\x80\xa2 Interfering with protected employee rights, such as the\nright to self-organize;\n\xe2\x80\xa2 Discriminating against employees for union-related\nactivities;\n\xe2\x80\xa2 Retaliating against employees who invoke their labor\nrights;\n\nEmployment Law | 234\n\n\x0c\xe2\x80\xa2 Refusing to engage in collective bargaining;\n\xe2\x80\xa2 Interfering with the administration of a union; and\n\xe2\x80\xa2 Discouraging employees from forming or joining a union.\nUnfair labor practices by unions include:\n\xe2\x80\xa2 Causing an employer to discriminate against an employee\nwho is not a union member;\n\xe2\x80\xa2 Engaging in an illegal strike or boycott;\n\xe2\x80\xa2 Requiring an employer to hire more employees than\nnecessary (called featherbedding);\n\xe2\x80\xa2 Coordinating a secondary boycott (an action against a\nthird party who deals with the employer but has no direct\ncontact with the union);\n\xe2\x80\xa2 Refusing to engage in collective bargaining; and\n\xe2\x80\xa2 Charging excessive dues.\nMost states also have laws that make it illegal for an employer\nto mandate union membership as a condition of employment.\nThe NLRA also states that supervisors are not employees and\ndo not have a right to join a union. Supervisors are individuals\nwith the authority to make independent decisions on hiring,\nfiring, disciplining, or promoting other employees.\nUnder the NLRA, a validly recognized union is the exclusive\nrepresentative of the employees. This means that the union\nrepresents all the employees, even if a particular worker is not\na member of the union or has not paid dues. The employer\nmay not bargain directly either with employees or with another\norganization representing the employees.\nUnions have a duty of fair representation, which requires\nunions to treat all members fairly, impartially, and in good faith.\nA union may not favor some members over others and may not\n\n235 | Employment Law\n\n\x0cdiscriminate against members based on their membership in\na protected class, such as race or gender.\n\nOrganizing a Union\nA union trying to represent employees follows these steps:\nUnion organizers try to persuade employees to\nform a union. An employer may not restrict\norganizing discussions unless they interfere\nwith business operations. An employer may\npresent anti-union views but may not use\nthreats or rewards to defeat a union drive.\n\n1.\n\nCampaign\n\n2.\n\nUnion organizers ask employees to sign\nAuthorization\nauthorization cards stating that they want the\nCards\nunion to represent them.\n\n3.\n\nPetition\n\n4. Election\n\nIf a union obtains authorization cards from 30%\nof the workforce, it may petition the NLRB for\nan election.\nIf more than 50% of the employees vote for the\nunion, the NLRB designates it as the exclusive\nrepresentative of the employees.\n\nFigure 13.8 Process of Union Organizing\n\nEmployment Law | 236\n\n\x0c237 | Employment Law\n\n\x0cCollective Bargaining\nOnce a union is formed, the employer and union must\nnegotiate to create a new employment contract that regulates\nemployment\n\nconditions\n\ncalled\n\na\n\ncollective\n\nbargaining\n\nagreement (CBA). The bargaining unit is a group of employees\nauthorized to engage in collective bargaining on behalf of all of\nthe employees of a company or an industry sector.\nThe NLRA allows the parties to bargain almost any subject\nthey wish but it requires them to bargain wages, hours, and\nother terms and conditions of employment. Conditions of\nemployment include:\n\xe2\x80\xa2 Benefits;\n\xe2\x80\xa2 Retirement benefits;\n\xe2\x80\xa2 Order of layoffs and recalls;\n\xe2\x80\xa2 Production quotas;\n\xe2\x80\xa2 Work rules, such as safety practices; and\n\xe2\x80\xa2 Onsite food service and prices.\nThe parties are not required to reach an agreement but they\nare required to bargain in good faith. In other words, they must\nmeet with open minds and make a reasonable effort to reach a\ncontract.\n\nConcerted Activity\nConcerted activity is an action by employees concerning\nwages or working conditions. It is action taken by members\nof a union to gain a bargaining advantage. Concerted activity\nis protected by the NLRA and cannot be used as a basis for\ndisciplining or discharging an employee.\n\nEmployment Law | 238\n\n\x0cThe most common forms of concerted activity are strikes and\npicketing. A strike is an organized cessation or slowdown of\nwork by employees to compel the employer to meet the\nemployees\xe2\x80\x99 demands. The NLRA protects the employees\xe2\x80\x99 right\nto strike when:\n\xe2\x80\xa2 The parties are unable to reach a CBA;\n\xe2\x80\xa2 The employer engages in an unfair labor practice; or\n\xe2\x80\xa2 The employer is considering sending work elsewhere.\nHowever, a strike is illegal when:\n\xe2\x80\xa2 The union does not provide the employer with sixty days\nnotice (when issue is modifying or terminating a CBA);\n\xe2\x80\xa2 The union represents public employees;\n\xe2\x80\xa2 The union engages in a sit-down strike, in which\nemployees stop working but physically block replacement\nworkers from taking their places; and\n\xe2\x80\xa2 The union engages in partial strikes, in which employees\nstrike intermittently to disrupt operations but prevent the\nemployer from hiring replacement workers.\nWhen unions go on strike, employers have the right to hire\nreplacement workers to keep the business operating. If the\nunion engages in an economic strike to obtain increased\nwages and benefits, the employer may hire permanent\nreplacement workers. When an economic strike ends, the\nemployer is under no obligation to lay off replacement workers\nto allow strikers to return to work. However, if and when the\nemployer hires additional employees, it may not discriminate\nagainst the employees who went on strike. If the union\nengages in an unfair labor practices strike to protest an\nemployer\xe2\x80\x99s unfair labor practice, union members are entitled to\ntheir jobs after the strike ends.\nPicketing is the demonstration by one or more employees\n239 | Employment Law\n\n\x0coutside a business to protest its activities or policies and to\npressure it to meet the protesters\xe2\x80\x99 demands. The power of\npicketing is to publicize a labor dispute and influence the\npublic to withhold business from the employer. Picketing is\nusually lawful, as long as the picketers do not prevent other\nemployees, replacement workers, or customers from entering\nthe business.\nEmployers have their own form of legal pressure on union\nmembers called a lockout. A lockout occurs when an employer\ncloses a business or prevents workers from entering the\npremises and earning their paychecks because of a labor\ndispute. By withholding work and wages, the employer tries to\npressure the union to bargain less aggressively. Most lockouts\nare legal.\n\nGrievance Procedure\nOne of the main benefits to union members is that they are\nable to participate in a grievance procedure when issues at\nwork exist. A grievance is a formal employee complaint about\na violation of a workplace policy or the collective bargaining\nagreement between the union and employer.\nFigure 13.9 Grievance Procedure\n\nEmployment Law | 240\n\n\x0cThe grievance procedure defines the rules and process for\ndocumenting, presenting, and resolving workplace disputes.\nThe exact steps are usually defined in the collective bargaining\nagreement. However, most grievance procedures start with a\ndiscussion between the employee and his or her manager,\noften with a union representative present. Issues often are\nresolved informally at this step.\nIf the issue is not resolved, then the employee may write a\nformal grievance, which is then sent to management. After\nreceiving a written grievance, management of the company\ninvestigates and discusses how to address the issues contained\nin the grievance. This process often involves the human\nresource department, union representatives, and consultation\nwith legal counsel.\nManagement will then issue a written decision. If the union is\nnot satisfied with the company\xe2\x80\x99s response, it may decide to\n241 | Employment Law\n\n\x0crefer the grievance to the national union. If the national union\ndecides to pursue the issue further, then arbitration before the\nNLRB or a private arbitrator often occurs.\n\n13.11 Concluding Thoughts\nEmployment and labor laws regulate the employer-employee\nrelationship. Although most laws are written to provide rights\nto employees, the laws try to balance the need of employers\nto run a profitable business with the right of employees to\nfair treatment. While the law does not always strike the right\nbalance, it is helpful to understand that employers retain a\nlot of control in their day-to-day business operations and in\nestablishing the business culture.\n\nEmployment Law | 242\n\n\x0c14. Anti-Discrimination\nLaw\n14.1 Introduction\nLEARNING OBJECTIVES\n1. Understand the primary federal anti-discrimination laws.\n2. Learn the procedure for bringing and defending against\ndiscrimination complaints.\n3. Explore how businesses can protect themselves from\ndiscrimination claims.\nThe Civil Rights Movement of the 1960s resulted in several\nimportant federal laws that addressed discrimination. The first\nwas the Equal Pay Act of 1963, which requires equal pay for\nequal work, regardless of the worker\xe2\x80\x99s gender. Title VII of the\nCivil Rights Act of 1964 is probably the most well-known of\nthe civil rights legislation. Title VII prohibits employment\ndiscrimination on the basis of race, color, religion, gender and\nnational origin. Since the 1960s, more laws have been passed\nto refine what constitutes discriminatory practices and expand\ncoverage to additional groups, such as people with disabilities.\nFigure 14.1 Participants in the 1963 March on Washington\n\n243 | Anti-Discrimination Law\n\n\x0cIt is important for businesses to know and comply with these\nlaws so they are not liable for discriminating against their\nemployees, customers, and members of the public. State and\nlocal governments may pass laws that expand or provide\nprotections to additional groups but they cannot reduce\nprotections found in federal law.\n\nAnti-Discrimination Law | 244\n\n\x0cType of\nDiscrimination\n\nFederal Anti-Discrimination Laws\n\nRace\n\nTitle VII of the Civil Rights Act of 1964\n\nColor\n\nTitle VII of the Civil Rights Act of 1964\n\nReligion\n\nTitle VII of the Civil Rights Act of 1964\n\nNational Origin\n\nTitle VII of the Civil Rights Act of 1964;\nImmigration Reform and Control Act of 1986\nEqual Pay Act of 1963;\n\nGender\n\nTitle VII of the Civil Rights Act of 1964;\nPregnancy Discrimination Act of 1978\n\nAge\n\nAge Discrimination in Employment Act of 1967\nAmericans with Disabilities Act of 1990;\n\nDisability\n\nGenetic\nInformation\n\nAmericans with Disabilities Amendments Act of\n2008\nGenetic Information Nondiscrimination Act of\n2008\n\nCounselor\xe2\x80\x99s Corner We live in a multicultural society\nand our anti-discrimination laws are intended to\naddress inequality in employment. While not\nperfect, they have addressed the some of the most\nblatant discriminatory practices. However, all\nemployers (even those who see themselves as\nhaving \xe2\x80\x9cgood intentions\xe2\x80\x9d) need to review their\npractices to ensure that they are not perpetuating\nsystemic discrimination against protected classes of\npeople. Although this may seem like a backburner\nissue to some employers, it will help protect them\nfrom legal liability (which is costly) and send a\npositive message to their employees about how\n\n245 | Anti-Discrimination Law\n\n\x0cthey value them (which is invaluable). ~ LaTeesha S.,\nattorney\n\n14.2 The Equal Pay Act of 1963\nThe Equal Pay Act of 1963 seeks to eliminate the wage gap\nbetween men and women. In 1963, women earned roughly\nfifty-nine cents for every dollar men earned. In 2019, that\nnumber increased to seventy-nine cents. The Equal Pay Act\nrequires employers to provide equal pay for equal work, and it\napplies to all employers. All forms of compensation are covered\nby\n\nthe\n\nAct,\n\nincluding\n\nbenefits\n\nsuch\n\nas\n\nvacation\n\nand\n\nby\n\nGender\n\nand\n\ncompensation such as salary and bonuses.\nFigure\n\n14.2\n\nMedian\n\nWeekly\n\nEarnings\n\nEducational Level from US Department of Labor\n\nAnti-Discrimination Law | 246\n\n\x0cVictims do not need to file a complaint with the Equal\nEmployment Opportunity Commission (EEOC) but may file an\nequal pay claim in federal court, as long as they do so within\ntwo years after learning of the inequality in pay or benefits.\nVictims typically also pursue Title VII claims at the same time\nthey pursue Equal Pay Act claims.\nThe Equal Pay Act is difficult to enforce. Since demanding\nidentical pay is virtually impossible due to differences in jobs\nand job performance, courts have essentially interpreted the\nlaw as requiring equal pay for substantially equal work. A\ncommon problem occurs when women voluntarily leave the\nworkforce to raise children. This can result in a challenging\ncomparison between a woman\xe2\x80\x99s experience for pay purposes\nand her male counterparts, who may not have an interruption\nin their careers.\n247 | Anti-Discrimination Law\n\n\x0cFigure 14.3 Participation Rates for Women Professionals from\nEqual Employment Opportunity Commission\n\n14.3 Title VII of the Civil Rights Act of\n1964\nThe Civil Rights Act of 1964 has broad significance for all racial\nminorities, religious organizations, and women. The bill has\nseveral provisions, but the most important for businesses is\nknown widely as \xe2\x80\x9cTitle VII.\xe2\x80\x9d It applies to employers with more\nthan fifteen employees. Its aim is to eliminate discrimination\non the basis of:\n\xe2\x80\xa2 Race;\n\xe2\x80\xa2 Color;\n\xe2\x80\xa2 Religion;\n\xe2\x80\xa2 Gender; and\n\xe2\x80\xa2 National origin.\n\nAnti-Discrimination Law | 248\n\n\x0cDiscrimination on any of these bases is illegal. These acts may\nbe a refusal to hire, a failure to fully compensate, a failure for\nopportunities for advancement, a demotion, a temporary\nlayoff, a termination of employment, or any other term or\ncondition of employment.\nFigure 14.4 Employment Discrimination Claims Made to the\nEqual Employment Opportunity Commission\n\nRace and Color\nRace discrimination involves treating someone unfavorably\nbecause he or she is of a certain race or because of personal\ncharacteristics associated with race, such as hair texture, skin\ncolor, or certain facial features. Color discrimination involves\ntreating someone unfavorably because of skin color or\ncomplexion.\nRace and color discrimination also can involve treating\nsomeone unfavorably because the person is married to, or\nassociated with, a person of a certain race or color. Race and\ncolor discrimination can occur within the same racial group.\n\n249 | Anti-Discrimination Law\n\n\x0cFigure\n\n14.5\n\nProfessionals\n\nParticipation\nfrom\n\nRates\n\nEqual\n\nfor\n\nAfrican\n\nEmployment\n\nAmericans\nOpportunity\n\nCommission\n\nReligion\nThe prohibition against religious discrimination protects\nanyone who has sincerely held religious or moral beliefs.\nTherefore, Native American tribes are protected, as well as\nmajor religions such as Buddhism, Christianity, Hinduism,\nIslam, and Judaism. In general, employees cannot be required\nto participate in religious activities as a condition of\nemployment, unless the place of employment is a church,\nsynagogue, mosque, or temple.\nEmployers must reasonably accommodate an employee\xe2\x80\x99s\nreligious beliefs or practices as long as it does not cause an\nundue hardship on the employer\xe2\x80\x99s operation of its business.\nTypically, this involves being flexible in schedule changes and\nleaves for sabbath observance or religious holidays. Issues of\ndress and appearance are often grounds for charges of\nAnti-Discrimination Law | 250\n\n\x0creligious discrimination. For example, if a Muslim woman wears\na hijab, or traditional headscarf, then she should be permitted\nto do so unless it places an undue hardship on business\noperations.\n\nGender\nThe\n\nprohibition\n\non\n\ngender\n\ndiscrimination\n\nmeans\n\nthat\n\nemployers cannot categorize certain jobs as single-sex only\nunless a bona fide occupational qualification (BFOQ) applies.\nCustomer preferences or market realities are not the basis for\nBFOQ. However, an example of a legitimate BFOQ is hiring\nfemale security officers to monitor women\xe2\x80\x99s changing areas for\nloss prevention in retail stores.\nGender discrimination also includes making stereotypical\nassumptions about women simply because they might be the\nprimary caregiver to children at home. If there are two equally\nqualified job applicants, for example, and both have young\nchildren at home, it would be illegal to give preference to the\nmale candidate over the female candidate. Once a female\nemployee has children, it would be illegal to assume that she is\nless 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.\nIf an employer voluntarily provides time off to new mothers, for\nexample, it must extend identical benefits to new fathers.\nFigure 14.6 Pew Research Center Results Regarding Gender\nDiscrimination at Work\n\n251 | Anti-Discrimination Law\n\n\x0cIn 2019, unmarried childless women earned 95 percent of what\nmen did, while married mothers earned 75 percent (averaging\nto 79 percent as discussed above). This discrepancy has led\nto an increase in family responsibility discrimination claims\nunder Title VII. This includes claims that mothers are given less-\n\nAnti-Discrimination Law | 252\n\n\x0cappealing assignments than fathers based on misconceptions\nabout being less qualified or lacking commitment to the job.\nThe Pregnancy Discrimination Act of 1978 amended Title VII\nto make it illegal to discriminate on the basis of pregnancy,\nchildbirth, or related medical conditions. This means employers\ncannot refuse to hire a woman because she is pregnant or is\nconsidering becoming pregnant, or because of prejudices held\nby coworkers or customers about pregnant women. A female\nworker who becomes pregnant is entitled to work as long as\nshe can perform her tasks, and her job must be held open for\nher while she is on maternity leave. Furthermore, pregnancyrelated benefits cannot be limited only to married employees.\nGender discrimination can also take the form of workplace\nsexual harassment. Courts have generally recognized two\nforms of sexual harassment. The first, known as quid pro quo,\ninvolves asking for sexual favors in return for job opportunities\nor advancement. Courts reason that if a male worker asks a\nfemale worker for sex in return for favorable treatment, it is\nbecause that worker is female, and therefore a Title VII violation\nhas occurred. If a supervisor fires a subordinate for breaking up\nwith him or her, then quid pro quo harassment has taken place.\nThe second is hostile work environment, which is discussed in\nmore detail below.\n\nNational Origin\nDiscrimination on the basis of national origin involves treating\nworkers unfavorably because of where they are from (specific\nnation or region) or ethnicity. It is illegal to discriminate against\na worker because of his or her foreign accent unless it seriously\ninterferes with work performance. Workplace \xe2\x80\x9cEnglish-only\xe2\x80\x9d\n\n253 | Anti-Discrimination Law\n\n\x0crules are also illegal unless they are required for the job being\nperformed.\nThe protected class of national origin means that it is illegal to\ndiscriminate against noncitizens. Therefore, employers should\nnot ask job applicants about their nation of origin. Instead,\nthey are permitted to ask whether the applicant is authorized\nto work in the US. If they applicant answers \xe2\x80\x9cyes,\xe2\x80\x9d then the\nemployer cannot ask for evidence of authorization until the\napplicant is hired and completes the Employment Eligibility\nVerification (I-9) Form.\nTitle\n\nVII\n\ncreates\n\nonly\n\nfive\n\nprotected\n\nclasses.\n\nOther\n\ncharacteristics, such as obesity, attractiveness, and political\naffiliation, are not protected classes. Note too that Title VII does\nnot prohibit all discrimination. Employers are free to consider\nfactors such as experience, business acumen, personality, and\neven seniority, as long as those factors are related to the job\nin question. Title VII requires employers to treat employees\nequally, but not identically.\n\nProhibited Activities\nThere are four types of illegal activities under Title VII:\n1. Disparate Treatment;\n2. Disparate Impact;\n3. Hostile Work Environment; and\n4. Retaliation.\nTo prove a disparate treatment case, a plaintiff must show that\nhe or she was treated differently because of his or her race,\ncolor, religion, gender or national origin. In other words,\ndisparate treatment is intentional discrimination. Winning a\ndisparate treatment case is hard because it is unusual for a\nAnti-Discrimination Law | 254\n\n\x0cdefendant to say explicitly that his or her intention is\ndiscriminatory. Evidence of discriminatory intent is often\ninferred through someone\xe2\x80\x99s conduct. For example, a hiring\nmanager refuses to hire women because he does not want\nto deal with maternity leave requests would be evidence of\ndisparate treatment.\nDisparate impact, on the other hand, applies when a rule or\npolicy is not discriminatory on its face but negatively impacts\na protected group when it is applied. In other words, disparate\nimpact is unintentional discrimination. Business policies that\nraise suspicions of disparate impact include educational\nqualifications, written tests, intelligence or aptitude tests,\nheight and weight requirements, credit checks, and subjective\nprocedures such as interviews. Businesses that have these\nsorts of policies need to be very careful that the policies are\ndirectly related to, and necessary for, the job function under\nconsideration.\nFigure 14.7 Disparate Impact Cartoon\n\n255 | Anti-Discrimination Law\n\n\x0cProving a disparate impact case is not easy for victims of\ndiscrimination. It is not enough for the employee to use\nstatistics alone to show a policy or practice has a disparate\nimpact on the victim\xe2\x80\x99s protected class. Victims must show that\nthey were harmed from the discriminatory practice.\nEmployers also violate Title VII if they have a hostile work\nenvironment towards people in a protected category that\naffects their ability to work. These cases often involve\nallegations where a company or employees try to get a\nmember of a protected group to quit through name calling,\nundesirable work assignments, slurs, and threats. Employers\nare liable for hostile work environment claims if the victim\nsuffered a \xe2\x80\x9ctangible employment action\xe2\x80\x9d such as a demotion,\nundesirable reassignment, or termination of employment.\nEven if the victim did not suffer a tangible employment action,\nan employer may be liable unless it can prove (1) it used\nreasonable care to prevent and correct the inappropriate\nbehavior, and (2) the victim unreasonably failed to take\nadvantage of the company\xe2\x80\x99s complaint procedures.\nHostile work environment claims often involve allegations of\nconstructive discharge. Constructive discharge occurs when\nan employer makes the employee\xe2\x80\x99s working conditions so\nintolerable that a reasonable employee would feel compelled\nto\n\nquit.\n\nConstructive\n\ndischarge\n\nclaims\n\nrecognize\n\nthat\n\nemployees should not be forced to stay in situations that risk\ntheir physical, mental, and emotional safety.\nTitle VII also prohibits acts of retaliation against anyone who\ncomplains\n\nabout,\n\nor\n\nparticipates\n\nin,\n\nany\n\nemployment\n\ndiscrimination complaint. Employers need to be very careful\nabout this provision, because while the employer may be\ninnocent of the first charge of discrimination, taking any\nsubsequent action after an employee has complained can be\na separate charge of discrimination. Once an employee has\n\nAnti-Discrimination Law | 256\n\n\x0cmade a complaint of discrimination, it is very important that\nthe employer not alter any condition of his or her employment\nuntil the complaint has been resolved. Similarly, if a witness\ntakes part in an investigation or hearing of another employee\xe2\x80\x99s\ncomplaint, the witness could also bring charges of retaliation.\n\nBona Fide Occupational Qualification\nThe law does, however, allow discrimination on the basis of\nreligion,\n\ngender,\n\nand\n\nnational\n\norigin\n\nif\n\na bona\n\nfide\n\noccupational qualification (BFOQ) reasonably necessary for\nnormal business operations exists. For example, a Jewish\nsynagogue may restrict hiring of rabbis to Jewish people only,\nand a Catholic church can restrict hiring priests to Catholic\nmen only. Since BFOQ discrimination extends to national\norigin, a producer casting for a role that specifically calls for a\nFilipino actor can legally restrict hiring to Filipinos only.\nManagers\n\nshould\n\nbe\n\nvery\n\ncareful\n\nin\n\napplying\n\nBFOQ\n\ndiscrimination. It is an exception that is very much based on\nindividual cases and subject to strict interpretation. The BFOQ\nmust be directly related to an essential job function to be \xe2\x80\x9cbona\nfide.\xe2\x80\x9d Customer preference is not a basis for BFOQ. For\nexample, airlines cannot refuse to hire men even if surveys\nshow customers prefer female flight attendants.\n\n257 | Anti-Discrimination Law\n\n\x0c14.4 Enforcement of Title VII\nEqual Employment Opportunity\nCommission\nThe Civil Rights Act of 1964 is a federal law, but it does not give\nvictims of discrimination the immediate right to file a federal\nlawsuit. Instead, the Act created a federal agency, the Equal\nEmployment Opportunity Commission (EEOC) to enforce civil\nrights in the workplace. The EEOC publishes guidelines to\nassist businesses in deciding what employment practices are\nlawful. The EEOC also investigates complaints filed by workers\nwho believe they are victims of unlawful discrimination. If the\nEEOC believes that unlawful discrimination has taken place,\nthe EEOC can file charges against the employer.\nEmployees must file a Title VII charge with the EEOC before\ngoing to court. If the EEOC investigates and decides not to\npursue the case any further, the EEOC will issue a \xe2\x80\x9cright to\nsue\xe2\x80\x9d letter. With that letter, the employee can then file a case\nin federal court within 90 days of the date of the letter. Any\nEEOC complaint must be filed within 180 days of the alleged\ndiscriminatory act taking place. If employees wait beyond 180\ndays, their claims will be dismissed.\nIn 2009, the Lilly Ledbetter Fair Pay Act clarified that\ndiscriminatory pay decisions occur every time unequal\ncompensation is paid and the statute of limitations begins\nagain on the date of each unequal paycheck. Therefore,\nplaintiffs have 180 days from the time they receive a\ndiscriminatory paycheck to file a complaint with the EEOC.\nThe EEOC has the authority to award several remedies to\nvictims of discrimination. These include the award of back pay\n\nAnti-Discrimination Law | 258\n\n\x0cfor any lost wages, the issuance of an injunction to stop the\nemployer\n\nfrom\n\ncontinuing\n\nany\n\nacts\n\nor\n\npolicies\n\nof\n\ndiscrimination, ordering a terminated or demoted employee\nreinstated to his or her prior position, and the award of\ncompensatory damages for out-of-pocket costs resulting from\nthe discrimination as well as emotional harm. In cases of severe\nor reckless discrimination, punitive damages are also available.\n\nEEOC Procedure\nAfter receiving the charge, the EEOC will investigate the\nallegations. If there is sufficient proof of discrimination, the\nEEOC may (1) help the parties reach a settlement; (2) impose\nsanctions; or (3) prosecute the case in federal court. The EEOC\xe2\x80\x99s\ninvestigative and enforcement powers are broad.\nWhen filing a complaint, the plaintiff must show a prima facie\ncase of discrimination. This means that \xe2\x80\x9con first look,\xe2\x80\x9d the\nplaintiff has evidence that the defendant discriminated against\nhim or her based on membership in a protected class. The\nplaintiff is not required to prove discrimination at this stage.\nInstead, the plaintiff must show only a presumption that\ndiscrimination occurred.\nThe defendant then files a response and may present evidence\nthat its decision was based on a legitimate, non-discriminatory\nreason or business necessity. For example, an employee was\nfired for poor performance rather than membership in a\nprotected class.\nAfter the defendant presents its case, the plaintiff must show\nthat the defendant\xe2\x80\x99s reason is pretext. In other words, the\nreason the defendant gave was a \xe2\x80\x9ccover\xe2\x80\x9d for discrimination.\nIn disparate impact cases, the plaintiff may show that less\ndiscriminatory rules would achieve the same result.\n259 | Anti-Discrimination Law\n\n\x0cThe case is investigated and decided by the EEOC hearing\nofficer. The officer will issue either a finding on the charge or a\nnotice of the right to sue, after which an employee has 180 days\nto file a discrimination complaint in federal court.\nFigure 14.8 Burden of Proof in Equal Employment Opportunity\nCommission Charges\n\nAffirmative Action\nTo correct past mistakes in treatment of women and minorities,\nmany\n\nbusinesses\n\nemployers\n\nby\n\ngo\n\nbeyond\n\nadopting\n\nbeing\n\naffirmative\n\nequal\naction\n\nopportunity\nprograms.\n\nBusinesses are not legally required to undertake affirmative\naction programs, but many do. Businesses may voluntarily\nundertake affirmative action programs, as long as those\nprograms are meant to correct an imbalance in the workforce,\n\nAnti-Discrimination Law | 260\n\n\x0care temporary, and do not unnecessarily infringe on the rights\nof non-beneficiaries.\nAffirmative action plans can be tricky to administer because\nCaucasian Americans can also be the victims of race\ndiscrimination, which is often called reverse discrimination.\nThe provisions of Title VII are meant to protect all individuals\nfrom race discrimination.\nThe EEOC will take into consideration if a defendant\xe2\x80\x99s actions\nare part of an affirmative action program. However, businesses\nmay still be liable for discrimination even if they adopt an\naffirmative action program. Therefore, businesses should be\ncareful that they are not adopting a program that results in\ndisparate impact claims from other protected groups.\n\n14.5 The Age Discrimination in\nEmployment Act of 1967\nThe Age Discrimination in Employment Act of 1967 (ADEA)\nmakes it illegal to discriminate against workers over the age\nof forty. It does not protect younger workers so an employer\nmay favor an older worker over a younger worker. The ADEA\napplies to any employer with over twenty workers, including\nstate governments. The ADEA prohibits employers from\ntreating any covered person unfavorably in any term or\ncondition of employment, including the hiring decision. It is\nillegal, for example, to hire an inexperienced twenty-five-yearold for a job when a fifty-year-old is better qualified and willing\nto work under the same conditions. Mandatory retirement age\nis illegal under the ADEA, except for very high-level executives\nover the age of sixty-five who are entitled to a pension.\nEmployers may discriminate against older workers if there is\n261 | Anti-Discrimination Law\n\n\x0ca bona fide occupational qualification such as a production\ncompany casting for a young actor to play a young character,\nor airlines setting a mandatory retirement age for pilots.\nOf course, older workers can still be dismissed for good cause,\nsuch as poor job performance or employee misconduct.\nCompanies may also administer a layoff plan or early\nretirement plan that is evenly applied across all workers, and\ncan offer early retirement incentives to induce workers to retire.\nIn 2005, the Supreme Court held that the disparate impact\ntheory can apply to age discrimination cases. For example, an\nemployer\n\ncannot\n\nrequire\n\noffice\n\nworkers\n\nto\n\nundertake\n\nstrenuous physical tests if those tests are not related to the job\nbeing performed and would have a disparate impact on older\nworkers.\n\n14.6 The Americans with Disabilities\nAct of 1990\nThe Americans with Disabilities Act of 1990 (ADA) and the\nAmericans with Disabilities Amendments Act of 2008 (ADAA)\nexpand the promise of equal opportunity in the workplace to\ncover persons with disabilities. It is illegal for employers with\nfifteen or more employees to discriminate against \xe2\x80\x9cqualified\nindividuals with disabilities.\xe2\x80\x9d\nThe ADA only applies to the qualified disabled. To be qualified,\nthe individual must meet the legitimate skill, experience,\neducation, or other requirements for the position he or she is\nseeking and be able to perform the \xe2\x80\x9cessential functions\xe2\x80\x9d of the\njob without reasonable accommodation. In other words, the\nfirst step an employer must take is to define what the essential\nfunctions of the job are, and then see if a disabled individual\nAnti-Discrimination Law | 262\n\n\x0cwho has applied for the job meets the requirements for the job\nand can perform those essential functions. Obviously, someone\nwho is legally blind will not be permitted to be a bus driver or\nairline pilot under this test.\nOn the other hand, the \xe2\x80\x9cessential functions\xe2\x80\x9d test means that\nemployers must be very careful in denying employment to\nsomeone\n\nwho\n\nis\n\ndisabled.\n\nIf\n\nthe\n\nreason\n\nfor\n\ndenying\n\nemployment is the disabled person\xe2\x80\x99s inability to perform some\nincidental task (rather than an essential function), then that\nis illegal discrimination. The ADA also permits employers to\nexclude any disabled individual who poses a direct threat to\nthe health or safety to the individual or of others, if the risk of\nsubstantial harm cannot be reduced below the level of \xe2\x80\x9cdirect\nthreat\xe2\x80\x9d through reasonable accommodation.\nThe ADA makes it illegal for an employer to require a job\napplicant take a medical exam before an employment offer is\nmade. However, after a job offer has been made, applicants can\nbe asked to take medical and drug exams. Tests for illegal use\nof drugs, any time during employment, are permitted under\nthe ADA.\nOne of the hardest challenges is defining who is disabled. The\nADA states that an individual is disabled if he or she has a\n\xe2\x80\x9cphysical or mental impairment that substantially limits one or\nmore major life activities,\xe2\x80\x9d has a record of such impairment, or\nis regarded as having such an impairment. Major life activities\ninclude seeing, hearing, speaking, walking, running, breathing,\nlearning, and caring for oneself.\nConsider a person being actively treated for cancer. During\nthe treatment, many major life activities may be substantially\nlimited, so the person is disabled. However, if a major life\nactivity is not limited but the person loses his or her hair as a\nresult of chemotherapy, he or she may be \xe2\x80\x9cregarded\xe2\x80\x9d as having\nan impairment, which makes him or her disabled under the\n263 | Anti-Discrimination Law\n\n\x0cADA. An employer who purposefully refuses to hire a qualified\njob applicant with no hair because the employer believes the\napplicant has cancer (regardless of whether the cancer is active\nor in remission) is therefore violating the ADA. Finally, if the\ncancer patient recovers fully and has no physical sign of cancer,\nthat patient is still considered protected by the ADA because\nhe has a \xe2\x80\x9crecord\xe2\x80\x9d of a qualifying disability.\nEmployers must provide reasonable accommodations to any\ndisabled worker who asks for it. A reasonable accommodation\nis any change or adjustment to the work environment that\nwould allow the disabled worker to perform the essential\nfunctions of the job or to allow the disabled worker to enjoy\nthe benefits and privileges of employment equal to employees\nwithout\n\ndisabilities.\n\nReasonable\n\naccommodation\n\nmight\n\ninclude allowing the worker to work part-time; reassigning the\nworker to a vacant position; purchasing special equipment or\nsoftware; providing e-readers; or making an exception to an\nemployment policy. Employers do not have to undertake\nreasonable accommodation if doing so would cause them\nundue hardship, meaning it would require significant difficulty\nor expense, or significantly alter the nature or operation of\nthe business. Among factors to be considered in whether an\naccommodation would pose an undue hardship are the cost\nof the accommodation as well as the employer\xe2\x80\x99s size and\nfinancial resources.\n\nAnti-Discrimination Law | 264\n\n\x0cFigure 14.9 Americans with Disability Act Decision Tree\n\n14.7 Genetic Information\nNondiscrimination Act of 2008\nIn\n\n2008,\n\nCongress\n\npassed\n\n265 | Anti-Discrimination Law\n\nthe\n\nGenetic\n\nInformation\n\n\x0cNondiscrimination Act (GINA) to protect individuals from\nadverse decisions based on their genetics. Under GINA,\nemployers may not require genetic testing, or use information\nabout genetics (including family medical history) as a factor in\nhiring, promoting, demoting, or firing employees. This includes\nif an employee is a caretaker for someone with a genetic\ndisorder. Health insurers cannot use genetic information when\nmaking coverage and premium decisions. Finally, an employer\nwellness program cannot require participants to answer\nquestions about their family medical history.\n\n14.8 Concluding Thoughts\nAnti-discrimination laws are important for businesses to\nunderstand and follow. State and local laws may expand\nprotections and identify more protected classes. Therefore, it\nis important for businesses to research all levels of antidiscrimination laws that apply to them to ensure they are not\nliable for discrimination against their employees, customers,\nand members of the public.\nThe 1964 Civil Rights Act is an important law that affects most\nemployers in the United States. Originally created to ensure the\nintegration of African Americans into mainstream society, the\nlaw prohibits discrimination on the basis of race, color, religion,\ngender, and national origin. Some forms of discrimination on\nthe basis of religion, gender, or national origin are permitted\nif a bona fide occupational qualification exists. The Equal\nEmployment Opportunity Commission (EEOC) investigates\ncharges of illegal workplace discrimination. These charges\nmust be filed by workers within 180 days of the alleged\ndiscriminatory act occuring.\nThe EEOC\xe2\x80\x99s investigation and enforcement powers are broad.\nAnti-Discrimination Law | 266\n\n\x0cBoth parties have an opportunity to present evidence and\nargue their case to the EEOC. Filing a charge with the EEOC is\nrequired before filing a lawsuit alleging violations of Title VII in\nfederal court.\nThe Americans with Disabilities Act prohibits employment\ndiscrimination against the qualified disabled and prohibits preemployment medical testing. To be considered disabled, an\nindividual must demonstrate a mental or physical impairment\nthat substantially limits a major life activity. Disabled persons\nare entitled to reasonable accommodation in the workplace, as\nlong as reasonable accommodation does not place any undue\nhardship on the employer.\n\n267 | Anti-Discrimination Law\n\n\x0c15. Agency\n15.1 Introduction\nLEARNING OBJECTIVES\n1. Know the basic principles of an agency relationship.\n2. Identify the different duties principals and agents owe\neach other.\n3. Understand the consequences of legal liability for\nprincipals regarding an agent\xe2\x80\x99s actions.\nFundamentally, the principles of agency hold individuals and\nbusinesses liable for the acts of others. For example, if an\nemployee uses a racial slur against a customer, the business\nis liable for that employee\xe2\x80\x99s discriminatory act. Likewise, if an\nagent signs a contract in the name of a business, that business\nmay be bound by the terms of the contract.\nAgents cannot give themselves power without the express or\nimplied authority of the principal. Once an agency relationship\nis formed, agents and principals owe each other certain duties.\nThis ensures fair dealings between them and gives third parties\nsome assurance regarding their rights.\n\nCounselor\xe2\x80\x99s Corner Agency is not a sexy area of the\nlaw. Most people don\xe2\x80\x99t give much thought about it.\nBut I often see cases in my courtroom where people\nand businesses are liable for the acts of their agents.\n\nAgency | 268\n\n\x0cIt doesn\xe2\x80\x99t matter if you didn\xe2\x80\x99t know the person was\nlegally your agent. You are still responsible for their\nactions under the law. While there is no way to\nprevent all mistakes and bad behavior of others, the\nbest way you can insulate yourself from liability of\nan agent is to surround yourself with people who\nhave integrity. If your grandmother wouldn\xe2\x80\x99t\napprove of them, then you shouldn\xe2\x80\x99t work with\nthem. ~Christopher W., judge\n\n15.2 The Agency Relationship\nAn agency relationship is created when one person or entity\nagrees to perform a task for, and under the direction of,\nanother individual or entity. An agent is the person who is\nauthorized to act for or in place of another. A principal is the\nperson who authorizes another to act on his, her, or its behalf\nas an agent.\nAgency is a fiduciary relationship created by express contract\nor implied actions, in which the agent has the authority to act\non behalf of the principal and legally bind the principal to third\nparties.\nA fiduciary relationship is a relationship in which one person\nis under a duty to act for the benefit of the other on matters\nwithin the scope of the relationship. Fiduciary relationships\nrequire trust, good faith, and acting in the best interest of the\nother. In fiduciary relationships, the law requires the fiduciary\nto act with the highest duty of care. This means that the\nfiduciary must put the interests of the other party before their\n269 | Agency\n\n\x0cown. Examples of fiduciary relationships include doctorpatient, attorney-client, accountant-client, trustee-beneficiary,\nand guardian-child. An agent is also a fiduciary of a principal.\n\nTypes of Principals\nThere are three types of principals, which are described from\nthe perspective of a third party: disclosed, partially disclosed,\nand undisclosed.\nA disclosed principal is a principal whose identity is revealed\nby the agent to a third party. These are the most common\ntypes of principals. For example, employees work for a\ndisclosed principal when they are on the employer\xe2\x80\x99s premise,\nwear a name badge or uniform identifying the employer, or\nanswer the phone by identifying the employer\xe2\x80\x99s name.\nA partially disclosed principal is a principal whose existence,\nbut not actual identity, is revealed by the agent to a third party.\nIn other words, a third party knows that the agent represents\na principal but does not know the identity of the principal.\nFor example, a realtor in Aspen may represent celebrities and\nwealthy individuals who want to purchase property but do not\nwant the paparazzi to publicize the information.\nAn undisclosed principal is a principal whose identity is kept\nsecret by the agent. Often third parties do not realize that an\nagency relationship exists and believe that the agent is\nworking on his or her own behalf. Undisclosed principals occur\nwhen the identity of the principal can lead to increased\npurchase prices, unwanted publicity, and security concerns.\n\nAgency | 270\n\n\x0cTypes of Agents\nAn agent is someone who is authorized to act on behalf of a\nprincipal. Because there is a variety of authority that a principal\ncan grant an agent, there are many different types of agents.\nIn general, agents are described as either general or\nspecial. General agents have the authority to transact all the\nprincipal\xe2\x80\x99s business of a particular kind or in a particular place.\nGeneral agents often include partners, managers, factors and\nbrokers. Special agents, in contrast, only have the authority\nto conduct a particular transaction or to perform a specific\nact. Special agents often include realtors, athlete\xe2\x80\x99s agents, and\nemployment recruiters.\nSome of the most common business agents include:\nAgent\n\nDescription\n\nBroker\n\nReceives a commission to make contracts with third\nparties on behalf of a principal\n\nBusiness\nagent\n\nHas general power involving the exercise of\njudgment and discretion, such as a manager or\nofficer\n\nFactor\n\nReceives and sells goods or property for a\ncommission\n\nForwarding\nagent\n\nReceives and ships goods for a principal\n\nIndependent\ncontractor\n\nExercises independent judgment on the means\nused to accomplish the result demanded by\nprincipal\n\nLocal agent\n\nActs as a representative to transact business within\na specified area\n\nOrdinary\nagent\n\nActs under the direction and control of the\nprincipal, such as an employee\n\nProcess\nagent\n\nAuthorized to accept legal service of process on\nbehalf of the principal\n\nRegistered\nagent\n\nAuthorized to accept legal service of process for a\ncorporation in a particular jurisdiction\n\n271 | Agency\n\n\x0cTypes of Authority\nAuthority is the right or permission to act legally on another\xe2\x80\x99s\nbehalf.\n\nIn\n\ngeneral,\n\napparent. Actual\nauthority, occurs\n\nauthority\n\nauthority,\nwhen\n\na\n\ncan\n\nbe\n\neither\n\nsometimes\n\nprincipal\n\nactual\n\ncalled\n\nintentionally\n\nor\nreal\n\nconfers\n\nauthority on an agent. Actual authority can be either express\nor implied. Express authority is authority given by an express\nagreement, either orally or in writing. Implied authority is\nauthority granted to the agent as a result of the principal\xe2\x80\x99s\nconduct.\nFigure 15.1 Types of Authority\n\nApparent authority is authority that a third party reasonably\nbelieves an agent has, based on the third party\xe2\x80\x99s dealings with\nthe principal. If a principal\xe2\x80\x99s words or actions lead others to\nbelieve that he or she gave authority to someone else, then the\nprincipal is held accountable even if no authority was actually\n\nAgency | 272\n\n\x0cgiven to the agent. For example, if a principal fails to give notice\nthat an agent is no longer working for the principal, the agent\nmay still bind the principal through apparent authority when\ndealing with third parties.\nTo constitute apparent authority, three elements must be met:\n1. The principal\xe2\x80\x99s words or actions lead others to believe the\nagent has authority;\n2. A third party reasonably relies on the principal\xe2\x80\x99s words or\nactions; and\n3. The third party is injured.\nSometimes an agent acts without authority. If a disclosed\nprincipal likes what an agent does, even if done without\nauthority at the time, the principal can still benefit from the\nagent\xe2\x80\x99s actions. Ratification occurs when a disclosed principal\nadopts or confirms a contract entered into on his or her behalf\nby an agent who did not have authority to act. Unlike apparent\nauthority, the third party does not have to be injured. Rather,\nratification allows principals to enter into contracts for their\nbenefit. Ratification is an \xe2\x80\x9call or nothing\xe2\x80\x9d doctrine that prevents\nprincipals from ratifying only part of the contract or\nrenegotiating its terms.\n\n15.3 Duties of Agents and Principals\nBecause they are in a fiduciary relationship, agents and\nprincipals owe each other specific duties. While the duties are\nsimilar in nature, there are differences based on their roles.\n\n273 | Agency\n\n\x0cDuties of Agents\nFigure 15.2 Duties of Agents\n\nAgents are fiduciaries of principals and so they are required\nto act with the highest duty of care. In particular, agents owe\nprincipals the following duties:\n\nAgency | 274\n\n\x0cDuty\n\nDescription\n\nAccount\n\nAgent must keep proper records to account for all\nprincipal\xe2\x80\x99s money and property given to agent\n\nCare\n\nAgent must act reasonably, in good faith, and\navoid negligence at all times\n\nInform\n\nAgent must inform principal of all material facts\nthat affect principal\xe2\x80\x99s interests\n\nLoyalty\n\nAgent cannot engage in any dealings that\ncompete or interfere with the principal\xe2\x80\x99s business\nor interests\n\nObedience\n\nAgent must obey all principal\xe2\x80\x99s instructions\nwithin scope of agency unless they are illegal or\nunethical\n\nProtect\nconfidential\ninformation\n\nAgent cannot use or disclose principal\xe2\x80\x99s\nconfidential information\n\nIf an agent breaches a duty owed to the principal, the principal\nhas three available remedies:\n1. The principal may recover damages the breach has\ncaused;\n2. The principal may receive any profit the agent received as\na result of a breach of the duty of loyalty; and\n3. The principal may rescind a transaction when the duty of\nloyalty is violated.\n\nDuties of Principals\nPrincipals also owe duties to agents as part of the fiduciary\nrelationship. These duties are:\n\n275 | Agency\n\n\x0cDuty\n\nDescription\n\nCompensation\n\nPrincipal must pay agent for work performed\n\nHonesty\n\nPrincipals cannot deceive agents about the\nnature and scope of the work they are to\nperform\n\nIndemnification\n\nPrincipal must hold agent harmless and free\nfrom legal liability for actions properly taken on\nprincipal\xe2\x80\x99s behalf\n\nLoyalty\n\nPrincipal cannot engage in any dealings that\nprevent agent from performing agency tasks\n\nReimbursement\n\nPrincipal must reimburse agent for money\nreasonably expended on behalf of principal\n\nFigure 15.3 Duties of Principals\n\nIf a principal breaches a duty owed to the agent, the agent has\ntwo available remedies:\n1. The agent may recover damages the breach has caused;\nand\n2. The agent may terminate the agency relationship.\n\nAgency | 276\n\n\x0c15.4 Liability to Third Parties\nAn agency relationship affects liability to third parties. The\nscope of liability depends on the type of principal involved, the\ntype of authority involved, and the nature of the dispute.\n\nContractual Liability\nA principal is always liable on a contract if the the agent had\nauthority. However, the agent\xe2\x80\x99s liability on a contract depends\non how much the third party knows about the principal.\nDisclosure, when allowed by the principal, is the agent\xe2\x80\x99s best\nprotection against legal liability.\nFigure 15.4 When Agents are Liable on Contracts\n\n277 | Agency\n\n\x0cAn agent is not liable for any contracts he or she makes with\nauthority on behalf of a fully disclosed principal. Therefore, if a\nthird party knows the existence and identity of the principal,\nthen all legal liability lies with the principal. The only exception\nto this is when an agent exceeds his or her authority. In that\ncase, the agent has not acted with authority and becomes\npersonally responsible to the third party. If the agent did not\nhave authority, but the principal later ratifies the contract, then\nthe principal will be liable for the contract.\nIf a principal is partially disclosed, then the third party may\nrecover from either the principal or agent. In this situation,\nthe principal and agent are jointly and severally liable, and the\nthird party may sue either or both of them to recover the full\namount of damages owed. However, the third party cannot\nseek \xe2\x80\x9cdouble damages\xe2\x80\x9d and recover more than the total\namount owed for the contractual breach.\nIn the event of an undisclosed principal, a third party may\nrecover from either the agent or the principal. The fact that\na principal\xe2\x80\x99s existence or identity is hidden from third parties\ndoes not change the nature of the agent-principal relationship.\nTherefore, undisclosed principals may become liable for\ncontracts entered into by agents acting with actual authority.\nAn undisclosed principal has no liability to an agent or third\nparty when the agent exceeds the actual authority granted\nby the principal. In addition, the type of contract must be the\ntype that can be assigned to the undisclosed principal. If the\ncontract is for personal services, then liability cannot be\nassigned to the principal in case of a breach.\n\nTort Liability\nAgents,\n\nemployees,\n\nand\n\nindependent\n\ncontractors\n\nare\n\nAgency | 278\n\n\x0cpersonally liable for their own torts. This concept is rooted in\nthe notion that every individual who commits a tort is\npersonally liable to the party who is damaged by the tortious\nact. The law holds wrongdoers personally accountable.\nHowever, the reverse is not true. Agents, employees, and\nindependent contractors are not liable for the torts of the\nprincipal or employer. If a principal or employer is engaged\nin tortious behavior, its liability cannot be passed down to its\nagents and employees.\nFigure 15.5 When Principals Have Tort Liability for Employees\nand Independent Contractors\n\nAn employer is liable for the torts of an employee if the\nemployee is acting within the scope of employment. This\ndoctrine is called respondeat superior and imposes vicarious\nliability on employers as a matter of public policy. Even if the\nemployer does not direct its employees to act negligently or\nintentionally, the employer is responsible because employers\n\n279 | Agency\n\n\x0care usually in a better position to pay for damages than\nemployees. There is also a strong public policy consideration\nto not allow employers to turn a blind eye to an employee\xe2\x80\x99s\nbad behavior. By making an employer responsible for an\nemployee\xe2\x80\x99s actions, it incentivizes the employer to address\nsituations promptly that could lead to potential liability.\nConversely, a principal is not usually liable for the torts of an\nindependent contractor. Independent contractors have the\npower to control the details of the work they perform and\ngenerally are only responsible to a principal for the results of\ntheir work. Therefore, independent contractors are not directed\nand controlled by a principal as employees are by their\nemployers. As a result, the doctrine of respondeat superior\ndoes not apply to independent contractors.\nTwo exceptions exist that may impose liability on a principal for\nthe work of an independent contractor. The first exception is\nwhere the work is inherently dangerous. Public policy prevents\nprincipals from insulating themselves from the risks of liability\nby selecting an independent contractor rather than an\nemployee to perform the dangerous work. The second\nexception is where the work is illegal. Public policy also\nprevents principals from hiring independent contractors to\nperform a task that is illegal.\n\n15.5 Termination of Agency\nRelationship\nAgents and principals may end their agency relationship in\nvarious ways. The most common way is through mutual\nagreement. As a matter of contract, principals and agents may\ndecide to end their relationship. For example, an employee\n\nAgency | 280\n\n\x0cmay decide to quit his or her job, or the agency agreement may\nonly be for a set period of time or for a specific transaction.\nIn addition, there are some events that will terminate an\nagency relationship as a matter of law. Death of a principal or\nagent automatically terminates the agency agreement, even if\nthe other party is unaware of the death. Once the time of death\nis established, any transactions afterward are deemed void.\nSimilar to death, mental incapacity of a principal or agent\nterminates an agency relationship. It is often hard to determine\nthe precise time someone loses mental capacity. Therefore,\ncourts often hold that an agent\xe2\x80\x99s contract with a third party is\nbinding on the principal unless the third party was aware of the\nprincipal\xe2\x80\x99s incapacity.\nBankruptcy terminates an agency relationship when the\nbankruptcy\n\naffects\n\nthe\n\nsubject\n\nmatter\n\nof\n\nthe\n\nagency\n\nagreement. For example, if a principal declares bankruptcy and\nthe real property that an agent is authorized to sell is part of\nthe bankruptcy estate, then the bankruptcy will automatically\nterminate the agency relationship.\nFinally, the destruction or illegality of the subject matter will\nterminate the agency relationship. For example, if Congress\npasses a law making it illegal for private parties to sell specific\ntypes of weapons, the agency relationship between a gun\ndealer\n\nand\n\nits\n\nfactor\n\nfor\n\nselling\n\nthose\n\nweapons\n\nwill\n\nautomatically end.\n\n15.6 Concluding Thoughts\nAgency relationships are flexible and varied depending on the\nneeds and interest of the principals and agents. Because the\nagency relationship is fiduciary in nature, agents and principals\n281 | Agency\n\n\x0cowe each other certain duties. Third parties may hold principals\nlegally liable for the actions of their agents. Therefore, it is\nimportant for businesses to select their agents carefully to\nminimize their risk of liability.\n\nAgency | 282\n\n\x0c16. Business\nOrganizations\n16.1 Introduction\nLEARNING OBJECTIVES\n1. Know the available entity choices when forming a\nbusiness.\n2. Identify the factors that determine entity selection.\n3. Understand common business entities and their\nadvantages and disadvantages.\nAt its most fundamental level, a business exists to make a profit\nfor its owners. Some businesses make things in factories\n(manufacturers), other businesses sell things that other\nbusinesses make (retailers), and still other businesses exist to\nhelp both the makers and sellers make and sell better\n(business consultants). Some businesses don\xe2\x80\x99t make things at\nall, and instead profit by selling their services or by lending\nmoney.\nWith this diversity, it\xe2\x80\x99s not surprising that there is no \xe2\x80\x9cone size\nfits all\xe2\x80\x9d approach to choosing a business organization. When\nchoosing what form of entity is best, several factors are\nimportant to consider:\n1. How much it costs to create the entity and how hard it is\nto create.\n2. How easy it is for the business to continue if the founder\n\n283 | Business Organizations\n\n\x0cdies or retires.\n3. How difficult it is to raise money to grow or expand the\nbusiness.\n4. What type of managerial control they wish to keep on the\nbusiness, and whether they are willing to cede control to\noutsiders.\n5. If expanding ownership to members of the public is\ndesired.\n6. How to minimize the taxes paid on earnings and income.\n7. How to protect personal assets from claims, a feature\nknown as limited liability.\nDepending on the type of business and its goals, different\nbusiness entities may be appropriate.\n\nCounselor\xe2\x80\x99s Corner Selection of business entities is\noften the first step when going into business. Many\nentrepreneurs and small businesses do not spend\nenough time thinking about the legal and tax\nconsequences of the entity they choose. Ironically,\nan important discussion to have at the beginning is\nan exit strategy. What happens if one of the\nbusiness owners becomes ill, dies, or wants to leave\nthe business? What if the economic situation\nchanges and the business no longer is profitable?\nDiscussing exit strategies up front helps people\nmake the best decisions when crises happen. Don\xe2\x80\x99t\navoid hard conversations up front. It may be\nuncomfortable but will save a lot of problems down\nthe road. ~Allison W., attorney\n\nBusiness Organizations | 284\n\n\x0c16.2 Sole Proprietorship\nA sole proprietorship is an unincorporated business owned\nby one person or married couple. The legal name for a sole\nproprietorship is usually the owner\xe2\x80\x99s name.\nThere are many advantages to doing business as a sole\nproprietor. First, it\xe2\x80\x99s easy to create a sole proprietorship. In\neffect, no creation costs or time is required because there is\nnothing to create. The entrepreneur in charge of the business\nsimply starts doing business, charging money, and providing\ngoods or services.\nAnother key advantage to sole proprietorship is autonomy. The\nowner can decide how he or she wants to run the business. The\nowner can set her own hours, grow as quickly or slowly as she\nwants, and expand into new lines of businesses. That autonomy\nalso comes with total ownership of the business\xe2\x80\x99s finances. All\nthe money that the owner takes in, even if it is in a separate\nbank account, belongs to her, and she can do with that money\nwhatever she wants.\nA sole proprietorship is a flow-through tax entity, which means\nthe business does not pay tax on its profits and does not file a\nseparate tax return. Instead, the owner pays personal income\ntax on all business profits.\nThese\n\nadvantages\n\nmust\n\nbe\n\nweighed\n\nagainst\n\nsome\n\ndisadvantages. First, because a sole proprietorship can have\nonly one owner, it is impossible to bring in others to the\nbusiness. In addition, the business and the owner are identical\nso it is impossible to pass on the business.\nRaising working capital can be a problem for sole proprietors,\nespecially those early in their business ventures. Many\nentrepreneurial ventures are built on great ideas but need\n\n285 | Business Organizations\n\n\x0ccapital to flourish and develop. If the entrepreneur lacks\nindividual wealth, then he or she must seek those funds from\nother sources. Outsiders can make a loan to the owner, or enter\ninto a profit-sharing contract with her, but there is no way for\nhim to own any part of the owner\xe2\x80\x99s business. Traditionally, most\nsole proprietors seek funding from banks. Banks approach\nthese loans just like any other personal loan to an individual,\nsuch as a car loan or mortgage. Down payment requirements\nmay be high, and typically the banks require some form of\npersonal collateral to guarantee the loan, even though the loan\nis to be used to grow the business.\nSole proprietors are personally liable for all the business\xe2\x80\x99s debts\nand obligations. Unlimited liability puts all the personal assets\nof the sole proprietor at risk. Personal homes, automobiles,\nbank accounts and retirement accounts\xe2\x80\x94all are within reach\nof creditors.\nAdvantages of Sole\nProprietorship\n\n\xe2\x80\xa2 Easy to create\n\xe2\x80\xa2 No formal documents or\ngovernmental filings\nrequired to start business\n\xe2\x80\xa2 No formation start up costs\n\xe2\x80\xa2 Autonomy\n\xe2\x80\xa2 Total control over finances\nand management decisions\n\nDisadvantages of Sole\nProprietorship\n\xe2\x80\xa2 Flow-through tax entity\n(owner pays personal\nincome tax on all business\nprofits)\n\xe2\x80\xa2 Cannot bring someone else\ninto business\n\xe2\x80\xa2 Impossible to pass on the\nbusiness\n\xe2\x80\xa2 Hard to raise capital\n\xe2\x80\xa2 Unlimited liability\n\n16.3 Partnerships\nA partnership is an unincorporated association of two or more\n\nBusiness Organizations | 286\n\n\x0cco-owners who operate a business for profit. Each owner is\ncalled a general partner.\n\nGeneral Partnerships\nA general partnership is when all partners participate fully in\nrunning the business and share equally in profits and losses,\neven if the partners\xe2\x80\x99 monetary contributions vary. No legal\ndocuments are required to file with the government to form\na partnership. If two or more people do business together,\nsharing management of the business, profits and losses, they\nhave a partnership.\nIf a partnership is formed formally, then the written agreement\nis called the articles of partnership. The articles can set forth\nanything the partners wish to include about how the\npartnership will be run. Normally, all general partners have an\nequal voice in management, but as a creation of contract, the\npartners can modify this if they wish.\nA general partnership is taxed just like a sole proprietorship.\nA partnership is a flow-through tax entity, where the\npartnership\xe2\x80\x99s income \xe2\x80\x9cflows through\xe2\x80\x9d the business to the\npartners, who then pay individual tax on the business income.\nThe partnership may file an information return, reporting total\nincome and losses for the partnership, and how those profits\nand losses are allocated among the general partners. However,\nan information return is usually not required.\nGeneral partnerships are also similar to sole proprietorships in\nunlimited liability. Every partner in the partnership is jointly\nand severally liable for the partnership\xe2\x80\x99s debts and obligations.\nThis is a very unattractive feature of general partnerships. One\npartner may be completely innocent of any wrongdoing and\nstill be liable for another partner\xe2\x80\x99s malpractice or bad acts.\n287 | Business Organizations\n\n\x0cGeneral partnerships are dissolved as easily as they are formed.\nSince the central feature of a general partnership is an\nagreement to share profits and losses, once that agreement\nends, the general partnership ends with it. In a general\npartnership with more than two persons, the remaining\npartners can reconstitute the partnership if they wish, without\nthe old partner. A common issue that arises in this situation is\nhow to value the withdrawing partner\xe2\x80\x99s share of the business.\nArticles of partnership therefore typically include a buy/sell\nagreement, setting forth the agreement of the partners on\nhow to account for a withdrawing partner\xe2\x80\x99s share, which the\nremaining partners then agree to pay to the withdrawing\npartner.\n\nManagement Duties\nPartners have a fiduciary duty to the partnership. This means\nthat partners have a duty to act for the benefit of the\npartnership. In particular:\n\xe2\x80\xa2 Partners have an obligation of good faith and fair dealing\nwith each other and the partnership.\n\xe2\x80\xa2 Partners are liable to the partnership for gross negligence\nor intentional misconduct. Partners are not liable for\nordinary negligence.\n\xe2\x80\xa2 Partners cannot compete with the partnership.\n\xe2\x80\xa2 Partners cannot take opportunities away from the\npartnership unless the other partners consent.\n\xe2\x80\xa2 Partners cannot engage in conflicts of interest.\n\nBusiness Organizations | 288\n\n\x0cLimited Partnerships\nIn most states, owners can form a limited partnership. A limited\npartnership has both general partners and limited partners. As\na limited partner, the most he or she can lose is the amount\nof his investment into the business, nothing more. Limited\npartnerships have to be formed in compliance with state law,\nand\n\nlimited\n\npartners\n\nare\n\ngenerally\n\nprohibited\n\nfrom\n\nparticipating in day-to-day management of the business. This\noften occurs when someone invests money in the partnership\nbut is not interested in running the business.\nAdvantages of Partnerships\n\n\xe2\x80\xa2 Easy to create\n\xe2\x80\xa2 No formal documents or\ngovernmental filings\nrequired to start business\n\xe2\x80\xa2 Flexibility in sharing\nmanagement decisions\n\xe2\x80\xa2 Allows for investment by\nlimited partners to raise\ncapital\n\xe2\x80\xa2 Easy to dissolve\n\nDisadvantages of Partnerships\n\xe2\x80\xa2 Flow-through tax entity\n(owner pays personal\nincome tax on all business\nprofits)\n\xe2\x80\xa2 Unlimited liability\n\xe2\x80\xa2 May be hard to value\nindividual partner\xe2\x80\x99s share of\nbusiness\n\xe2\x80\xa2 Dissolution occurs any time\na new partner is added or\nold partner leaves\n\n16.4 Franchises\nA franchise is when a business grants to another the sole right\nof engaging in a certain business or in a business using a\nparticular trademark in a certain area. Franchises are not a\nseparate form of business organization. Rather, they are a form\nof contract between businesses. Most franchises involve\ncorporations or limited liability corporations, but they may\ninclude sole proprietorships and partnerships.\n\n289 | Business Organizations\n\n\x0cThe advantage of a franchise is that under a franchise\nagreement, an entrepreneur can open and run a business\nunder\n\na\n\nproven\n\nbusiness\n\nmodel.\n\nThe\n\nlocal\n\nowner,\n\nthe franchisee, uses the franchisor\xe2\x80\x99s trademark, intellectual\nproperty, and business model under a license agreement. The\nfranchisee offers goods or services to the public and keeps\nany income earned. In exchange for the right to sell goods or\nservices developed by the franchisor, the franchisee pays a fee\nto the franchisor.\nFranchises are common in some industries such as fast food\nrestaurants, hotels, and tax preparation services. Franchise\nagreements are very detailed and often require the franchisee\nto use specific vendors, ingredients, store layouts, colors, etc.\nFranchises are also very popular with US businesses interested\nin conducting business abroad. US businesses collect franchise\nfees from owners in other nations who are responsible for\nrunning the business abroad. This allows US companies to have\na presence in nations that may restrict business ownership by\nforeigners because the businesses themselves are owned and\noperated by locals.\n\n16.5 Joint Venture\nA joint venture is when two or more individuals or businesses\ncombine their efforts in a particular business enterprise and\nagree to share the profits and losses jointly or in proportion\nto their contributions. Unlike a partnership, which operates as\na general business for as long as the partners desire, a joint\nventure is for a single transaction or a limited activity. The\nbusinesses remain separate entities and they do not share\nfinancial or confidential information unless they decide to.\n\nBusiness Organizations | 290\n\n\x0cJoint ventures automatically terminate at the conclusion of an\nevent or project.\nJoint ventures are often formed to address a common need\nor to reach a mutual goal. For example, Google and National\nAeronautics and Space Administration (NASA) developed\nGoogle Earth as a joint venture. To do so, they shared resources\nand information necessary to develop Google Earth but Google\ndid not become part of the government, nor did NASA share\nany confidential information or intellectual property more than\nnecessary.\nJoint ventures are also common to share the costs of major\nresearch or infrastructure projects within an industry. This\noccurs frequently when industries are impacted by advances\nin technology. For example, BMW and Toyota created a joint\nventure to research hydrogen fuel cells, electric vehicles, and\nultra-lightweight materials needed in next generation vehicles.\nBy sharing the cost of research and development, the\ncompanies are able to be on the forefront of technological\nadvancements in their industry.\nFranchises\n\n\xe2\x80\xa2 The right to use a trademark\nby paying a fee to the\nfranchisor\n\xe2\x80\xa2 Contract isn\xe2\x80\x99t separate from\nthe business\n\xe2\x80\xa2 Franchise either offers a\ngood or a service\n\xe2\x80\xa2 Mainly used in conducting\nbusiness abroad\n\n291 | Business Organizations\n\nJoint Ventures\n\xe2\x80\xa2 Share a mutual goal/cost/\nlosses\n\xe2\x80\xa2 Combines efforts in a single\ntransaction or a limited\nactivity\n\xe2\x80\xa2 Agreement becomes\nterminated at the end of the\nevent or project\n\xe2\x80\xa2 Financial and confidential\ninformation is not shared\n\n\x0c16.6 Corporations\nUnlike a sole proprietorship or general partnership, a\ncorporation is a legal entity separate and distinct from its\nowners. It can be created for a limited duration, or it can have\na perpetual existence. Since it is a separate legal entity, a\ncorporation has continuity regardless of its owners. Similarly,\nin a publicly traded company, the identity of shareholders can\nchange, but the corporation continues its business operations\nwithout being affected.\nCorporations must be formed in compliance with the law of\nthe state law where they are incorporated. Most corporations\nincorporate where their principal place of business is located,\nbut not all do. Many companies choose to incorporate in\nDelaware. Delaware chancery courts have developed a\nreputation for fairly and quickly applying a very well-developed\nbody of corporate law in Delaware. The courts also operate\nwithout a jury, meaning that disputes heard in Delaware courts\nare usually predictable and transparent, with well-written\nopinions explaining how the judges decided the cases.\nTo start a corporation, the corporate founders must file articles\nof incorporation with the Secretary of State where they are\nincorporated. Articles of incorporation typically include:\n\xe2\x80\xa2 The name of the company;\n\xe2\x80\xa2 Whether the company is for-profit or nonprofit;\n\xe2\x80\xa2 The founders\xe2\x80\x99 names;\n\xe2\x80\xa2 The company\xe2\x80\x99s purpose;\n\xe2\x80\xa2 How many shares the corporation will issue initially; and\n\xe2\x80\xa2 The par value of any shares issued.\nUnlike\n\nsole\n\nproprietorships,\n\ncorporations\n\ncan\n\nbe\n\nquite\n\ncomplicated to manage and often require attorneys and\n\nBusiness Organizations | 292\n\n\x0caccountants to maintain corporate books in good order. In\naddition to the foundation requirements, corporate law\nrequires ongoing annual maintenance of corporations. In\naddition to filing fees due at the time of incorporation, there\nare typically annual license fees, franchise fees and taxes, and\nfees related to maintaining minute books, corporate seals,\nstock certificates and registries, as well as out-of-state\nregistration. A domestic corporation is entitled to operate in\nits state of incorporation but must register as a foreign\ncorporation to do business in other states.\n\nCorporate Legal Structure\nOwners of corporations are called shareholders. Corporations\ncan have as few as one shareholder or as many as millions\nof shareholders, and those shareholders can hold as few as\none share or as many as millions of shares. In a closely held\ncorporation, the number of shareholders tends to be small,\nwhile\n\nin\n\na\n\npublicly\n\ntraded\n\ncorporation,\n\nthe\n\nbody\n\nof\n\nshareholders tends to be large.\nIn a publicly traded corporation, the value of a share is\ndetermined by the laws of supply and demand, with various\nmarkets or exchanges providing trading space for buyers and\nsellers of certain shares to be traded. Shareholders own shares\nin the company but have no legal right to the company\xe2\x80\x99s\nassets. As a separate legal entity, the corporation owns any\nproperty in its name.\nShareholders of a corporation enjoy limited liability. The most\nthey can lose is the amount of their investment. Shareholders\xe2\x80\x99\npersonal assets are not available to the corporation\xe2\x80\x99s creditors.\nShareholders can be individuals or other business entities, such\nas partnerships or corporations. If one corporation owns all the\n293 | Business Organizations\n\n\x0cstock of another corporation, the owner is said to be a parent\ncompany, while the company being owned is a wholly owned\nsubsidiary. Often large corporations form subsidiaries for\nspecific purposes so that the parent company has limited\nliability or advantageous tax treatment. For example, large\ncompanies may form subsidiaries to hold real property so that\npremises liability is limited to that real estate subsidiary only,\nshielding the parent company and its assets from lawsuits.\nCompanies that deal in a lot of intellectual property may form\nsubsidiaries to hold their intellectual property, which is then\nlicensed back to the parent company so that the parent\ncompany can deduct royalty payments for those licenses from\nits taxes. This type of sophisticated liability and tax planning\nmakes the corporate form very attractive for larger businesses\nin the United States.\nAn exception to the rule of limited liability arises in certain\ncases involving closely held corporations. Many sole proprietors\nincorporate their businesses to gain limited liability but fail to\nrealize when they do so that they are creating a separate legal\nentity that must be respected as such. If sole proprietors fail to\nrespect the legal corporation with an arm\xe2\x80\x99s length transaction,\nthen creditors can ask a court to pierce the corporate veil. If\na court agrees, then limited liability disappears and those\ncreditors can reach the shareholder\xe2\x80\x99s personal assets.\n\nRights of Shareholders\nNot all shareholders in a corporation are necessarily equal. US\ncorporate law allows for the creation of different types, or\nclasses, of shareholders. Shareholders in different classes may\nbe given preferential treatment when it comes to corporate\nactions such as paying dividends or voting at shareholder\nmeetings.\n\nBusiness Organizations | 294\n\n\x0cShareholder rights are generally outlined in a company\xe2\x80\x99s\narticles of incorporation or bylaws. Some of these rights may\ninclude the right to obtain a dividend, but only if the board of\ndirectors approves one. They also include the right to attend\nshareholder meetings, the right to examine the company\xe2\x80\x99s\nfinancial records, and the right to a portion of liquidated\ncompany assets.\nUnder most state laws, shareholders are also given a unique\nright to sue a third party on behalf of the corporation. This\nis called a shareholder derivative lawsuit. In essence, a\nshareholder alleges that the people who are ordinarily charged\nwith acting in the corporation\xe2\x80\x99s best interests (the officers and\ndirectors) are failing to do so, and therefore the shareholder\nmust step in to protect the corporation.\nOne of the most important functions for shareholders is to\nelect the board of directors of a corporation. Only shareholders\nelect a director. The board is responsible for making major\ndecisions that affect a corporation, such as declaring and\npaying a corporate dividend to shareholders; authorizing major\ndecisions;\n\nappointing\n\nand\n\nremoving\n\ncorporate\n\nofficers;\n\ndetermining employee compensation, especially bonus and\nincentive plans; and issuing new shares and corporate bonds.\nOne critical function for boards of directors is to appoint\ncorporate officers. These officers often hold titles such as chief\nexecutive officer, chief operating officer, chief marketing\nofficer, and so on. Officers are involved in everyday decision\nmaking for the company and implement the board\xe2\x80\x99s decisions.\nAs officers of the company, they have legal authority to sign\ncontracts on behalf of the corporation, binding the corporation\nto legal obligations. Officers are employees of the company\nand work full-time for the company, but can be removed by the\nboard.\n\n295 | Business Organizations\n\n\x0cCorporate Taxation\nCorporations\n\nare\n\nsubject\n\nto\n\ndouble\n\ntaxation.\n\nBecause\n\ncorporations are separate legal entities, they must pay federal,\nstate, and local tax on net income. Then, if the board of\ndirectors declares a dividend, shareholders are taxed on the\ndividend that they receive in the form of a dividend tax.\nOne way for closely held corporations (such as small familyrun businesses) to avoid double taxation is to form an S\ncorporation. An S corporation (the name comes from the\napplicable subsection of the tax law) can choose to be taxed\nlike a partnership or sole proprietorship. In other words, taxes\nare only collected when a dividend is declared and not on\ncorporate net income. An S corporation is formed and treated\njust like any other corporation; the only difference is in tax\ntreatment.\nS\n\ncorporations\n\nprovide\n\nthe\n\nlimited\n\nliability\n\nfeature\n\nof\n\ncorporations but the single-level taxation benefits of sole\nproprietorships. There are some important restrictions on S\ncorporations, however. They cannot have more than one\nhundred shareholders, all of whom must be US citizens or\nresident\n\naliens\n\nand\n\ncannot\n\ninclude\n\npartnerships\n\nand\n\ncorporations. S corporations can have only one class of stock\nand there are restrictions on how shares may be transferred.\nFinally, all shareholders must agree that the company should\nbe an S corporation. These restrictions ensure that \xe2\x80\x9cS\xe2\x80\x9d tax\ntreatment is reserved only for small businesses.\n\nBusiness Organizations | 296\n\n\x0cAdvantages of Corporations\n\nDisadvantages of Corporations\n\n\xe2\x80\xa2 Separate legal entity from\nowners\n\xe2\x80\xa2 Corporation unaffected by\nchange of ownership/\nshareholders\n\xe2\x80\xa2 Limited liability for\nshareholders\n\xe2\x80\xa2 Not subject to some laws\n\xe2\x80\xa2 Considered as an\n\xe2\x80\x9cindividual\xe2\x80\x9d with\nConstitutional rights\n\n\xe2\x80\xa2 Formal documents required\nto filed in state of\nincorporation\n\xe2\x80\xa2 Can be complicated to\nmanage\n\xe2\x80\xa2 High formation and\nmaintenance costs\n\xe2\x80\xa2 Subject to double taxation\n\xe2\x80\xa2 Heavily regulated by\ngovernment\n\n16.7 Limited Liability Entities\nLimited Liability Companies\nA limited liability company (LLC) is a \xe2\x80\x9chybrid\xe2\x80\x9d form of business\norganization\n\nthat\n\noffer\n\nthe\n\nlimited\n\nliability\n\nfeature\n\nof\n\ncorporations but the tax benefits of partnerships. Owners of\nLLCs are called members. Just like a sole proprietorship, it is\npossible to create an LLC with only one member. LLC members\ncan be individuals or other LLCs, corporations, or partnerships.\nLLC members can participate in day-to-day management of\nthe business.\nMembers are not personally liable for the debts of the business.\nLike shareholders of a corporation, members of an LLC risk only\ntheir financial investment in the company.\nTaxation of LLCs is very flexible. Every year the LLC can choose\nhow it will be taxed. It may want to be taxed as a corporation,\nfor example, and pay corporate income tax on net income.\nOr it may choose instead to have income \xe2\x80\x9cflow through\xe2\x80\x9d the\n\n297 | Business Organizations\n\n\x0ccorporate form to the member-shareholders, who then pay\npersonal income tax just as in a partnership. Sophisticated tax\nplanning becomes possible with LLCs because tax treatment\ncan vary by year.\nFigure 16.1 LLC Taxation\n\nLLCs are formed by filing the articles of organization with the\nstate agency charged with chartering business entities,\ntypically the Secretary of State. Starting an LLC is often easier\nthan starting a corporation. Typical LLC statutes require only\nthe name of the LLC and the contact information for the LLC\xe2\x80\x99s\nlegal agent. Unlike corporations, there is no requirement for an\nLLC to issue stock certificates, maintain annual filings, elect a\nboard of directors, hold shareholder meetings, appoint officers,\nor engage in any regular maintenance of the entity. Most states\nrequire LLCs to have the letters \xe2\x80\x9cLLC\xe2\x80\x9d or words \xe2\x80\x9cLimited Liability\nCompany\xe2\x80\x9d in the official business name.\nAlthough the articles of organization are all that is necessary to\nstart an LLC, it is advisable for the LLC members to enter into\na written LLC operating agreement. The operating agreement\ntypically sets forth how the business will be managed and\nBusiness Organizations | 298\n\n\x0coperated. It may also contain a buy/sell agreement just like\na partnership agreement. The operating agreement allows\nmembers to run their LLCs any way they wish.\nSince LLCs are a separate legal entity from their members,\nmembers must take care to interact with LLCs at arm\xe2\x80\x99s length,\nbecause the risk of piercing the veil exists with LLCs as much\nas it does with corporations. Fundraising for an LLC can be as\ndifficult as it is for a sole proprietorship, especially in the early\nstages of an LLC\xe2\x80\x99s business operations. Most lenders require\nLLC members to personally guarantee any loans the LLC may\ntake out. Finally, LLCs are not the right form for taking a\ncompany public and selling stock. Fortunately, it is not difficult\nto convert an LLC into a corporation, so many start-up business\nbegin as LLCs and eventually convert into corporations prior to\ntheir initial public offering (IPO).\nAdvantages of LLCs\n\xe2\x80\xa2 Limited liability for owners\n\xe2\x80\xa2 Flow-through tax entity so\nnot subject to double\ntaxation\n\xe2\x80\xa2 Easier to form and operate\nthan corporation or S\ncorporation\n\xe2\x80\xa2 Owners can deduct losses\nfor personal taxes\n\nDisadvantages of LLCs\n\n\xe2\x80\xa2 Subject to state laws so\nlacks consistency in\nenforcement\n\xe2\x80\xa2 Laws not as developed as\ncorporate law & partnership\nlaw\n\nLimited Liability Partnerships\nA related entity to the LLC is the limited liability partnership, or\nLLP. Be careful not to confuse limited liability partnerships with\nlimited partnerships. LLPs are just like LLCs but are designed\nfor professionals who do business as partners. They allow the\npartnership to pass through income for tax purposes, but\n\n299 | Business Organizations\n\n\x0cretain limited liability for all partners. LLPs are especially\npopular with doctors, architects, accountants, and lawyers.\nMost of the major accounting firms have now converted their\ncorporate forms into LLPs.\n\nProfessional Corporations\nProfessional Corporations (PCs) are mostly a legacy form of\norganization. In other words, before LLCs and LLPs were an\noption, PCs were the only option available to professionals who\nwanted limited liability. Some states still require doctors,\nlawyers, and accountants to organize as a PC.\nIf a member of a PC commits malpractice, the PC\xe2\x80\x99s assets\nare at risk along with the personal assets of the member who\ncommitted malpractice. However, the personal assets of the\nnon-involved members are not at risk. PCs do not shield\nindividuals from their own malpractice but they offer limited\nliability to innocent members.\nPCs are a separate taxable entity but they are not flow-through\nentities like partnerships. As a result, taxation of PCs is\ncomplicated and a major drawback of this form of business\nentity.\n\nBusiness Organizations | 300\n\n\x0cType of\nBusiness\nOrganization\n\nEase of\nFunding\nFormation\n\nPersonal\nLiability for\nOwners\n\nTaxes\n\nEase of\nTransferr\nOwnersh\n\nSole\nVery easy\nProprietorship\n\nSame as\nowner\n\nYes\n\nMust sell\nFlow-through entire\nbusiness\n\nGeneral\nPartnership\n\nPartners\ncontribute\ncapital\n\nYes\n\nFlow-through Hard\n\nFlow-through Hard\n\nEasy\n\nLimited\nPartnership\n\nEasy\n\nPartners\ncontribute\ncapital\n\nGeneral\npartner is\npersonally\nliable;\nlimited\nliability for\nlimited\npartners\n\nCorporations\n\nDifficult\n\nSell stock to\nraise capital\n\nNo\n\nSubject to\ndouble\ntaxation\n\nEasy\n\nS\nCorporations\n\nDifficult\n\nSell stock to\nraise capital\n\nNo\n\nTaxed only on\ndividends\n\nTransfer\nrestrictio\n\nLimited\nLiability\nCompanies\n(LLCs)\n\nMedium\n\nMembers\nmake capital No\ncontributions\n\n301 | Business Organizations\n\nDepends\nFlow-through operating\nagreeme\n\n\x0cLimited\nLiability\nPartnerships\n(LLPs)\n\nProfessional\nCorporations\n\nDifficult\n\nNon-acting\npartners\nhave\nlimited\nliability;\nDepends\nMembers\nstate law\nthe\nmake capital\nFlow-through\nvaries\npartnersh\ncontributions\nregarding\nagreeme\nliability of\nacting\npartners vs.\npartnership\n\nDifficult\n\nMembers\nmake capital No\ncontributions\n\nComplex tax\nissues\n\n16.8 Concluding Thoughts\nDepending on a business\xe2\x80\x99s type and goals, different business\nentities may fit the needs of owners better than others. It is\nimportant when starting a business to decide how to minimize\ntax and liability exposure and to maximize profits. Because\nthere is no perfect \xe2\x80\x9cfit\xe2\x80\x9d for every business need, understanding\nthe advantages and disadvantages of the various business\nentities is important.\n\nBusiness Organizations | 302\n\nTransfer\nrestricted\nmember\nthe same\nprofessio\n\n\x0c17. Partnerships\n17.1 Introduction\nLEARNING OBJECTIVES\n1. Learn when a partnership exists.\n2. Understand the rights and duties of partners.\n3. Comprehend how a partnership is terminated and the\npriority of distributing assets.\nPartnerships are the most common business form in the\nUnited States. Partnerships may be express or implied, and\nthey are the default business organization when two or more\npeople work together who are not legally married. People do\nnot need to call themselves partners for a partnership to exist,\nso it is important for business professionals to understand what\nconstitutes a partnership so they do not inadvertently form a\nbusiness entity that they do not intend. And, if they do intend\nto form a partnership, partners should understand their rights\nand duties towards each other.\n\n17.2 Types of Partnerships\nA partnership is a voluntary association of two or more people\nwho jointly own and carry on a business for profit. Under the\nUniform Partnership Act, a partnership is presumed to exist if\nthe parties agree to share proportionally the business\xe2\x80\x99s profits\nor losses.\n\n303 | Partnerships\n\n\x0cThere are only two required elements to form a partnership:\n1. A common interest to conduct business together; and\n2. An understanding to share profits and losses.\nA general partnership is a partnership in which all partners\nparticipate fully in running the business and share equally in\nprofits and losses, even if the partners\xe2\x80\x99 monetary contributions\nvary.\nA limited partnership is composed of one or more people who\ncontrol the business and are personally liable for the\npartnership\xe2\x80\x99s debts. These partners are called general partners\nand they have the power to make all types of business\ndecisions and manage all aspects of the partnership. A limited\npartnership also has one or more people who contribute\ncapital and share profits but who cannot manage the business\nand are liable only for the amount of their contribution. These\npartners are called limited partners. The main purpose of a\nlimited partnership is to allow people to invest in a business\nwithout having to manage the business, and without risking\nmore than the invested sum.\nPartnerships may also have silent and secret partners. A silent\npartner is a partner who shares in the profits, has no active\nvoice in management of the business, and whose existence\nis not publicly disclosed. A secret partner is a partner whose\nconnection to the business is concealed from the public but\nmay participate in the management of the business. The\ndifference between a silent and secret partner relates to\nwhether the partner may make management decisions.\nA partnership by estoppel is an equitable doctrine in which\na partnership is implied when one or more people represent\nthemselves as partners to a third party who relies on that\nrepresentation. A person who is deemed a partner by estoppel\n\nPartnerships | 304\n\n\x0cbecomes liable for any credit extended to the partnership by\nthe third party.\n\nCounselor\xe2\x80\x99s Corner When a business is seeking to\ninnovate their operations, become more efficient,\nintroduce new products or seek competitive\nadvantages, corporate or business attorneys are\nmost effective if they are business partners from the\noutset. Consulting with legal counsel early and often\nallows the business to avoid legal pitfalls without\nwasting valuable time and other resources by\nmaking legal counsel a true business partner. So\noften in business, the legal consulting occurs at the\nend of the process but by forming the consulting\nrelationship early and often, it avoids being\nblindsided by possible legal restrictions or\nimpediments and more importantly allows the\nbusiness to adjust and adapt to any legal\nimplications during the process.\n\n~Rick T.,\n\nattorney\n\n17.3 Partnership Agreements\nA written partnership agreement is not required to form a\npartnership, but it is a best business practice. Given the variety\nof different types of partnerships, it is understandable that no\nformal requirements for a partnership agreement exist.\nHowever, the following provisions are ones that should be\nconsidered when writing a partnership agreement.\n\n305 | Partnerships\n\n\x0c\xe2\x80\xa2 Name of partnership. Partnerships may choose almost\nany name they would like. However, partnerships may not\nuse the word \xe2\x80\x9ccompany\xe2\x80\x9d or any other word that would\nimply the business is a corporation. If partners choose a\nname that does not include their names, the fictitious\nname statement requires that they must give public\nnotice as to the identities of the partners.\n\xe2\x80\xa2 Purpose and duration. Is the partnership for a limited\ntime or for a specific purpose? Is it a joint venture between\nbusinesses that grants partners only limited authority and\nproperty rights? Is it a general partnership with the\nflexibility to grow the business as the market allows?\n\xe2\x80\xa2 Capital contributions. Partners may contribute cash,\nintellectual property rights, real and personal property,\nand goodwill to the partnership. Capital contributions do\nnot include the partners\xe2\x80\x99 business experience. An\nindividual may also become a partner without making a\ncapital contribution as long as the other partners agree to\nit.\n\xe2\x80\xa2 Methods of sharing profits and losses. Without this\nprovision, the default rule is that each partner shares\nequally in the profits and losses of the partnership. These\nprovisions often include any credit for capital\ncontributions partners may receive in the event of\ndissolution.\n\xe2\x80\xa2 Effects of advances. If the partnership is short of cash and\na partner agrees to advance money to the partnership,\nthat cash advance could be considered either a personal\nloan or a capital contribution to the partnership.\nDetermining in advance how that money will be spent,\nrepaid, and/or credited within the partnership helps\nfacilitate these types of transactions.\n\xe2\x80\xa2 Compensation. If general partners receive any salary or\nadditional compensation for their management of the\nbusiness, the terms of compensation should be clearly\n\nPartnerships | 306\n\n\x0cdefined. In addition, the procedure for setting the amount\nand type of compensation should also be addressed.\n\xe2\x80\xa2 Fiscal year and accounting methods. How a partnership\nwill handle accounting and tax liabilities are important to\nclearly define, especially because partnerships are flowthrough tax entities.\n\xe2\x80\xa2 Property. Partnerships often use personal property of\npartners as well as property of the business. The default\nrule is that all property brought into the partnership or\nacquired by it becomes partnership property. If a partner\ndoes not want to lose property rights to the partnership or\nits creditors, he or she should specify that it remains\npersonal property.\n\xe2\x80\xa2 Dispute resolution. If partners are unable to agree on how\nto manage the business, how will the deadlock be\nresolved? These provisions are especially helpful when\nthere are an even number of partners to avoid dissolution\nwhen deadlock occurs.\n\xe2\x80\xa2 Modification. How may the partners modify the\npartnership agreement? Is unanimous consent required\nto add new partners or add new terms to the contract?\n\xe2\x80\xa2 Rights and obligations at dissolution. Partners should\nthink about what will happen if a partner chooses to leave\nthe partnership or dies. Can the remaining partner(s) buy\nout that partner\xe2\x80\x99s share of the business? If so, under what\nterms or process?\nIt is important to remember that partnership agreements exist\nbetween partners in a business, not between the partners and\nthird parties. Partnership agreements are contracts between\nindividuals who want to work together. Therefore, provisions\nthat help facilitate that business relationship within the\nparticular industry may be appropriate.\n\n307 | Partnerships\n\n\x0c17.4 Rights and Duties of Partners\nRights of Partners\nFigure 17.1 Rights of Partners\n\nAll general partners have an equal right to manage the\npartnership\xe2\x80\x99s business. This does not mean that partners\ncannot\n\ndivide\n\nup\n\nresponsibility\n\nfor\n\nthe\n\nday-to-day\n\nmanagement of the business. Rather, partners have the right\nto enter into contracts on behalf of the partnership, hire\nemployees, and engage in business transactions.\nPartners also have a right to compensation for services on\n\nPartnerships | 308\n\n\x0cbehalf of the partnership if they have an agreement for\ncompensation beyond profit sharing. Compensation provisions\nare particularly common in limited partnerships where some\npartners are active in the management of business and others\nare not.\nPartners also have the right to receive interest on cash\nadvances made to the partnership. Similar to a loan, an\nadvance is not automatically considered a capital contribution\nunless determined to be so under the partnership agreement.\nEvery partner is entitled to full and complete access to inspect\nthe business records of the partnership. Each partner has the\nright to receive notices and information from all other partners\nregarding the business. Therefore, partners must notify other\npartners about material information related to the business\nand business interests.\nSimilarly, partners are entitled to an accounting when another\npartner has withheld profits from the partnership, when there\nare legal proceedings against the partnership, or upon\ndissolution.\nPartners also have the right to indemnification from the\npartnership for actions of other partners. For example, if the\npartnership is sued because a partner commits a tort, the other\npartners\n\nmay\n\nlose\n\ntheir\n\nmonetary\n\ninvestment\n\nin\n\nthe\n\npartnership but their personal assets are not at risk.\nPartners are co-owners of partnership property. Unless altered\nby a partnership agreement, partners have an equal right to\npossess partnership property for business purposes.\n\n309 | Partnerships\n\n\x0cDuties of Partners\nFigure 17.2 Duties of Partners\n\nA partnership is a fiduciary relationship. Therefore, partners\nowe each other duties as a result of their relationship of trust\nand confidence.\nPartners owe each other a duty of care. In a partnership, this\ngenerally means refraining from intentional and reckless\nmisconduct. A partner is not liable to the other partners for\nsimple negligence. Thus, the duty of care for partnerships is not\nparticularly burdensome.\nPartners also owe each other the duty of loyalty, which requires\nthe partner to put the interests of the partnership before his\nor her own personal interests. Self-dealing and taking business\nopportunities away from the partnership are examples of\nbreaches of the duty of loyalty.\nFrom the duty of loyalty rise the remaining duties that partners\nowe each other: the duty of service, obedience, accounting,\nand to inform other partners of material information. When\n\nPartnerships | 310\n\n\x0cloyal to the partnership, a partner will work in service of the\npartnership, follow reasonable directions of other partners,\nprovide an accounting of business assets, and inform the other\npartners of material information that affects the business.\n\n17.5 Termination of a Partnership\nThe legal end of a partnership is called dissolution. Dissolution\nmay occur when partners mutually agree to stop working\ntogether, a partner dies or withdraws from the partnership,\nor a new partner is added. A new partnership is formed when\nthere is a change in partners, whether an existing partner\nleaves or a new partner is added. Often, these types of changes\ndo not impact the day-to-day operations of the business\nsignificantly. However, a new partnership agreement, and\nsometimes a new partnership name, is necessary.\nIf the partnership ceases to operate, then winding up\noccurs. Winding up is the process in which a partnership is\nliquidated. Partnership assets are reduced to cash, creditors are\npaid off, and any remaining profit and assets are distributed to\nthe partners. Partial winding up occurs when the partnership\nhas insufficient cash to operate its business and needs to sell\nits assets to pay off debts. Complete winding up occurs when\nthe partnership is no longer viable or the partners decide not\nto work together any more. Termination is when the process of\nwinding up is finished and the partnership no longer exists.\nFigure 17.3 Dissolution of Partnership\n\n311 | Partnerships\n\n\x0cMany factors can determine whether there is partial or\ncomplete winding up. For example, bankruptcy of a partner or\nthe partnership, change in laws that make the subject matter\nof the business illegal, the death or incapacity of a partner,\nchange in economic circumstances, or litigation.\nDuring winding up, there is a priority of distributing the\npartnership assets. In general, all creditors other than partners\nare entitled to be paid before the partners divide up the\npartnership\xe2\x80\x99s assets.\nThe priority of distributing the partnership assets is:\n1. Third party creditors;\n2. Partnership advances;\n3. Partnership capital; then\n4. Remaining profits to partners.\nIf the partnership does not have enough assets to cover its\nPartnerships | 312\n\n\x0cdebts, then the priority of paying creditors is governed by the\nstate law where the partnership exists. State laws vary\nregarding the priority of distributing assets, but most states\nfollow a process called marshaling of assets. Marshaling of\nassets is an equitable doctrine for a fair distribution of a\ndebtor\xe2\x80\x99s assets among multiple creditors.\n\n17.6 Concluding Thoughts\nPartnerships are the most common business form in the\nUnited States, in large part because of their flexibility and ease\nof creation. However, if individuals want to create a partnership,\na best practice would be to create a partnership agreement\nthat identifies the rights and obligations of the partners.\nPartnerships are fiduciary relationships in which the law\ncreates certain rights and obligations even if there is not a\npartnership agreement.\n\n313 | Partnerships\n\n\x0c18. Corporations\n18.1 Introduction\nLEARNING OBJECTIVES\n1. Understand how corporations are structured and\nmanaged.\n2. Learn about shareholder rights and the powers and\nliabilities of corporate officers and directors.\n3. Learn the legal theories under which limited liability is\ntaken away from corporations.\n4. Comprehend how corporations merge, consolidate, and\ndissolve.\nCorporations are incredibly important to the stability and\ngrowth of the US economy. Without corporations, industries\nsuch as pharmaceuticals and technology would not be able\nto raise the capital needed to fund their research and\ndevelopment of new drugs and products. As discussed in\nChapter 16, corporations are incorporated under state law and\nare subject to double taxation. Corporations are separate legal\nentities from the shareholders who own them.\n\nCounselor\xe2\x80\x99s Corner \xe2\x80\x9cCorporations are [often] people\ntoo!\xe2\x80\x9d Although the word \xe2\x80\x9ccorporation\xe2\x80\x9d is not found\nin the Constitution, US corporations are increasingly\nconsidered US persons for legal purposes. The\n\nCorporations | 314\n\n\x0cSupreme Court has ruled that corporations are\nentitled to equal protection, to make political\ncontributions, and to refuse certain employee health\nplans on religious grounds. Congress now generally\ndefines \xe2\x80\x9cperson\xe2\x80\x9d as including \xe2\x80\x9ccorporations,\xe2\x80\x9d which\nallows them to enter contracts, own property, sue\nand be sued, and pay taxes. The president has\nissued Executive Orders giving corporations certain\nprivacy protections regarding the government\xe2\x80\x99s\nauthority to collect and use information about them.\nCorporations do not, however, have all the legal\nprotections that people have, such as the right to\navoid self-incrimination. Nevertheless, generally\nthinking of US corporations as US persons will often\nhelp you better understand their legal rights,\nresponsibilities, and protections, and make you a\nmore educated business person, lawyer, or citizen.\n~Tom M., attorney\n\n18.2 Corporate Structure\nUnder most state laws, corporations are required to have at\nleast one director. A director is a person appointed or elected to\nsit on a board that manages the business of a corporation and\nsupervises its officers. Directors are elected by shareholders\nand collectively are called the Board of Directors. Directors\nelect officers, who are responsible for the daily operations of\nthe corporation. Officers often have titles such as president,\nchief operating officer, chief financial officer, or controller.\n315 | Corporations\n\n\x0cFigure 18.1 Corporate Legal Structure\n\n18.3 Shareholder Rights\nAs owners of the corporation, shareholders have specific rights\nto help them assess their investment decisions. Shareholders\nare not entitled to manage the day-to-day operations of the\nbusiness, but they enjoy the following rights.\nFigure 18.2 Corporate Shareholder Rights\n\nCorporations | 316\n\n\x0cInspection\nShareholders have the right to inspect the certified financial\nrecords of a corporation. This right also extends to other\ninformation related to exercising their voting privilege and\nmaking investment decisions.\nThe right, however, is limited to good-faith inspections for\nproper purposes at an appropriate time and place. A proper\npurpose is one that seeks to protect the interests of both the\ncorporation and the shareholder seeking the information. In\nother words, the inspection cannot be against the best interest\nof the corporation.\nCourts have held that proper purposes include:\n\n317 | Corporations\n\n\x0c\xe2\x80\xa2 Reasons for lack of dividend payments or low dividend\namounts;\n\xe2\x80\xa2 Suspicion of mismanagement of assets or dividends; and\n\xe2\x80\xa2 Holding management accountable.\nCorporations have a legitimate interest in keeping their\nfinancial and managerial documents private. Therefore,\ninspection of documents usually occurs at the corporation\xe2\x80\x99s\nheadquarters during regular business hours. Documents made\navailable for inspection do not have to be allowed off premise if\nthe corporation does not want them to be removed.\n\nShareholder Meetings\nShareholders have the right to notice and to attend\nshareholder meetings. Shareholder meetings must occur at\nleast annually, and special meetings may be called to discuss\nimportant issues such as mergers, consolidations, change in\nbylaws, and sale of significant assets. Failure to give proper\nnotice invalidates the action taken at the meeting.\nA quorum of shareholders must be present at the meeting\nto conduct business. A quorum is the minimum number of\nshareholders (usually a majority) who must be present to take\na vote. The corporation\xe2\x80\x99s bylaws define what constitutes a\nquorum, if not set by state law.\nIf a shareholder is not able to be physically present during\na meeting, he or she may vote by proxy. A proxy is a person\nauthorized to vote on another\xe2\x80\x99s stock shares.\n\nCorporations | 318\n\n\x0cVote\nDepending on the type of share owned, shareholders may have\nthe right to vote. In general, shareholders of common stock are\nentitled to a vote for each share of stock owned. Owners of\npreferred stock often do not have a voting right in exchange for\na higher dividend amount or preference in receiving dividends.\nCommon issues that shareholders vote on include:\n\xe2\x80\xa2 Election of directors;\n\xe2\x80\xa2 Mergers, consolidations, and dissolutions;\n\xe2\x80\xa2 Change of bylaws;\n\xe2\x80\xa2 Change in major corporate policies; and\n\xe2\x80\xa2 Sale of major assets.\n\nPreemptive Rights\nThe Preemptive right is a shareholder\xe2\x80\x99s privilege to buy newly\nissued stock in the corporation before the shares are offered\nto the public. Shareholders are allowed to buy shares in an\namount proportionate to their current holdings to prevent\ndilution of the existing ownership interests.\nPreemptive rights usually must be exercised within thirty to\nsixty days of being offered. This allows the corporation to\ncomplete the sale to shareholders before offering any\nremaining shares to the public.\n\nDerivative Suit\nA derivative suit is a lawsuit brought by a shareholder on the\ncorporation\xe2\x80\x99s behalf against a third party because of the\n319 | Corporations\n\n\x0ccorporation\xe2\x80\x99s failure to take action on its own. Derivative\nactions are usually brought by shareholders against officers or\ndirectors for not acting in the best interest of the corporation.\nTo be eligible to bring a derivative action, a shareholder must\nown shares in the corporation at the time of the alleged injury.\nAn individual or business cannot buy shares in a corporation to\nfile a derivative suit for actions that occurred before becoming\na shareholder.\nBefore bringing a derivative suit, shareholders must show that\nthey attempted to get the officers and directors to act on\nbehalf of the corporation first. Only after the officers and\ndirectors refuse to act may a derivative suit be filed.\nDissatisfaction\n\nwith\n\nthe\n\ncorporation\xe2\x80\x99s\n\nmanagement\n\nis\n\ninsufficient to justify a derivative suit. Derivative suits have\nbeen successful when misconduct or fraud of a director or\nofficer is involved. If successful, any damages are awarded to\nthe corporation, not the shareholders who brought the lawsuit.\n\nDividends\nA dividend is a portion of a corporation\xe2\x80\x99s profits distributed to\nits shareholders on a pro rata basis. Dividends are usually paid\nin the form of cash or additional shares in the corporation.\nAlthough shareholders have a right to a dividend when\ndeclared, the board of directors has the discretion to decide\nwhether to declare a dividend. The board may decide to\nreinvest profits into the corporation, pay for a capital expense,\npurchase additional assets, or to expand the business. As long\nas the board of directors acts reasonably and in good faith,\nits decision regarding whether to declare a dividend is usually\nupheld by the courts.\n\nCorporations | 320\n\n\x0c18.4 Corporate Officer and Directors\nAlthough shareholders own the corporation, the officers and\ndirectors are empowered to manage the day-to-day business\nof the corporation. The officers and directors owe a fiduciary\nduty to both the corporation and its shareholders. This means\nthat the officers and directors must act in the best interest of\nthe corporation and shareholders.\n\nDuty of Loyalty\nAs part of their fiduciary duty, officers and directors have a duty\nof loyalty to the corporation and its shareholders. The duty of\nloyalty requires them to act:\n\xe2\x80\xa2 In good faith;\n\xe2\x80\xa2 For a lawful purpose;\n\xe2\x80\xa2 Without a conflict of interest; and\n\xe2\x80\xa2 To advance the best interests of the corporation.\nDuty of loyalty issues frequently arise in the context of a\ndirector entering into a contract with the corporation or\nloaning it money. Other situations may involve a director taking\na business opportunity away from the corporation for his or\nher own personal gain. The corporate opportunity doctrine\nprevents officers and directors from taking personal advantage\nof a business opportunity that properly belongs to the\ncorporation.\n\nDuty of Care\nThe duty of care requires officers and directors to act with the\n321 | Corporations\n\n\x0ccare that an ordinary prudent person would take in a similar\nsituation. In other words, they have a duty not to be negligent.\nThe extent of this duty depends on the nature of the\ncorporation and the type of role the director or officer fills. For\nexample, the duty of care imposed on the board of directors of\na federally-insured bank will be higher than the duty imposed\non a small nonprofit organization.\nIn general, though, directors should understand the nature and\nscope of the corporation\xe2\x80\x99s business and industry, as well as\nhave any particular skills necessary to be successful in their\nrole. Officers and directors also should stay informed about\nthe corporation\xe2\x80\x99s activities and hire experts when they lack\nthe expertise necessary to make the best decisions for the\ncorporation. The duty of care requires officers and directors to\nmake informed decisions.\n\nCompensation\nOfficers and directors are usually entitled to compensation for\ntheir work on behalf of the corporation. Some states restrict\nwhether directors may receive compensation and, if so, how\nmuch. The issue of executive compensation has been a hot\nbutton issue in recent decades.\n\nBusiness Judgment Rule\nThe business judgment rule is the presumption that corporate\ndirectors act in good faith, are well-informed, and honestly\nbelieve their actions are in the corporation\xe2\x80\x99s best interest. The\nrule shields directors and officers from liability for unsuccessful\n\nCorporations | 322\n\n\x0cor unprofitable decisions, as long as they were made in good\nfaith, with due care, and within their authority.\nIt is important to understand that courts do not focus on the\nresult of the business decision. Instead, courts look at the\nprocess that the decision makers went through. If the process\nis careless or not in the best interest of the corporation and\nshareholders, the business judgment rule will not protect\nthem.\nThe business judgment rule does not protect officers and\ndirectors from decisions made in their own self-interest or selfdealing. In those situations, the action must be approved by\ndisinterested\n\nmembers\n\nof\n\nthe\n\nboard\n\nof\n\ndirectors\n\nor\n\nshareholders. If the decision is subject to a derivative suit, the\ncourt may determine that the decision was fair to the\ncorporation. If the decision is approved by the court or\ndisinterested board members or shareholders, then the\ndecision may be valid.\nThe business judgment rule does not protect officers and\ndirectors from decisions made in bad faith, as a result of fraud,\nthrough gross negligence, or as an abuse of discretion. In those\nsituations, the officers and directors may be personally liable\nfor their actions.\nFigure 18.3 Business Judgment Rule Flowchart\n\n323 | Corporations\n\n\x0c18.5 Legal Theories\nOne of the main benefits of corporations is limiting\nshareholders\xe2\x80\x99 liability to the amount of their investment in the\ncorporation. In general, a shareholder may lose his or her\ninvestment in the corporation if it is not a successful business\nor if it is sued. Because corporations are a separate legal entity\nthan their shareholders, shareholders are generally shielded\nfrom corporate liability. However, three exceptions to this rule\nallow shareholders to be held liable for the corporation\xe2\x80\x99s\nactions.\n\nCorporations | 324\n\n\x0cPiercing the Corporate Veil\nPiercing the Corporate Veil is a legal theory under which\nshareholders or the parent company are held liable for the\ncorporation\xe2\x80\x99s actions or debts. Under this theory, plaintiffs ask\nthe court to look beyond the corporate structure and allow\nthem to sue the shareholders or parent company as if no\ncorporation existed. In essence, the court strips the \xe2\x80\x9cveil\xe2\x80\x9d of\nlimited liability that incorporation provides and hold a\ncorporation\xe2\x80\x99s shareholders or directors personally liable.\nThis theory applies most often in closely held corporations.\nWhile legal requirements vary by state, courts are usually\nreluctant to pierce the corporate veil. However, courts will do\nso in cases involving serious misconduct, fraud, commingling\nof\n\npersonal\n\nand\n\ncorporate\n\nfunds,\n\nand\n\ndeliberate\n\nundercapitalization during incorporation.\n\nAlter Ego Theory\nThe Alter Ego Theory is the doctrine that shareholders will be\ntreated as the owners of a corporation\xe2\x80\x99s property or as the real\nparties in interest when necessary to prevent fraud or to do\njustice. In other words, the court finds a corporation lacks a\nseparate identity from an individual or corporate shareholder.\nThis theory applies most often when a corporation is a whollyowned subsidiary of another company. Courts allow the alter\nego theory when evidence exists that the parent company is\ncontrolling the actions of the subsidiary, and the corporate\nform is disregarded by the shareholders themselves. The\nrationale is that shareholders cannot benefit from limited\nliability when there is such unity of ownership and interest that\na separate entity does not actually exist. To allow shareholders\n\n325 | Corporations\n\n\x0cto \xe2\x80\x9chave it both ways\xe2\x80\x9d would result in injustice to the\ncorporation\xe2\x80\x99s debtors and those hurt by its actions.\n\nPromotion of Justice Theory\nThe Promotion of Justice Theory is used when the corporate\nform is used to defraud shareholders or to avoid compliance\nwith the law. Courts use this theory to prevent shareholders\nfrom using a corporation to achieve what they could not do\ndirectly themselves. For example, if a state limits the number of\nliquor licenses an individual may obtain at one time, a person\ncannot form multiple corporations to obtain more licenses.\n\n18.6 Mergers, Consolidations, and\nDissolutions\nOnce incorporated, corporations may last forever. However,\nthey also may be merged or consolidated into other business\nentities or dissolved.\nOften businesses will buy the assets of another business. When\nthis happens, the seller remains in existence and retains its\nliabilities. The buyer does not become legally responsible for\nthe seller\xe2\x80\x99s actions through a mere purchase of assets.\nMergers and consolidations, however, involve the termination\nof the seller.\n\nMerger\nA merger occurs when one corporation absorbs another. The\nCorporations | 326\n\n\x0cacquiring corporation continues to exist but the target\ncorporation ceases to exist. The acquiring corporation acquires\nall the assets and liabilities of the target corporation.\nCorporate mergers must conform to state laws and usually\nmust be approved by the majority of shareholders of both\ncorporations. Many states require approval by two-thirds of the\nshareholders. If approved, articles of merger must be filed in\nthe state(s) where the corporations exist.\nFigure 18.4 Merger\n\nConsolidation\nConsolidation occurs when two or more corporations are\ndissolved and a new corporation is created. The new\ncorporation owns all the assets and liabilities of the former\ncorporations.\nLike mergers, consolidations must be approved by the majority\nor two-thirds of shareholders of all corporations involved. If\napproved, articles of consolidation must be filed in the state(s)\nwhere the corporations existed.\nMergers and consolidations are often scrutinized under\nantitrust laws to ensure that the resulting corporation is not a\nmonopoly in the relevant market. Antitrust laws are discussed\nin Chapter 19.\nFigure 18.5 Consolidation\n\n327 | Corporations\n\n\x0cVoluntary Dissolution\nA corporation that has obtained its charter but has not begun\nits business may be dissolved voluntarily by its incorporators.\nThey simply need to file articles of dissolution in the state of\nincorporation.\nIf a corporation has been in business, voluntary dissolution is\npossible when either (1) all shareholders give written consent or\n(2) the board of directors vote for dissolution and two-thirds of\nthe shareholders approve.\nTo dissolve a corporation voluntarily, the corporation must file\na statement of intent to dissolve. At that point, the corporation\nmust cease all business operations except those necessary to\nwind up its business affairs. The corporation must give notice\nto all known creditors of its dissolution. If the corporation fails to\ngive notice, then the directors become personally responsible\nfor any debt and legal liability. The corporation is required to\npay off all debts before distributing any remaining assets to\nshareholders.\nUntil the state issues the articles of dissolution, the statement\nof intent may be revoked if shareholders change their mind.\n\nCorporations | 328\n\n\x0cInvoluntary Dissolution\nStates have the power to create corporations through granting\ncorporate charters. Similarly, states have the right to revoke\ncorporate charters. Actions brought by the state to cancel a\ncorporate charter are called quo warranto proceedings.\nCorporate charters may be canceled when a corporation:\n\xe2\x80\xa2 Did not file its annual report;\n\xe2\x80\xa2 Failed to pay its taxes and licensing fees;\n\xe2\x80\xa2 Obtained its charter through fraud;\n\xe2\x80\xa2 Abused or misused its authority;\n\xe2\x80\xa2 Failed to appoint or maintain a registered agent; or\n\xe2\x80\xa2 Ceased to do business for a certain period of time.\nShareholders may also request dissolution when:\n\xe2\x80\xa2 The shareholders are deadlocked and cannot elect a board\nof directors;\n\xe2\x80\xa2 When there is illegal, fraudulent or oppressive conduct by\nthe directors or officers;\n\xe2\x80\xa2 When majority shareholders breach their fiduciary duty to\nthe minority shareholders;\n\xe2\x80\xa2 Corporate assets are being wasted or looted; or\n\xe2\x80\xa2 The corporation is unable to carry out its purpose.\nFinally, dissolution may occur as a result of bankruptcy or when\nthe corporation is unable to cover its debts to creditors.\n\n18.7 Concluding Thoughts\nCorporations are owned by shareholders but are run by\n\n329 | Corporations\n\n\x0cdirectors and officers. As a legal entity separate from its\nshareholders,\n\ncorporations\n\nprovide\n\nlimited\n\nliability\n\nto\n\nshareholders who invest in them. However, personal liability\nmay be imposed when fraud or other serious misconduct\noccurs. As long as their decisions are made in good faith, with\ndue care, and within their authority, officers and directors are\nprotected by the business judgment rule. Finally, corporations\nhave a perpetual existence unless they are dissolved through\ntheir own action, by the state, or initiated by shareholders or\ncreditors.\n\nCorporations | 330\n\n\x0c19. Antitrust Law\n19.1 Introduction\nLEARNING OBJECTIVES\n1. Understand the important federal antitrust laws, along\nwith their exemptions.\n2. Learn the factors used to determine whether a monopoly\nexists.\n3. Comprehend the common types of unreasonable\nrestraints on trade.\nAntitrust laws are designed to protect trade and commerce\nfrom unreasonable restraints, monopolies, price fixing, and\nprice discrimination. Antitrust laws regulate the market just\nenough to foster economic growth and competition while\npreventing stagnation and unethical practices by monopolies\nthat prevent the free market from operating as it should.\nThe main federal antitrust laws are the Sherman Act, the\nClayton Act, and the Federal Trade Commission Act. The\nlegislative declarations of these Acts make it clear that\nCongress wants to promote fair competition within the market\neconomy.\n\nCounselor\xe2\x80\x99s Corner It is difficult at first blush to\ndetermine if a business\xe2\x80\x99s strong market presence is\nthe result of a superior product or service that the\n\n331 | Antitrust Law\n\n\x0cpublic demands or unfair business practices. In the\ntechnology industry, the big players have invested\nso much into research and development to bring\ncutting edge products to market. But if their\nproducts are not user friendly and do not meet\ncustomer needs, they will not get a return on their\ninvestment. As a result, we see an uptick in antitrust\ncomplaints from competitors to bring down\nbusinesses when they can\xe2\x80\x99t do so on the open\nmarket. Antitrust laws are not a sword of\ncompetitors to be used for unjust means. Thus,\nantitrust allegations require examining the entire\nrelevant market, including the complaining party.\n~Robert S., judge\n\n19.2 Historical Development\nThe United States economy was founded on the capitalist\nprinciple of free enterprise. Free enterprise is a private and\nconsensual system of production and distribution, usually\nconducted for profit in a competitive environment, that is\nrelatively free of governmental interference. The theory is that,\ngiven the freedom, businesses will operate efficiently and be\nresponsive to consumer needs and demands.\nThe weakness of the free enterprise system is that it assumes\nthat businesses will be ethical and compete with each other\nfairly. During the Industrial Revolution, powerful businessmen\ntook advantage of the free enterprise system to increase their\n\nAntitrust Law | 332\n\n\x0cwealth at the expense of their workers, competitors, and\nconsumers.\nThese Industrialists bought shares in competing companies\nthen transferred the shares to a trust. The trust then set prices\nfor goods within the industry, determined which companies\ncould operate in a given geographic area, and micromanaged\nthe business operations of companies within an industry. As\na result, companies that were not part of the trust went\nbankrupt, new competitors were prevented from entering the\nmarket,\n\nand\n\nconsumer\n\nprices\n\nrose\n\nbeyond\n\nmarket\n\nrequirements.\nStates tried to stop the abuses of the Industrialists through\nthe trusts. State attempts failed because the US economy was\ngrowing beyond state industries to national ones. As a result,\nnational legislation was needed to restore balance to the\nmarket. The resulting legislation is called \xe2\x80\x9cantitrust law\xe2\x80\x9d\nbecause its purpose was to break up the power of the\nIndustrialists\xe2\x80\x99 trusts.\nIn 1890, Congress passed the Sherman Antitrust Act under its\npower to regulate interstate commerce. The Sherman\nAntitrust Act (also known as the Sherman Act) prohibits direct\nor indirect interference with the freely competitive interstate\nproduction and distribution of goods. The Act addresses two\nmain concerns:\n1. Unreasonable restraints on trade between two or more\nparties; and\n2. Monopolies.\nIn 1914, Congress passed the Clayton Act. The Clayton Act\namended the Sherman Act and expanded antitrust regulations\nto prohibit:\n\n333 | Antitrust Law\n\n\x0c1. Price discrimination;\n2. Tying arrangements;\n3. Exclusive-dealing contracts; and\n4. Mergers resulting in monopolies or substantially lessening\ncompetition.\nCongress also passed the Federal Trade Commission Act in\n1914. The Federal Trade Commission Act established the\nFederal Trade Commission (FTC) to protect consumers against\ndeceptive practices and enforce antitrust laws. The Act\nprohibits false, deceptive, and unfair advertising and trade\npractices. Some of these practices are discussed in more detail\nin Chapter 20.\nFigure 19.1 The Federal Trade Commission Act\n\nThe last major antitrust law is the Robinson-Patman Act, which\nwas passed by Congress in 1936. The Robinson-Patman Act\namended the Clayton Act and prohibits price discrimination\nthat hinders competition or that tends to create a monopoly.\n\nAntitrust Law | 334\n\n\x0c19.3 Monopoly\nA monopoly is the control or advantage obtained by one\nsupplier or producer over the commercial market within a\ngiven region. Not all monopolies are illegal. In fact, some\nindustries are exempted from antitrust laws:\n\xe2\x80\xa2 Highly regulated industries;\n\xe2\x97\xa6 Utilities;\n\xe2\x97\xa6 Railroads;\n\xe2\x97\xa6 Airlines;\n\xe2\x97\xa6 Insurance companies;\n\xe2\x97\xa6 Securities; and\n\xe2\x97\xa6 Banks\n\xe2\x80\xa2 Labor unions;\n\xe2\x80\xa2 Agricultural and fishing cooperatives (farmers not\ndistributors);\n\xe2\x80\xa2 Exporters;\n\xe2\x80\xa2 Lobbyists;\n\xe2\x80\xa2 States (unclear if includes US territories); and\n\xe2\x80\xa2 Professional baseball.\nTo be an illegal monopoly, a business must have (1) monopoly\npower (2) in the relevant market and (3) the intent to acquire\nand use such power.\n\nMonopoly Power\nMonopoly power is the power of a business to fix prices\nunilaterally or to exclude competition. The size of a business\xe2\x80\x99s\nmarket share is a primary factor of whether monopoly power\nexists.\n\n335 | Antitrust Law\n\n\x0cCourts have found monopoly power when a business controls\nseventy percent or more of a market.\nIf a business controls 51-69 percent of a market, then it is\npossible that monopoly power exists. Courts examine other\nfactors such as number of competitors, market concentration,\ndegree of difficulty for new businesses to enter the industry,\nand the nature of the industry. If the entry costs and barriers\nare high and there are few other competitors, a business may\nhave monopoly power when it controls slightly more than half\nthe market.\nIf a business controls fifty percent or less of a market, then no\nmonopoly power exists.\n\nRelevant Market\nTo determine whether a business has monopoly power, it must\nbe determined whether it has monopoly power within the\nrelevant market. However, defining the relevant market can be\nchallenging. The relevant market includes both the product or\nservice market and the geographic area.\n\nProduct or Service Market\nThe first element in determining the relevant market is to\ndetermine what goods or services are interchangeable in\nconsumers\xe2\x80\x99 minds. This is sometimes called substitutability or\nfunctional interchangeability. Defining the exact product or\nservice market is usually heavily litigated because it may result\nin market concentration or dilution, and ultimately whether a\nbusiness has enough market share to be deemed a monopoly.\n\nAntitrust Law | 336\n\n\x0cFor example, Ford shares the passenger truck market with\nmanufacturers such as Chevrolet, GMC, Dodge, Toyota, Nissan,\nand Honda. However, Ford shares the commercial truck\nmarket with manufacturers such as Peterbilt, Volvo, Daimler,\nand Volkswagen. If sued for violation of antitrust law, Ford\nwould want a broad definition of the product market, such\nas \xe2\x80\x9ctrucks,\xe2\x80\x9d to include a greater number of competitors and\nlessen its own market share. Plaintiffs would want to define\nthe product narrowly, such as \xe2\x80\x9cthree-quarter ton passenger\ntrucks,\xe2\x80\x9d to lessen the number of competitors and heighten\nFord\xe2\x80\x99s market share.\nAs large companies expand their products and services across\nindustries, this inquiry becomes more complex and expensive\nto litigate.\n\nGeographic Area\nDetermining\n\na\n\nbusiness\xe2\x80\x99s\n\nmarket\n\npower\n\nalso\n\nrequires\n\ndetermining the geographic area in which the business\noperates. As globalization and e-commerce increase the\ngeographic reach of businesses, this inquiry is also becoming\nmore difficult.\nFor example, should the market for Ford passenger trucks be\ndetermined by city, state, nation, continent, hemisphere, or\nglobally? Ford trucks may have higher sales in Detroit,\nMichigan than in Tokyo, Japan. Determining the geographic\narea of the relevant market may include areas of higher or\nlesser concentrations of sales. Therefore, parties also heavily\nlitigate what is the appropriate geographic area for the relevant\nmarket.\n\n337 | Antitrust Law\n\n\x0cIntent\nThe third factor is the business\xe2\x80\x99s intent to acquire and use its\nmonopoly power.\nNot all monopolies are the result of a business\xe2\x80\x99s predatory\nactions. Some \xe2\x80\x9cboom and bust\xe2\x80\x9d industries, such as mining and\noil and gas, are difficult to maintain long-term success. If an\nindustry goes through a difficult time and competitors go out\nof business, the remaining company may end up as a\nmonopoly without engaging in anticompetitive behavior.\nTo determine intent, courts look at the conduct of the business.\nPurchasing smaller competitors to increase its market share\nand engaging in predatory pricing is often evidence of a\ncompany\xe2\x80\x99s intent to become a monopoly.\nSpecifically, an intent to monopolize requires:\n1. Predatory or anticompetitive conduct;\n2. Specific intent to control prices or destroy competition;\nand\n3. A dangerous probability of success.\nA business\xe2\x80\x99s intent is evaluated in the context of the current\nindustry and economic conditions. For example, are there\nsignificant changes to the law that affect the profitability of the\nindustry or an economic downturn that impacts competition?\nJust because a company is large enough to successfully survive\na challenging time, it may not have the necessary intent to\nbecome an illegal monopoly.\n\nAntitrust Law | 338\n\n\x0c19.4 Unreasonable Restraints on\nTrade\nAntitrust laws prohibit unreasonable restraints on trade.\nA restraint on trade is an agreement between two or more\nbusinesses intended to eliminate competition, create a\nmonopoly, artificially raise prices, or adversely affect the free\nmarket. A restraint on trade that produces a significant\nanticompetitive effect and, therefore, violates antitrust laws is\nan unreasonable restraint on trade.\n\nConcerted Action\nConcerted action is an action that has been planned, arranged,\nand agreed on by parties acting together to further some\nscheme or cause. Concerted action can be either horizontal\nor vertical. Horizontal agreements occur between direct\ncompetitors. For example, cell phone providers decide to lock\ncustomers into two-year contracts. Customers are required to\nagree to terms that benefit the companies, regardless of which\nprovider they choose.\nFigure 19.2 Horizontal Restraints on Trade\n\n339 | Antitrust Law\n\n\x0cHorizontal agreements are almost always struck down as per\nse violations of antitrust laws. Because competitors appear to\nmake decisions based on their own self-interest rather than\nletting the market forces decide price and conditions, courts\nconclude that such agreements are not in the interest of\nconsumers and the free market.\nVertical agreements occur between businesses at different\nplaces along the distribution chain of a given product. For\nexample, a manufacturer suggests a sale price to a wholesaler\nof its product (i.e. \xe2\x80\x9cmanufacturer\xe2\x80\x99s suggested retail price\xe2\x80\x9d).\nFigure 19.3 Vertical Restraints on Trade\n\nVertical agreements are usually subject to a \xe2\x80\x9crule of reason\xe2\x80\x9d test\nto determine if they are illegal. The rule of reason test is a caseby-case analysis of the agreement, industry, effects, and intent\nof the businesses. Although it is possible to show that a vertical\n\nAntitrust Law | 340\n\n\x0cagreement is legal, it usually costs businesses a lot to litigate\nthese types of cases.\n\nPrice Fixing\nPrice fixing is the artificial setting or maintaining of prices\nat a certain level, contrary to the workings of the free\nmarket. Horizontal\n\nprice\n\nfixing\n\nis\n\nprice\n\nfixing\n\namong\n\ncompetitors at the same level, such as retailers throughout an\nindustry. Vertical price fixing is price fixing among businesses\nin the same chain of distribution, such as manufacturers and\nretailers attempting to control a product\xe2\x80\x99s resale price.\nOne form of price fixing is predatory pricing. Predatory pricing\noccurs when a company lowers its prices below cost to drive\ncompetitors out of business. Once a predator rids the market of\ncompetition, it raises prices to make up lost profits. The goal of\npredatory pricing is to win control of a market or to maintain it.\nPredatory pricing has three elements:\n1. The alleged predator is selling products below cost;\n2. The alleged predator intends that its competition goes out\nof business; and\n3. If the competitors go out of business, the alleged predator\nwill be able to earn sufficient profits to recover its prior\nlosses.\nPredatory pricing cases are often hard to win because it is\ndifficult to prove the alleged predator\xe2\x80\x99s intent.\n\n341 | Antitrust Law\n\n\x0cDivision of the Market\nDivision of the market occurs when businesses agree to\nexclusively sell products or services in specific geographic\nterritories. A horizontal division of the market is when\ncompetitors enter into an agreement to not compete for\ncustomers by dividing a geographic area into separate sales\nterritories. A vertical division of the market is when a\nmanufacturer\n\nand\n\nits\n\nwholesalers\n\nagree\n\nto\n\nexclusive\n\ndistributorships in a given territory.\nExclusive\n\ndistributorships\n\nare\n\nusually\n\nlegal\n\nunless\n\nthe\n\nmanufacturer has dominant power in the overall market. For\nexample, Wendy\xe2\x80\x99s grants exclusive distributorships to its\nfranchisees to avoid oversaturation in a given geographic area.\nAs long as Wendy\xe2\x80\x99s is not the only fast food restaurant within a\nparticular market, the exclusive distributorships will be upheld.\nThis is because Wendy\xe2\x80\x99s has a legitimate business interest in\nnot diluting the value of its franchises, which does not restrict\nconsumers\xe2\x80\x99 choice of fast food restaurants in the overall\nmarket.\n\nGroup boycotts\nA boycott is an action designed to socially or economically\nisolate an adversary. A group boycott is an agreement between\ntwo competitors who refuse to do business with a third party\nunless it refrains from doing business with an actual or\npotential competitor of the boycotters. Group boycotts may be\neither horizontal or vertical.\nFigure 19.4 Horizontal Group Boycott\n\nAntitrust Law | 342\n\n\x0cExclusionary Contracts\nExclusionary contracts require businesses to buy or lease\nproducts on the condition that they do not use the goods\nof a competitor of the seller. The most common types of\nexclusionary contracts are tying arrangements and exclusive\ndealing arrangements.\nA tying arrangement occurs when a buyer is not permitted\nto purchase one item without purchasing another. These are\noften called \xe2\x80\x9cbundling packages.\xe2\x80\x9d These arrangements benefit\na seller because it allows the seller to wed a popular item with\none that is less desirable and would not get as many sales\nindependently.\nUnder the rule of reason test, a tying arrangement is illegal\nwhen:\n1. The agreement involves two distinct products not closely\nrelated to each other;\n2. Commerce is impacted significantly; and\n\n343 | Antitrust Law\n\n\x0c3. The seller has sufficient economic power in the tying\nproduct to enforce the tie-in.\nAn exclusive dealing arrangement exists when a buyer agrees\nto purchase all of its requirements from a single seller or a seller\nagrees to sell all of its output to a single buyer. Exclusive dealing\narrangements are illegal when they substantially lessen\ncompetition or tend to create a monopoly.\n\nMergers and Acquisitions\nRegardless of a business\xe2\x80\x99s intention when merging or\nacquiring another business, a merger or acquisition is\nprohibited when it may substantially lessen competition or\nmay create a monopoly. When analyzing a potential merger,\nthe court considers:\n1. The relevant market;\n2. The pre-merger profile of the business; and\n3. The post-merger profile of the business.\nAs discussed above, the relevant market is determined by\nexamining the relevant product or service market, as well as\nthe geographic area of the business\xe2\x80\x99s operations.\nThe pre-merger profile is determined by analyzing the type\nof merger, the size of the companies involved, and the\nconcentration of the industry. Mergers may be horizontal,\nvertical, or conglomerate. Horizontal mergers are between\ncompetitors. Vertical mergers are between businesses within\na supply chain. And conglomerate mergers are between\ncompanies\n\nin\n\ndifferent\n\nindustries.\n\nAn\n\nexample\n\nof\n\na\n\nconglomerate merger is Amazon\xe2\x80\x99s acquisition of Whole Foods\nin 2107.\n\nAntitrust Law | 344\n\n\x0cThe post-merger profile uses the same factors as the premerger profile but looks at the anticipated business after the\nmerger.\n\n19.5 Price Discrimination\nPrice discrimination is the practice of offering identical or\nsimilar goods to different buyers at different prices when the\ncosts\n\nof\n\nproducing\n\nthe\n\ngoods\n\nare\n\nthe\n\nsame.\n\nPrice\n\ndiscrimination may violate antitrust laws if it reduces\ncompetition.\nPrice discrimination may be either direct or indirect. Direct\nprice discrimination occurs when a seller charges different\nprices to different buyers. Indirect price discrimination occurs\nwhen a seller offers special concessions (such as favorable\ncredit terms) to some, but not all, buyers.\nThe Robinson-Patman Act defines discrimination in terms of\nfirst, second and third lines. First line price discrimination is\nwhen the seller directly offers different prices to different\nbuyers. For example, coffee sold to individual customers is\npriced differently. First line price discrimination is legal when\nthe lower price is offered to customers who buy large\nquantities, use coupons, or are part of a loyalty program. It is\nalso legal if the price difference is the result of manufacturing,\nsales or delivery costs. For example, coffee prices may be lower\nfor Hawaiian coffee in Hawaii because there are less\ntransportation costs involved than shipping coffee to the\nContinental United States.\nFigure 19.5 First Line Discrimination\n\n345 | Antitrust Law\n\n\x0cSecond line price discrimination occurs when a manufacturer\ndemands lower prices from suppliers. For example, large\nretailers often demand discount prices from manufacturers\nbecause they buy goods in large quantities. Second line price\ndiscrimination is legal as long as the negotiations for the lower\nprice\n\nare\n\ndone\n\nfairly\n\nand\n\nthere\n\nis\n\nnot\n\na\n\nsubstantial\n\nanticompetitive impact in the market. When second line price\ndiscrimination results in larger businesses freezing out smaller\ncompetitors, it violates antitrust laws.\nFigure 19.6 Second Line Price Discrimination\n\nAntitrust Law | 346\n\n\x0cThird line price discrimination occurs when a customer of a\ncustomer of the seller is benefited by the seller\xe2\x80\x99s actions. For\nexample, a clothing manufacturer gives a price discount to a\nclothing wholesaler, who then passes the savings on to the\nretailer,\n\nwho\n\nthen\n\nreduces\n\nprices\n\nfor\n\nconsumers.\n\nThe\n\nconsumers ultimately benefit from the price discount given to\nthe wholesaler by the manufacturer.\nFigure 19.7 Third Line Price Discrimination\n\n347 | Antitrust Law\n\n\x0cPrice discrimination, at any line, is legal when a seller lowers\nprices in good faith to meet an equally low price offered by\na competitor. If lower prices are a result of good faith, courts\ndetermine that the prices reflect market forces at work. In\nother words, the businesses are honestly competing for\nconsumers. However, if the lowered prices are not done in good\nfaith but are an attempt to undercut competition, then the\nbusiness commits predatory pricing.\n\nAntitrust Law | 348\n\n\x0c19.6 Enforcement\nAntitrust laws impose both civil and criminal penalties. A\nprivate business that has been injured by anticompetitive\npractices may sue for damages. To encourage private\nenforcement, the Sherman and Clayton Acts award successful\nlitigants treble (i.e. triple) damages and attorneys\xe2\x80\x99 fees. To be\nsuccessful, a plaintiff must show that an anticompetitive act\ndirectly resulted in a tangible injury.\nHowever,\n\nmost\n\nantitrust\n\nactions\n\ninvolve\n\ngovernmental\n\nenforcement. This makes sense because the government has\nthe power to investigate and subpoena that private businesses\ndo not. It also saves businesses a lot of money for the\ngovernment to enforce the laws rather than through private\nlitigation.\nBoth the Department of Justice and the Federal Trade\nCommission enforce antitrust laws. Both agencies may pursue\ncivil and criminal remedies for violations of the law.\nCivil remedies include:\n\xe2\x80\xa2 Injunctions (court orders prohibiting the business from\ncommitting further violations);\n\xe2\x80\xa2 Consent decrees (court-approved agreements in which a\nparty does not admit wrongdoing but agrees to change its\nbehavior); and\n\xe2\x80\xa2 Divesture orders (court orders requiring a company to sell\nits interest in an acquired company).\nThe Department of Justice may also pursue criminal charges\nfor violations of antitrust laws. If convicted of a felony,\nindividuals may be fined up to $1 million per violation and may\nbe sentenced up to ten years in prison. A business may be fined\nas much as $100 million per violation.\n349 | Antitrust Law\n\n\x0c19.7 Concluding Thoughts\nThe underlying tension of antitrust laws is the appropriate\namount of regulation in a free enterprise system. By definition,\na free enterprise market-oriented system should be free from\ngovernmental regulation. However, it is clear that some\nregulation and oversight is necessary to protect individuals and\nbusinesses from unethical and anticompetitive business\npractices. Even absent unethical practices, some businesses\nmay be so successful that over time they gain enough market\nshare to freeze out competition, and have less incentive to\ndeliver quality products and services. As a result, the market\nmay become stagnant, which is not in the best interest of\nthe national economy or consumers. Antitrust laws attempt\nto protect consumers and the economy while allowing free\nenterprise to operate.\n\nAntitrust Law | 350\n\n\x0c20. Consumer Law\n20.1 Introduction\nLEARNING OBJECTIVES\n1. Learn the primary consumer laws that protect purchasers\nand debtors.\n2. Understand the enforcement role of the Consumer\nFinancial Protection Bureau.\nConsumer law is the area of law dealing with consumer\ntransactions, including an individual\xe2\x80\x99s ability to obtain credit,\ngoods, real property, or services for personal, family, or\nhousehold purposes. Business to business transactions are\nusually governed by contract law and are not considered part\nof consumer law.\nConsumer protection laws are laws designed to protect\nconsumers against unfair trade and credit practices involving\nconsumer goods, as well as to protect consumers against faulty\nand dangerous goods. The focus of these laws is to ensure that\nbusinesses do not take advantage of individual consumers.\n\nCounselor\xe2\x80\x99s Corner Approximately 80 percent of\nAmericans are in debt. Consequently, consumer\nprotection laws, especially those that protect\ndebtors, are incredibly important to the majority of\nAmericans, even if they don\xe2\x80\x99t realize it. Debt\n\n351 | Consumer Law\n\n\x0ccollection agencies can be aggressive and unethical.\nKnow your rights so that you are not bullied or taken\nadvantage of. ~Maria M., attorney\n\n20.2 Protecting the Purchaser\nConsumer protection laws that protect purchasers of goods\nand services generally fall into four categories:\n\xe2\x80\xa2 Labeling and packaging;\n\xe2\x80\xa2 Sales;\n\xe2\x80\xa2 Deceptive advertising; and\n\xe2\x80\xa2 Hazardous materials.\n\nLabeling and Packaging\nHow goods are labeled and packaged influences whether\nconsumers will buy them. As a result, regulations require that\nlabels must be truthful and allow consumers to understand\nwhat the product is, what it contains, and any potential\nhazards.\nLabeling and packaging regulations fall into four categories:\n\nConsumer Law | 352\n\n\x0cType\n\nExample\n\nProduct\ncomparison\n\nNutrition labels on food and beverages\n\nPreventing\ninjury\n\nWarning not to use lawn mower to trim hedges\n\nPreventing\naccess\n\nChildproof caps on medications; tobacco\nsecured in retail stores\n\nInforming of\npotential\nhazards\n\nPotential side effects of hazardous items and\ndrugs\n\nSales\nThe general principle in sales regulations is that advertising\nmust be honest. Consumers should be able to make informed\ndecisions based on what products and services really are and\nnot based on false claims or empty promises. These regulations\napply to all sales materials regardless of medium: print,\nelectronic, social media, or radio.\nOne\n\nimportant\n\nregulation\n\ninvolves\n\ndoor-to-door\n\nsales.\n\nConsumers who buy goods or services from door-to-door\nsalespeople have three days to cancel purchases without\npenalty. This is called a cooling off period and is intended to\nprotect consumers from high pressure sales tactics. The\nexception to the cooling off period is when services are\nimmediately rendered. For example, someone who aerates a\nlawn or removes snow as soon as a consumer consents to pay\nfor the service is entitled to payment without being subject to\na cooling off period.\nAnother important regulation involves delivery of goods\nordered online, through catalogs, or by door-to-door sales.\nGoods must be shipped within the promised time period or\nnotice must be given to the consumer. If the goods are not\n\n353 | Consumer Law\n\n\x0cshipped and proper notice is not given, then the consumer\nhas the right to cancel the order for a full refund. Similarly, if a\nconsumer receives goods that he or she did not order through\nthe mail, the consumer can treat it as a gift and does not have\nto pay for it.\nSellers are allowed to promote their goods and services and\nmake them appealing to consumers. Puffery is a broad\npromotional statement made by a business about goods or\nservices that is not intended to be taken literally. In other words,\npuffery is an exaggerated opinion, such as \xe2\x80\x9cthe best,\xe2\x80\x9d \xe2\x80\x9cmost\npopular,\xe2\x80\x9d and \xe2\x80\x9cnobody can beat it!\xe2\x80\x9d As long as puffery remains\nan opinion and does not contain false factual statements,\npuffery is legal. However, if puffery contains false statements,\nthen the statements are deceptive advertising and illegal.\n\nDeceptive Advertising\nDeceptive advertising is a material misrepresentation or\nomission likely to mislead a potential customer and would\nmislead a reasonable customer. In other words, deceptive\nadvertising is a lie.\nFor example, if a car manufacturer advertises a vehicle as \xe2\x80\x9cthe\nbest in its class\xe2\x80\x9d or \xe2\x80\x9cthe most popular\xe2\x80\x9d sedan, such statements\nare legal puffery. If the manufacturer advertises that the vehicle\ngets 35 miles per gallon when it only gets 30 miles per gallon,\nthen that statement is deceptive advertising.\nAnother form of deceptive advertising is called bait and switch\nor bait advertising. Bait and switch is a sales practice where\na seller advertises a low-priced product to lure consumers into\na store only to induce them to buy a higher-priced product.\nOften the advertised product is not actually available as\nadvertised or the seller refuses to sell it on the advertised terms.\nConsumer Law | 354\n\n\x0cThe low-priced product is the \xe2\x80\x9cbait\xe2\x80\x9d that brings consumers in\nbut then the seller \xe2\x80\x9cswitches\xe2\x80\x9d the higher-priced product as the\nsubject of the transaction. Bait and switch advertising can also\napply to sales of services.\n\nHazardous Materials\nIn\n\nthe\n\ncontext\n\nof\n\nconsumer\n\nprotection\n\nlaw,\n\nhazardous materials are products deemed dangerous to the\nconsuming public. Hazardous materials include drugs that\nmay be consumed safely in small amounts under supervision\nof a medical provider, as well as toxic chemicals that are\nbanned for certain public uses such as lead and asbestos.\nHazardous materials regulations are extensive to ensure that\nproducts reaching consumers are safe for their intended use\nand other reasonable, foreseeable uses. These regulations also\ncontrol product recalls.\nRegulations vary depending on the business\xe2\x80\x99s industry. To help\nconsumers understand their rights and report harmful\nproducts,\n\nthe\n\nConsumer\n\nProduct\n\nSafety\n\nCommission\n\nestablished the www.SaferProducts.gov website.\n\n20.3 Protecting the Debtor\nA debtor is someone who owes an obligation to another\nindividual or business, especially the obligation to pay money.\nConsumers become debtors when they owe a business money\nfor the purchase price of goods and services. If consumers pay\nthe purchase price at the time of the transaction or shortly\nafterward, then the transaction is completed. If, however, the\n\n355 | Consumer Law\n\n\x0cconsumer does not immediately pay but receives the goods\nor services, then the consumer becomes a debtor under\nconsumer protection laws.\nConsumer protection laws that protect debtors generally fall\ninto five categories:\n\xe2\x80\xa2 Obtaining credit;\n\xe2\x80\xa2 Reporting credit information;\n\xe2\x80\xa2 Electronic fund transfers;\n\xe2\x80\xa2 Identity theft; and\n\xe2\x80\xa2 Debt collection.\n\nObtaining Credit\nThe process of obtaining credit is regulated by two federal laws.\nThe Truth in Lending Act regulates what information must be\nprovided by creditors who wish to extend credit to consumers.\nThe Equal Credit Opportunity Act prohibit creditors from\ndiscriminating against consumers based on their membership\nin certain protected classes.\n\nTruth in Lending Act\nCongress passed the Truth in Lending Act (TILA) in 1968 to help\nconsumers understand and compare various credit options\navailable to them. TILA only applies to consumer credit\ntransactions and leasing. The law does not apply to commercial\ncredit transactions.\nTILA applies to all real estate transactions and consumer credit\ntransactions of $25,000 or less. The law also applies to credit\n\nConsumer Law | 356\n\n\x0ctransactions involving finance charges or when the loan\nrepayment involves four or more installments.\nTILA also regulates credit cards. The law prohibits credit card\ncompanies from issuing credit cards unless they were\nrequested by the consumer. Any changes to interest rates or\npolicies to existing credit card accounts must be provided in\nwriting to consumers, who must be allowed to cancel their\ncredit cards without penalty. Consumers are required to pay\nany outstanding balance accrued to that point, but they\ncannot be forced to accept altered terms.\nTILA requires certain disclosures be made to applicants for\ncredit. These disclosures include:\n\xe2\x80\xa2 Minimum rate of repayment;\n\xe2\x80\xa2 Billing period;\n\xe2\x80\xa2 Interest rate in the form of the annual percentage rate;\n\xe2\x80\xa2 Type of interest (simple or compound);\n\xe2\x80\xa2 Service charges and fees; and\n\xe2\x80\xa2 Prepayment penalties.\nAll disclosures must be in ordinary language that makes sense\nto the ordinary customer. Disclosures must also be clear and\nconspicuous, meaning that the terms cannot be buried in a\ncontract to hide them from consumers.\n\nEqual Credit Opportunity Act\nCongress passed the Equal Credit Opportunity Act (ECOA) in\n1975 to protect consumers from discrimination when applying\nfor credit. ECOA prohibits creditors from discriminating against\ncreditors based on their:\n\xe2\x80\xa2 Race;\n357 | Consumer Law\n\n\x0c\xe2\x80\xa2 Color;\n\xe2\x80\xa2 National origin;\n\xe2\x80\xa2 Religion;\n\xe2\x80\xa2 Gender;\n\xe2\x80\xa2 Age;\n\xe2\x80\xa2 Marital status; and\n\xe2\x80\xa2 Welfare status.\nThe purpose of ECOA is to require creditors to consider only\nthose\n\ncharacteristics\n\nof\n\nan\n\napplicant\n\nrelated\n\nto\n\ncreditworthiness rather than social status or stereotypes.\nTherefore, creditors may consider an applicant\xe2\x80\x99s marital or\nwelfare status only to the extent that it relates to the applicant\xe2\x80\x99s\ncreditworthiness. For example, an applicant\xe2\x80\x99s marital assets\nand debts are relevant factors when determining how much\ncredit, if any, should be extended to the applicant. However,\ndenying or granting credit solely on the basis of marital and\nwelfare status is illegal.\nECOA also requires creditors to provide specific reasons for\ndenying credit to applicants. This allows applicants to\ndetermine whether the denial was for discriminatory reasons\nor as pretext to hide the discriminatory reason, in violation of\nthe law.\n\nReporting Credit Information\nCongress passed the Fair Credit Reporting Act (FCRA) in 1970\nto regulate the gathering, storage, and reporting of creditrelated information. FCRA applies to individual consumer\ninformation only. FCRA does not apply to business entities\xe2\x80\x99\ncredit reports.\nA credit bureau is an organization that maintains and\n\nConsumer Law | 358\n\n\x0cdistributes information regarding a person\xe2\x80\x99s credit worthiness\nto potential creditors, insurance companies, and employers.\nThe three main credit bureaus in the United States are Equifax,\nExperian, and Transunion.\nBefore releasing consumer information, a credit bureau must\nconfirm the identity of the party making the request and verify\nthe reason for its use. The credit bureau then provides\ninformation about a consumer\xe2\x80\x99s credit in the form of a credit\nreport.\nIn general, consumers do not have to consent to the release of\ntheir information. FCRA requires notice to consumers in three\nspecific circumstances:\n\xe2\x80\xa2 A credit report is provided to an employer and includes\nnegative information that could prevent the consumer\nfrom being hired;\n\xe2\x80\xa2 When the consumer is denied credit, insurance, or\nemployment based on information contained in the\nreport;\n\xe2\x80\xa2 An investigative report is requested about the consumer\xe2\x80\x99s\ncharacter, personal attributes, and living arrangements.\nCredit bureaus must delete general information that is more\nthan seven years old, and bankruptcies that are more than\nten years old. If debts were incurred over seven years ago, or\nbankruptcies filed more than ten years ago, but are still \xe2\x80\x9copen\xe2\x80\x9d\nbecause the debt has not been paid off, then that information\nmay be reported.\nFCRA gives consumers some specific rights regarding their\nconsumer reports. First, consumers are entitled to one free\nreport per year from each of the credit bureaus. Consumers\nmay pay for additional copies of their credit reports.\nSecond, consumers are entitled to dispute information\n359 | Consumer Law\n\n\x0cincluded in a credit report. If the credit bureau determines that\nthe report contained an error, the erroneous information must\nbe removed. If the credit bureau confirms the information or\ncannot determine that it was erroneous, then the consumer\nhas the right to add an objection to the information in the\nreport.\nFinally, consumers are entitled to place a credit freeze on their\ncredit reports. A credit freeze is when the consumer restricts or\nprohibits creditors from requesting credit reports about them.\nIn essence, a credit freeze prevents third parties from\nrequesting a consumer\xe2\x80\x99s credit report without the consumer\xe2\x80\x99s\npermission. If the consumer wants to apply for credit or a new\njob, then the consumer may lift the credit freeze for a limited\nperiod of time or give authority to specific entities to request a\ncredit report.\n\nElectronic Fund Transfers\nThe Electronic Fund Transfer Act (EFTA) was passed by\nCongress in 1978 to protect consumers from unauthorized\nelectronic fund transfers from their accounts. EFTA applies to\nelectronic direct deposits and withdrawals, automatic teller\nmachines\n\n(ATMs),\n\nand\n\npoint-of-sale\n\ntransactions\n\nwith\n\nmerchants.\nEFTA requires banks to investigate errors and reported fraud\npromptly and to correct any errors within one business day. A\nconsumer\xe2\x80\x99s liability for unauthorized transfers is limited to $50\nor the amount of the transfer (whichever is less) for transfers\nmade before the consumer notified the bank of the\nunauthorized use. After the consumer notifies the bank, the\nconsumer is not liable for any additional unauthorized\ntransfers. However, if the consumer fails to notify the bank\n\nConsumer Law | 360\n\n\x0cwithin two business days of the unauthorized transfer, then the\nconsumer\xe2\x80\x99s liability rises to $500.\nA preauthorized\n\ntransfer is an electronic fund transfer\n\nauthorized in advance to recur at regular intervals. For\nexample, a consumer authorizes her monthly mortgage\npayment to be automatically withdrawn from her banking\naccount on the first of every month. Preauthorized transfers\nrequire banks to:\n\xe2\x80\xa2 Receive written instructions from the consumer about the\ntiming, amount, and duration of the transfers; and\n\xe2\x80\xa2 Allow the consumer to stop payment up to three business\ndays before the scheduled transfer date.\n\nIdentity Theft\nIdentity theft is an increasing concern for businesses and\nconsumers. The Federal Trade Commission estimates that at\nleast ten million consumers are victims of identity theft each\nyear.\nWhile consumers cannot completely prevent identity theft,\nthere are some steps that they can take to minimize their risk.\nFirst, consumers should monitor their bank accounts and\ncharges on their credit and debit cards. If they notify their\nbanks of unauthorized transactions as soon as possible, then\nthey will minimize their personal liability. Second, consumers\nshould request their credit report at least annually. Parents\nare entitled to request credit reports for their minor children.\nThird, consumers can place a credit freeze on their credit report\nto prevent third parties from accessing their financial and\npersonal information and from obtaining credit under their\nname.\n\n361 | Consumer Law\n\n\x0cIf a consumer is a victim of identity theft, he or she can post\na fraud alert with the credit bureaus to be included in his or\nher credit report. A fraud alert requires businesses to verify the\nidentity of an applicant for credit before extending any credit to\nhim or her.\n\nDebt Collection\nBusinesses that are owed money from debtors may seek a\ncourt judgment to collect the debt. However, the judicial\nprocess is often expensive and time consuming. As a result,\nmany businesses prefer to collect debts outside of the court\nsystem.\nTo prevent abusive practices by debt collectors, Congress\npassed the Fair Debt Collection Practices Act (FDCPA) in 1978.\nUnder FDCPA, a debt collector must, within five days of\ncontacting a debtor, send a written notice containing:\n\xe2\x80\xa2 The amount of the debt;\n\xe2\x80\xa2 The name of the creditor to whom the debt is owed; and\n\xe2\x80\xa2 A statement that if the debtor disputes the debt in writing,\nall collection efforts must stop until the creditor receives\nevidence of the debt.\nFDCPA also prohibits certain debt collection practices. Debt\ncollectors cannot:\n\xe2\x80\xa2 Contact a debtor who has notified the collector in writing\nthat he or she wants no further contact;\n\xe2\x80\xa2 Contact a debtor who is represented by an attorney;\n\xe2\x80\xa2 Call a debtor before 8:00 a.m. or after 9:00 p.m.;\n\xe2\x80\xa2 Threaten a debtor or use obscene or abusive language;\n\xe2\x80\xa2 Contact a debtor at work if the employer prohibits such\n\nConsumer Law | 362\n\n\x0ccontact;\n\xe2\x80\xa2 Imply or say that they are attorneys or government\nofficials when they are not;\n\xe2\x80\xa2 Use a false name;\n\xe2\x80\xa2 Make any false, deceptive, or misleading statements;\n\xe2\x80\xa2 Contact family and acquaintances of the debtor more\nthan once or for any reason other than to locate the\ndebtor;\n\xe2\x80\xa2 Tell family and acquaintances of the debtor that he or she\nis in debt;\n\xe2\x80\xa2 Publish the debtor\xe2\x80\x99s name and address on a \xe2\x80\x9cbad debt\xe2\x80\x9d list\non the internet or in the newspaper; or\n\xe2\x80\xa2 Collect charges in addition to the debt unless permitted\nby state law or contract signed by the debtor.\nFiling a collection action in court does not violate any of these\nrules.\n\n20.4 Enforcement\nCongress empowered both the Federal Trade Commission and\nthe Consumer Financial Protection Bureau to enforce the\nprimary federal consumer protection laws. However, numerous\nfederal and state laws contain provisions to protect consumers.\nAs a result, there are many federal and state agencies that have\nregulations related to consumer protection.\nThe Consumer Financial Protection Bureau (CFPB) was\ncreated by Congress in 2010 to be a single point of contact for\nconsumers who seek financial consumer protection. The CFPB\nis intended to consolidate enforcement efforts and to make\nthem more consistent than when they were shared among\nagencies. The CFPB is authorized to enforce the federal\n\n363 | Consumer Law\n\n\x0cconsumer protection laws discussed in this chapter, as well as\nothers.\n\n20.5 Concluding Thoughts\nConsumer protection laws are intended to protect consumers\nfrom unethical and unfair business practices. These laws are\nbroad in range, from advertising and marketing to recalling\ndelivered products that are hazardous. With the continued\nevolution of electronic transactions and banking, consumer\nlaw will continue to evolve to address areas of concern as they\ndevelop.\n\nConsumer Law | 364\n\n\x0c21. Workplace Privacy\nand Information\nSecurity\n21.1 Introduction\nLEARNING OBJECTIVES\n1. Identify some of the most important privacy laws\nimpacting businesses today.\n2. Understand the Constitutional basis for privacy rights.\n3. Explore the legal issues involved with modern technology\nand information security.\nPrivacy is a fundamental right of individuals that is often\ncompromised by government and businesses. Sometimes\nindividuals and businesses voluntarily give up their privacy\nrights, without considering the consequences of doing so.\nWorkplace privacy and information security is a fast growing\narea of the law that has important implications across\nindustries.\n\nCounselor\xe2\x80\x99s Corner Privacy and cybersecurity are\ntwo of the most dynamic areas of the law. As our\nsociety becomes more and more dependent on\ntechnology, and as the Internet of Things continues\n\n365 | Workplace Privacy and\nInformation Security\n\n\x0cto expand, we are seeing privacy issues explode in\npersonal and professional contexts. Businesses\nwould do well to consult with cybersecurity and\nprivacy experts to ensure that they are complying\nwith the law and protecting their networks and\nconfidential information as much as possible.\nBringing in experts after you have a security breach\nor lawsuit filed is way too late. Be proactive. It just\nmay save your business. ~Katie D., attorney\n\n21.2 Right to Privacy\nPrivacy is the right of a person or person\xe2\x80\x99s property to be free\nfrom unwarranted public scrutiny or exposure. In other words,\nit is the right to personal autonomy and to express oneself\nselectively. Privacy includes both bodily integrity and the\nprotection of confidential information, including medical and\nfinancial records.\n\nImplied Constitutional Right\nPrivacy is an implied Constitutional right, meaning it is a right\nbased on the \xe2\x80\x9czones of privacy\xe2\x80\x9d created by the US Constitution.\nHowever, the word \xe2\x80\x9cprivacy\xe2\x80\x9d is not in the Constitution itself.\nThe right to privacy was first mentioned in a Harvard Law\nReview article in 1890 by Samuel Warren and Louis Brandeis,\nwho later served on the US Supreme Court from 1916 until\n1939. Warren and Brandeis argued the right to privacy is an\nWorkplace Privacy and Information Security | 366\n\n\x0cimportant civil liberty which should not be violated by\nsensational journalists and developments in technology. The\ntechnology in the late 1890s they were the most concerned\nwith was photography and telephones. In particular, they were\nconcerned about people losing their right to privacy when\nothers\n\ntake\n\nphotographs\n\nof\n\nthem\n\nor\n\nlisten\n\nto\n\ntheir\n\nconversations.\nPrivacy was discussed in the legal community for 75 years\nbefore the US Supreme Court expressly held individuals have\na Constitutional right to privacy in the 1965 Griswold v.\nConnecticut decision.\nPrivacy cases involve different circumstances, such as the right\nto choose whether to marry and to whom, the right to choose\nwhether to have children, and the right to protect confidential\ninformation such as medical and financial records.\nThe Framers of the Constitution did not include the word\n\xe2\x80\x9cprivacy\xe2\x80\x9d in the Constitution but it is a fundamental right\nunderlying the core tenets of the document. The Bill of Rights\nbegins by recognizing fundamental rights that are essential to\nan individual\xe2\x80\x99s identity: speech, religion, press, assembly, and\npetition for redress from the government. From there, the Bill\nof Rights expands protection of individuals to include their\nhomes and possessions. For example, the Fourth Amendment\nprohibits\n\nunreasonable\n\nsearches\n\nand\n\nseizures\n\nby\n\nthe\n\ngovernment. As reflected in the Bill of Rights, privacy is an\nessential right the Constitution intends to protect.\nWhen analyzing privacy cases, courts ask whether an\nindividual has a reasonable expectation of privacy. To establish\na \xe2\x80\x9creasonable expectation of privacy,\xe2\x80\x9d a person must meet two\nrequirements:\n1. The individual has an actual, subjective expectation of\nprivacy. In other words, did that particular person think he\n367 | Workplace Privacy and Information Security\n\n\x0cor she was doing something in private that others could\nnot observe?\n2. Society accepts the individual\xe2\x80\x99s expectation of privacy as\nreasonable. In other words, as a community do we expect\nthose circumstances to be private?\nThis legal test has both a subjective and objective standard. If\nan individual does not expect their actions to be private, then\nno right to privacy exists under the circumstances. Similarly,\nif society as a whole does not expect to have privacy under\nthe circumstances, it does not matter what the individual may\npersonally believe, no right of privacy exists.\nFor example, if a person calls her doctor to discuss medical\ntest results, then she has a subjective expectation of privacy. If\nshe calls her doctor from her home, then she has an objective\nexpectation of privacy because society recognizes the right of\npeople to have private conversations in their own homes.\nHowever, if she has the conversation on her cell phone while\nriding the bus, then she does not have a right to privacy\nbecause it is not objectively reasonable to expect privacy on\npublic transportation.\nPrivacy cases also focus on whether a person has given either\nexpress or implied consent to disclose or use personal\ninformation. Express consent is often given in the form of\ncontracts, including end user agreements. Implied consent is\nusually based on the person\xe2\x80\x99s actions, such as a history of\nbusiness transactions. In essence, implied consent means that\na business has reason to believe that a person would give\nconsent if the business asked for it. For example, customers\nwho sign up for a loyalty program may give implied consent to\nreceive marketing emails from that particular business.\nWhile consent and the expectation of privacy are interrelated\nconcepts, they are legally different concepts.\n\nWorkplace Privacy and Information Security | 368\n\n\x0cStatutes\nCongress and state legislatures have also passed various laws\nto protect the privacy of individuals and their property. Some\nof the most important federal laws related to workplace privacy\nare discussed below.\nThere is a growing trend among states to require internet\nservice providers to obtain consent from consumers before\nsharing any of their personal information, including websites\nvisited and consumer habits.\nBusinesses\n\nengaged\n\nin\n\ne-commerce\n\nwith\n\nresidents\n\nof\n\nCalifornia must post their privacy policy conspicuously on their\nwebsites and abide by their policies. California law also requires\ndisclosure of consumer software tracking policies.\n\nInternational Law\nThe right to privacy is contained in Article 12 of the Universal\nDeclaration of Human Rights, which was adopted in 1948 in\nresponse to the horrors of World War II. The Universal\nDeclaration of Human Rights states:\nNo one shall be subjected to arbitrary interference with\nhis privacy, family, home or correspondence, nor to\nattacks upon his honor and reputation.\nThe Universal Declaration of Human Rights has been adopted\nby the majority of nations, including the United States.\nMany other bilateral treaties and conventions recognize the\nright to privacy in various circumstances. Currently, about 150\nnations recognize privacy as part of their international legal\n\n369 | Workplace Privacy and Information Security\n\n\x0cobligations. However, enforcement of the right to privacy is\ninconsistent across nations.\nIt is important for US businesses operating in Europe or\nconducting\n\nbusiness\n\nunderstand\n\nthat\n\nthe\n\ntransactions\n\nwith\n\nEuropean\n\nUnion\n\nEuropeans\n(EU)\n\nto\n\nhas\n\na\n\ncomprehensive set of laws to protect the privacy of European\nindividuals and businesses. The EU General Data Protection\nRegulation (GDPR) applies to all businesses, even located\noutside of Europe, that collect, store, or process data about\nany European. Under GDPR, individuals have the right to know\nhow their personal data is being collected and used, to remove\ninformation from the internet, and to stop companies from\nprocessing their data. GDPR has significant penalties. For\nexample, businesses mishandling customer information may\nbe fined up to four percent of their annual worldwide revenue.\nUnder GDPR, businesses must comply with six data processing\nprinciples. Personal information must be:\n1. Processed lawfully, fairly and transparently;\n2. Collected only for specific legitimate purposes;\n3. Adequate, relevant and limited to what is necessary;\n4. Accurate and, where necessary, kept up to date;\n5. Stored only as long as is necessary; and\n6. Processed in a manner that ensures appropriate security.\n\n21.3 Workplace Privacy\nEmployees generally do not have a reasonable expectation of\nprivacy in the workplace, especially when using company\nequipment or when the employer has a policy stating\nemployees may be monitored. However, some areas such as\nemployee restrooms and locker rooms may not be monitored.\n\nWorkplace Privacy and Information Security | 370\n\n\x0cCourts have held employees do not give up all expectations\nof privacy by the nature of their employment. Therefore,\nemployers should ensure that they limit monitoring activities\nto reasonable places where the employer has a legitimate\nbusiness interest for doing so.\n\nHiring Process\nEmployers often run background checks on prospective\nemployees as part of their hiring process. Depending on what\ntype of background check is done and the information used, a\nrange of privacy issues are involved. Some states regulate the\ntype of documents that a prospective employer may consider\nwhen making hiring decisions. Businesses need to ensure they\ncomply with all state laws where they hire employees.\nThe use of artificial intelligence (AI) is a growing trend in\nrecruiting and hiring. AI is often used to review resumes,\napplications, and publicly available social media. AI-powered\nvideo-interview platforms apply algorithms to video-recorded\ninterviews to facilitate an employer\xe2\x80\x99s assessment of applicants.\nIllinois was the first state to pass an AI Interview Act, which\nrequires prospective employers to notify applicants of their use\nof AI and to obtain their consent before using AI tools on their\napplication materials. Although limited to its state, the Illinois\nlaw has been cited by many legal experts as a template for\nother federal and state laws.\nBased on the Illinois law, employers who use AI during their\nhiring process should adopt the following best practices:\n\xe2\x80\xa2 Give notice to applicants of the use of AI-powered videointerview platforms;\n\xe2\x80\xa2 Explain what the AI is and how it works in ordinary\n371 | Workplace Privacy and Information Security\n\n\x0clanguage to applicants;\n\xe2\x80\xa2 Obtain consent of applicants to use and record their video\ninterviews;\n\xe2\x80\xa2 Offer an alternative interview method for interviews; and\n\xe2\x80\xa2 Have a procedure in place for the destruction of\nrecordings.\n\nDrug and Alcohol Testing\nEmployers with drug and alcohol testing policies are highly\nregulated by the states where they operate. State requirements\nvary about required notice of testing, the nature and location\nof testing, and when testing may occur. All states protect\nemployee privacy regarding who receives the test result and\nhow those results are to be collected, stored, and destroyed.\nEmployers who engage in drug and alcohol testing need to\nbe informed about the legal consequences of enforcing their\npolicies.\nEmployees frequently challenge drug and alcohol testing as a\nviolation of their right to privacy. Employers generally win these\nlawsuits when:\n\xe2\x80\xa2 The employer complies with all state requirements for\ndrug and alcohol testing;\n\xe2\x80\xa2 Conducts the test with the employee\xe2\x80\x99s consent;\n\xe2\x80\xa2 Conducts the test in a manner that was not offensive; and\n\xe2\x80\xa2 The test results do not reveal information unrelated to the\npurpose of the test.\nEmployers must be careful to limit disclosure of test results\nto only those with a need to know. Businesses may lawfully\nconduct a drug or alcohol test but still be liable for privacy\nviolations based on how they handled the results.\n\nWorkplace Privacy and Information Security | 372\n\n\x0cHealth Insurance Portability and\nAccountability Act\nThe Health Insurance Portability and Accountability Act of 1996\n(HIPAA) seeks to protect confidential health information and\nmandates standards for handling such information.\nHIPAA has a Privacy Rule regulating the use and disclosure\nof individually identifiable health information. The Privacy Rule\nprotects Protected Health Information (PHI), which includes\nall information related to the past, present or future health\nstatus of an identified individual, of treatment received, or of\npayment for treatment. PHI also includes billing records,\ninformation about premium payments, and enrollment\ninformation. As a result, PHI includes medical information\nrequired by employers to carry out their obligations under the\nAmericans with Disabilities Act, the Family Medical Leave Act,\nworkers\xe2\x80\x99 compensation, drug testing, and employer-sponsored\nhealth care plans.\nHIPAA also has a Security Rule to ensure the confidentiality,\nintegrity and availability of electronic PHI. Under the Security\nRule,\n\xe2\x80\xa2 Confidentiality means PHI is not made available or\ndisclosed to unauthorized individuals or processes;\n\xe2\x80\xa2 Integrity means PHI is not altered or destroyed in an\nunauthorized manner; and\n\xe2\x80\xa2 Availability means PHI is accessible and usable upon\ndemand by an authorized individual.\nThe Security Rule also requires businesses to protect electronic\nPHI against reasonably anticipated threats and reasonably\nanticipated violations of the Privacy Rule.\nFigure 21.1 HIPAA Security Rule\n373 | Workplace Privacy and Information Security\n\n\x0cHIPAA requires businesses to designate a single person who\nis ultimately responsible for the security of electronic PHI. This\nperson is also responsible for ensuring the business engages\nin the mandatory security management process under HIPAA.\nThis process starts with a risk analysis of the potential\nvulnerabilities in the business\xe2\x80\x99s system and management of\nWorkplace Privacy and Information Security | 374\n\n\x0cPHI.\n\nThe\n\nsecurity\n\nmanagement\n\nprocess\n\nis\n\nextensively\n\nregulated.\nImportantly, HIPAA applies to \xe2\x80\x9ccovered entities\xe2\x80\x9d rather than\nspecific types of information. Personal fitness trackers such\nas Fitbit, gather what is essentially healthcare data of its\nconsumers. However, Fitbit data can be sold as consumer\ninformation because Fitbit is not a covered entity under HIPAA\nwith regard to its consumers. However, if Fitbit gathers PHI\nof its employees who request medical leaves of absence, then\nFitbit is a covered entity as an employer.\n\nElectronic Monitoring\nFederal law and most state laws allow employers to monitor\ntheir employees\xe2\x80\x99 electronic communications occurring over\nthe employer\xe2\x80\x99s hardware, software, and servers. If the employer\nprovides the computer system, the employer has the right to\nmonitor electronic communications on the system, even if\nthose communications are not work related.\nEmployers\n\nmay\n\nalso\n\nmonitor\n\ncommunications\n\nwhen\n\nemployees consent to the monitoring. Therefore, many\nemployers require employees to sign a waiver consenting to\nprivate communications sent via the employer\xe2\x80\x99s equipment to\nbe monitored. This helps defend against invasion of privacy\nclaims better than having a policy in the employee handbook\nalone.\nBusinesses may also monitor conversations with customers in\nthe ordinary course of business as long as they give notice. As\na result, many customer service lines use a recorded message\nthat \xe2\x80\x9cthis call may be monitored for training purposes\xe2\x80\x9d before\ncustomers are connected to a customer service agent.\n\n375 | Workplace Privacy and Information Security\n\n\x0cThe most important federal law regarding monitoring of\nelectronic communications is the Electronic Communications\nPrivacy Act (ECPA), which was passed by Congress in 1986.\nECPA has two parts. The first part is known as the Wiretap\nAct and the second as the Stored Communications Act. ECPA\nprohibits the acquisition of the the content of a wire, oral or\nelectronic communication using an electronic, mechanical or\nother device. ECPA also prohibits the use or disclosure of an\nunlawfully intercepted communication.\nECPA exposes businesses to multiple levels of liability within\na business. For example, personnel in the IT department may\nbe liable for unlawfully intercepting an employee\xe2\x80\x99s email, and\nhuman resource personnel who use and disclose the email\nmay\n\nbe\n\nliable\n\nas\n\nwell.\n\nEach\n\nunlawfully\n\nintercepted\n\ncommunication may give rise to liability. Therefore, a handful of\ncommunications may result in multiple individuals throughout\na business repeatedly violating ECPA.\n\nWorkplace Recordings\nAlthough recordings may be useful to capture the content of\na conversation, recordings pose legal and business risks to\nemployers. Both employers and employees may violate federal\nand state wiretapping laws by recording conversations without\nconsent of the other parties. Even with consent, businesses\nthat engage in recording employees and customers damage\nemployee morale and risk losing customers.\nTwelve states prohibit recording a conversation unless all\nparties consent. The majority of states allow customers and\nemployees to hold a business liable for wiretapping violations\nunder the respondeat superior doctrine. As a result, businesses\nmay be liable for their employees\xe2\x80\x99 unlawful recordings if done\n\nWorkplace Privacy and Information Security | 376\n\n\x0cin the course and scope of employment or done to help the\nbusiness.\nState and federal wiretapping laws carry both civil and criminal\npenalties. Many state laws provide for treble damages or a\nstatutory damage amount. Federal wiretapping laws impose\nfines up to one hundred dollars per day or ten thousand dollars,\nwhichever is greater.\nAnother\n\npotential\n\nproblem\n\nfor\n\nbusinesses\n\nis\n\nputting\n\nconfidential business information at risk. For example,\nemployees may capture trade secrets, proprietary information,\nor business strategies that the business wants to protect.\nRecorded information can be compromised or shared against\nthe business\xe2\x80\x99s interests.\n\nSocial Media\nAn employer\xe2\x80\x99s right to monitor electronic communications\ngenerally does not include social media. As a result, employers\nare not entitled to monitor social media accounts through\ncoercion or deceit. For example, an employer cannot require\nemployees to provide passwords to their social media\naccounts. Employers also cannot log onto the social media\naccounts of others (including employees) and pose as them to\nsee private accounts.\nHowever, if social media accounts are public, then employers\nare entitled to review them to the same extent as other\nmembers of the public.\n\n377 | Workplace Privacy and Information Security\n\n\x0cVideotaping and Surveillance Cameras\nECPA only protects electronic communications. As a result,\nECPA does not apply to video or camera surveillance without\nan audio component. To avoid violating ECPA, businesses\nshould ensure their security and surveillance cameras do not\ncapture human voices.\nSecurity cameras cannot be used in areas in which employees\nand customers have a reasonable expectation of privacy. For\nexample, retailers cannot use cameras in changing rooms,\nrestrooms, and locker rooms. Businesses need to place\ncameras so that private activity cannot, and is not, monitored\nand recorded.\nBusinesses engaged in surveillance must use the most limited\nmeans available to conduct the surveillance. Companies\nshould have a legitimate business reason to use security\ncameras, and they need to ensure the surveillance is targeted\nand limited in duration and scope.\nRetailers who use cameras to prevent theft at entryways and\ncash registers should place cameras in positions that are open\nand obvious to act as notice to customers. Signs giving express\nnotice are also a best practice to avoid legal liability.\n\nBiometrics and Wearable Technology\nBiometrics is the automated identification of people using\ntheir physical characteristics. While many metrics can be used,\nfingerprints and facial recognition are the most common. It is\nhelpful to think of biometrics as measurements of some aspect\nof a person.\nThere is a growing trend among businesses to move from\nWorkplace Privacy and Information Security | 378\n\n\x0ctraditional time clocks to biometric time clocks that scan\nfingerprints, retinas, or irises to verify an employee\xe2\x80\x99s identity\nand clock the employee in and out of work. Biometric time\nclocks prevent time clock fraud, increase timekeeping\nefficiency, and increase accuracy of wages.\nThe type of biometric technology used impacts the privacy\nrights involved. Technology storing biometric data directly\nimpacts privacy rights more than technology creating a\n\xe2\x80\x9ctemplate\xe2\x80\x9d through an algorithm to create a representation\nof a fingerprint. Whether the technology captures and uses\nexisting personal information or creates a replica has legal\nconsequences.\nThere have been a series of class action lawsuits against\nemployers that have not notified employees when their\nbiometric identifiers and data were being shared with third\nparty timekeeping vendors. Consent is only a defense for\nemployers if they give notice and obtain consent for all uses of\nthe information.\nAnother\n\ntechnology\n\ntrend\n\nis\n\nthe\n\nuse\n\nof\n\nwearable\n\ntechnology. Wearable technology is a category of electronic\ndevices that can be worn as accessories, embedded in clothing,\nimplanted in the user\xe2\x80\x99s body, or even tattooed on skin. The\ndevices are intended to be hands-free, are powered by\nmicroprocessors and connect with the Internet. Wearable\ntechnology includes smartwatches, fitness trackers, and\nmedical devices. It is helpful to think of wearable technology as\nsomething that an employee has.\nWearable technology is often used to track employee locations\nand grant access to areas. Concerned about private companies\ncoercing employees to be microchipped, states are passing\nlaws prohibiting employers to require, coerce, or compel an\nindividual to receive a microchip implant or use wearable\ntechnology as a condition of employment.\n379 | Workplace Privacy and Information Security\n\n\x0c21.4 Information Security Issues\nInformation security is one of the fastest growing areas of the\nlaw affecting businesses today. Any business that collects, uses,\nand stores personal information about employees and\ncustomers is subject to these laws. Businesses are also\nincreasingly targeted by hackers who seek to steal private\ninformation on a large scale.\n\nSecurity Analysis\nA simple but widely-used security model is the CIA Principle\nor CIA Security Rule, which stands for Confidentiality, Integrity\nand Availability. The principle is applicable across points of\ncontact from access to a user\xe2\x80\x99s internet history to security of\nencrypted data across the Internet.\nFigure 21.2 CIA Principle\n\nWorkplace Privacy and Information Security | 380\n\n\x0cConfidentiality is the ability to hide information from those\nwithout authorization to view it. While perhaps the most\nobvious principle, it is usually the one that is attacked most\noften. Cryptography and Encryption are methods used to\nprotect confidentiality of data transferred across the Internet.\nIntegrity is the ability to ensure that data is an accurate and\nunchanged representation of the original information. One\ncommon security attack is to intercept some important data\nand make changes to it before sending it on to the intended\nreceiver.\nAvailability is the ability to make information readily accessible\nto authorized users at all times. Some security attacks attempt\nto deny access to appropriate users, either to inconvenience\nthem or to achieve another goal such as redirecting business\nto a competitor.\n\n381 | Workplace Privacy and Information Security\n\n\x0cAs discussed in Section 21.3 above, HIPAA\xe2\x80\x99s Security Rule\nrequires covered entities to implement the CIA principle to\nprotect PHI.\n\nData Breaches\nAccording to the Pew Research Center, almost eighty-five\npercent of individuals in the US shop online. And most retailers\ncollect customer\xe2\x80\x99s personal and financial data. If a customer\nuses a form of payment other than cash, then the customer\xe2\x80\x99s\npersonal and financial information will be shared with the\nbusiness.\nRather than pickpocket an individual consumer, thieves today\nare targeting businesses to collect personal and financial\ninformation of entire consumer sets. Data breaches affect all\nindustries, such as retail, credit bureaus, hospitals, and\ngovernment agencies. In the first half of 2019, there were over\n4.1 billion compromised documents reported as part of only\n3,800 disclosed data breaches.\nCybersecurity\n\nexperts\n\nadvise\n\nthat\n\ncyber\n\ncriminals\n\nrun\n\nautomated online scripts looking for unsecured databases.\nWhile some larger businesses are particularly targeted, cyber\ncriminals are the most successful when targeting small to\nmedium-sized businesses that are unaware of the threat or do\nnot want to spend adequate resources on cybersecurity.\nBusinesses should be aware, though, that approximately sixty\npercent of data breaches are the result of human error rather\nthan outdated or insufficient technology. Therefore, by\nadequately training employees, many data breaches may be\navoided. For example, breaches often result from sending\nemails to the wrong person, responding to phishing attacks,\nsharing passwords, and leaving computer screens open.\nWorkplace Privacy and Information Security | 382\n\n\x0cAnother big risk is when people use the same password for\nmultiple accounts, such as email accounts, bank accounts, and\nsocial media. If the password is obtained by cyber criminals and\nadded to the database of passwords, all the accounts will be at\nrisk.\n\nBig Data\nIn addition to financial data, businesses collect personal\ninformation about consumers and their habits. This is\ncalled big data. Consumer information is very valuable because\nbusinesses can search the data to identify spending habits to\ntarget marketing to likely customers. This reduces costs and\nincreases profit for businesses, especially as e-commerce\nincreases the number of competitors across industries.\nAnother benefit to mining the data available about consumers\nis businesses can make more profitable decisions. For example,\nhealth insurance companies are heavily invested in big data\nbecause they want information about the lifestyle habits of\nthe people they insure and potentially insure. If they know\nsomeone is a smoker, eats a lot of sugary foods, or has a\nsedentary lifestyle, then they can adjust premiums accordingly\nto minimize their risk. Insurance companies look for trends\nnot just for individuals but also regions, types of occupations\n(including those with the highest risk of addiction or obesity),\nand socio-economic status.\nBig data is also connected to the Internet of Things. The\nInternet of Things (IoT) is a system of interrelated computing\ndevices, mechanical and digital machines, objects, animals or\npeople that are provided with unique identifiers and the ability\nto transfer data over a network without requiring human-tohuman or human-to-computer interaction. In other words, the\n\n383 | Workplace Privacy and Information Security\n\n\x0cIoT includes everyday devices connected to the internet,\nincluding medical devices, appliances, vehicles, and buildings.\nAs more businesses seek big data about consumers and sell\nIoT items to consumers, privacy rights are impacted. Data\ncollection in public spaces, such as billboards tracking who\nstops to read them, may be lawful. However, the location and\nmanner of data collection involves different expectations of\nprivacy. For example, businesses argue that by purchasing and\ninstalling \xe2\x80\x9csmart home\xe2\x80\x9d appliances and products, consumers\nhave consented to surveillance and data collection. Consumer\nadvocacy groups argue that purchasing goods for a particular\nuse does not give consent to businesses to invade consumer\nprivacy in their homes. These issues will be heavily litigated in\nthe years to come.\n\nTransborder Data Transfers\nAs discussed previously, the EU has a comprehensive set of\nprivacy laws and regulations. The EU has strict limits on the\nexport of all human resources data and consumer information\nto the US, even when the data export occurs within the same\nbusiness. To help US businesses comply with the EU laws, the\nUS Department of Commerce negotiated a \xe2\x80\x9csafe harbor\xe2\x80\x9d of\ndata protection practices that the EU approved. If a US\nbusiness can certify its compliance with the Safe Harbor\nPrinciples, then the EU will approve data transfers to that\nbusiness.\n\nWorkplace Privacy and Information Security | 384\n\n\x0cSecurity Incident Preparation and\nResponse\nBusinesses are not able to prevent all data security breaches.\nHowever, businesses need to take steps to protect against\nknown and reasonably anticipated threats to confidential\ninformation.\n\nFor\n\nbusinesses\n\nwithout\n\nsufficient\n\nin-house\n\ncybersecurity staff or expertise, Managed Security Service\nProviders (MSSPs) offer a wide range of security services,\nincluding setting up security infrastructure and incident\nresponse.\nAlthough\n\nfederal\n\nand\n\nstate\n\nlaws\n\nvary\n\nregarding\n\nlegal\n\nrequirements, a business should have a written cybersecurity\nprogram\n\nthat\n\nconforms\n\nto\n\ntheir\n\nindustry\xe2\x80\x99s\n\nrecognized\n\ncybersecurity framework.\nIn general, a cybersecurity program should:\n\xe2\x80\xa2 Protect the security and confidentiality of all electronically\nstored records containing an employee or customer\xe2\x80\x99s\nsocial security number, driver\xe2\x80\x99s license number, state\nidentification card number, credit and debit card\ninformation, dates of birth, passwords, and personal\ninformation;\n\xe2\x80\xa2 Protect against any anticipated threats or hazards to the\nsecurity or integrity of the confidential information;\n\xe2\x80\xa2 Provide for reliable and accurate backups of data; and\n\xe2\x80\xa2 Protect against unauthorized access to and acquisition of\ninformation likely to result in an employee or customer\nbeing exposed to a material risk of identity theft or fraud.\nMany laws, including HIPAA, have cybersecurity regulations\nwith which businesses must comply. Certain industries have\nalso issued their own security standards. For example, the\n\n385 | Workplace Privacy and Information Security\n\n\x0cPayment Card Industry (PCI) Security Standards Council has\nissued standards for the safety of credit and debit cardholder\ndata across the globe.\nBusinesses\n\nwanting\n\ninformation\n\nabout\n\nimplementing\n\ncybersecurity programs that are appropriate for their industry\nshould consider the National Institute of Standards and\nTechnology\xe2\x80\x99s\n\n(NIST)\n\nFramework\n\nfor\n\nImproving\n\nCritical\n\nInfrastructure Cybersecurity. The mission of NIST is to help\norganizations understand and improve their management of\ncybersecurity risks. It is an excellent place to start when\nanalyzing cybersecurity issues.\n\n21.5 Concluding Thoughts\nThe internet and technology are changing the world at an\nincredibly fast pace. With those changes come the challenges\nto individuals and businesses to maintain privacy and protect\npersonal information. Privacy is an implied Constitutional right\ndeeply impacted by the use of technology. Regardless of type\nof industry, businesses need to have adequate cybersecurity\npolicies and practices in place to protect confidential business,\nemployee, and customers information.\n\nWorkplace Privacy and Information Security | 386\n\n\x0c22. Property\n22.1 Introduction\nLEARNING OBJECTIVES\n1. Distinguish between personal property and real property.\n2. Understand classifications of property.\n3. Examine methods of acquisition of real and personal\nproperty.\n4. Examine the landlord-tenant relationship.\n5. Understand how property is transferred through wills and\ntrusts.\n6. Explore common land use regulations and environmental\nlaws that businesses face.\nProperty refers to tangible and intangible items that can be\nowned. Ownership is a concept that means the right to\nexclude others. Legal systems create a peaceful means to\nacquire, retain, and divest property, and to settle property\ndisputes. Businesses need to understand the legal system\nregarding both personal and real property because they often\nown or lease both. In addition, the government regulates how\nreal property can be used as well as any environmental impact\na business has.\n\nCounselor\xe2\x80\x99s Corner Property is regulated by state\nlaws. Because of the variation of laws from state to\n\n387 | Property\n\n\x0cstate, it is imperative that businesses understand all\nlegal requirements where they have property\ninterests. Property can be a great seducer\xe2\x80\x93it seems\nlike owning or possessing property is an asset.\nHowever, the liability that comes with it may not be\nin the business\xe2\x80\x99s best interest. Take the time to\nassess the financial and legal risks and rewards\nbefore acquiring property interests to ensure that\nyou are not overextending yourself. ~Elizabeth H.,\njudge\n\n22.2 Personal Property\nProperty can be classified as real or personal. Real property is\nland, and certain things that are attached to it or associated\nwith it. Real property is raw land, such as a forest or a field, as\nwell as buildings, like a house or an office. Additionally, things\nassociated with land, like mineral rights, are also real property.\nPeople often talk about real property by using the term real\nestate, which includes both real property and its related\nownership interest.\nFigure 22.1 Types of Real Estate Legal Issues\n\nProperty | 388\n\n\x0cPersonal property is property that is not real property. Tangible\nproperty is something that can be touched. Moveable, tangible\npersonal property is called chattel. Many businesses exist to\nsell personal property. For example, the primary purpose of\nretailers is to sell personal property. Some property can also\nbe described as fungible property. Property that can easily be\nsubstituted with identical property is said to be fungible. Types\nof fungible goods include juices, oil, metals such as steel or\naluminum, and physical monetary currency.\nIntangible property does not physically exist, but it is still\nsubject to ownership principles, including acquisition, transfer,\nand sale. For instance, the right to payment under a contract,\nthe right to exclude others from a patented product, and the\nright to prohibit others from using copyrighted materials are all\nexamples of intangible property.\n\n389 | Property\n\n\x0cPersonal property can become attached to the land as a\nfixture. A fixture is something that used to be personal\nproperty, but it has become attached to the land so that it is\nlegally a part of the land. Fixtures are treated like real property\nso when real property is transferred, fixtures are transferred as\na part of the real property. A ceiling fan for sale at a store is\npersonal property. However, once the fan is installed in a house,\nit becomes a fixture and is part of the real property.\nSome things that are attached to the land are not fixtures but\nare part of the real property itself. Imagine a farm with planted\ncorn. The corn crop is an example of real property that can\nbecome personal property. While the corn is growing and still\nattached to the land, the corn is real property. Once it is picked\nfrom the stalk, the ear of corn becomes personal property.\nProperty also can be classified by ownership. Personal and real\nproperty can be private or public. Private property is owned\nby someone or some entity that is not the government, such\nas individuals, corporations, and partnerships. Private property\ncan include real property like land or buildings, and personal\nproperty, such as vehicles, furniture, and computers. Property\nthat is owned by the government is public property. Rocky\nMountain National Park is an example of public property that\nis real property. Public property can also include personal\nproperty, such as vehicles and computers owned by state or\nlocal governments.\n\nMethods of Acquisition of Personal Property\nPersonal property may be acquired in several different ways.\nFor example, ownership by production occurs when one\nproduces something. However, if an employee produces a\ngood as part of his or her job, then the employer will own\n\nProperty | 390\n\n\x0cthe property, not the employee. Ownership by purchase is the\nmost common method of acquiring property. For example, if\na customer buys a good, then the customer owns it through\npurchase from the manufacturer.\nProperty may also be gifted. A gift is a voluntary transfer of\nproperty. Generally, the donor of the gift must intend to gift the\nproperty, the donor must deliver the gift, and the gift must be\naccepted by the intended recipient. A conditional gift is a gift\nthat requires a condition to be met before the gift will transfer,\nsuch as a wedding or graduation.\nProperty that someone finds can be classified in several ways.\nIf property is abandoned, a person who finds it may claim\nownership. However, the original owners of abandoned\nproperty must intend to relinquish ownership in it. For\nexample, if someone takes a chair to the landfill, he or she\nhas abandoned the chair. Someone may come along and take\nlegal possession of it. However, if the property is simply lost or\nmislaid, then the finder must relinquish it once the rightful\nowner demands its return. Another classification of personal\nproperty applicable to found property is treasure trove.\nA treasure trove is money or precious metals, like gold, which\nis hidden in the ground or other private place by an unknown\nowner. Whoever finds a treasure trove becomes the owner\nunless the true owner (i.e. the person who hid it) comes\nforward.\n\n391 | Property\n\n\x0cType of\nProperty\n\nRights of\nFinder\n\nRights of\nOwner\n\nFinder\nacquires\nrights to the\nproperty\n\nNone\n\nFinder has\nrights to the\nproperty\nagainst\neveryone\nexcept the\nowner\n\nOwner has\nright to have\nproperty\nreturned\nbecause\nowner never\nlost\nownership\ninterest\n\nOwner intentionally\nplaced property in a\nspecific place but\nhas forgotten where\n\nFinder has no\nrights and\ncannot keep\nproperty\n\nOwner has\nright to have\nproperty\nreturned\nbecause\nowner never\nlost\nownership\ninterest\n\nOwner intentionally\nhid property\n\nFinder\nacquires\nrights to the\nproperty\nunless the\nowner comes\nforward\n\nOwner must\ncome forward\nto maintain\nright to\nproperty; if\nnot, finder\nbecomes new\nowner\n\nDescription\n\nOwner intentionally\nparted with\nAbandoned property with intent\nto relinquish\nownership rights\n\nLost\n\nMislaid\n\nTreasure\nTrove\n\nOwner\nunintentionally\nparted with\npossession of the\nproperty\n\nBailment\nSometimes it is necessary to intentionally leave personal\nproperty with someone else. A bailor is someone in the rightful\npossession of personal property who gives the property to\nsomeone else to hold, who is called a bailee. A bailment is the\narrangement in which the personal property is exchanged. The\nbailee agrees to accept the property and has the duty to return\nit. For example, a customer gives clothes to a dry cleaner. The\nProperty | 392\n\n\x0cdry cleaner is a bailee and has a duty to return the clothes\n(personal property) upon demand by the customer, who is the\nbailor.\nBailments may be voluntary or involuntary. A voluntary\nbailment is created when intention exists to create the\nbailment, as described in the dry cleaner example above. An\ninvoluntary bailment is created when someone finds lost or\nmislaid property. The finder may not destroy the property,\nthough the duties that he or she owes regarding the property\nmay vary from state to state.\nBailment is common in business, including placing packages\nwith common carriers for delivery, warehousing goods with a\nthird party, or taking clients\xe2\x80\x99 or customers\xe2\x80\x99 automobiles in a\nvalet service.\nThe duty of care that the bailee owes to a bailor depends on\nthe nature and value of the property involved, as well as who\nbenefits from the bailment. In general, a higher standard of\ncare is required for more valuable property. Damages in a\nbailment case are based on the retail replacement value of the\nproperty.\n\n22.3 Real Property\nReal property is land, and certain things that are attached to\nor associated with it. Real property includes undeveloped land,\nlike a field, and it includes buildings, such as houses, and office\nbuildings. Real property also includes things associated with\nthe land, like subsurface rights (rights to minerals and things\nfound beneath the surface).\n\n393 | Property\n\n\x0cMethods of Acquisition\nReal property may be acquired by purchase, inheritance, gift, or\nthrough adverse possession. Ownership rights are transferred\nby title. Ownership of real property means that the owner has\nthe right to possess the property, as well as the right to exclude\nothers, within the boundaries of the law. If someone\nsubstantially interferes with the use and enjoyment of real\nproperty, the owner may bring a nuisance claim. Similarly, the\nowner may bring a trespass claim against those who enter the\nland without consent or permission.\n\nPurchase\nLand owners may convey or sell part or all of their land\ninterests. Different types of deeds convey different types of\ninterests. A quitclaim deed, for instance, conveys whatever\ninterests in title that the grantor has in the property to the\nparty to whom the quitclaim is given. That means if the grantor\nhas no interests in the real property, a conveyance by quitclaim\nwill not grant any interests in the property. By comparison,\na warranty deed conveys title and the seller gives a warranty\nagainst defects in title as well as encumbrances. Buyers\ntypically demand a warranty deed when they purchase\nproperty because the seller assumes the risk of the title not\nbeing clear.\nAfter title is transferred by the deed, the deed is recorded in\nthe county where the property is located. Recording a deed\nis important because it places others on notice about who\nowns the property. States have different rules about who is\nconsidered the legitimate owner when a conflict in ownership\nclaim exists. A bona fide purchaser is a purchaser who takes\ntitle in good faith, with no knowledge of competing claims to\n\nProperty | 394\n\n\x0ctitle. Many states recognize a bona fide purchaser\xe2\x80\x99s rights to\nownership over those who did not properly record a deed.\n\nInheritance\nAnother common way in which real property may be obtained\nis through inheritance. Real property may be bequeathed\nthrough a will or may be transferred by state law when\nsomeone dies without a will. Generally speaking, people have\nthe right to dispose of their property as they wish when they\ndie, providing that their will or other transfer instrument meets\ntheir state\xe2\x80\x99s requirements for validity. If someone dies without\nliving relatives, the government becomes the owner of the\nproperty.\n\nGift\nReal property may also be acquired through a gift. A gift is valid\nwhen:\n1. The person giving property intends to make the gift;\n2. The person delivers the deed to the recipient; and\n3. The recipient accepts the gift.\nIf one of these elements is not met, then title will not be\nconveyed.\nFigure 22.2 Comparison of Contract and Gift\n\n395 | Property\n\n\x0cAdverse Possession\nA less common way to acquire real property is through the\ndoctrine of adverse possession. Adverse possession is when\nsomeone who is not the owner of real property has claimed the\nreal property for his own. This is referred to as \xe2\x80\x9csquatter\xe2\x80\x99s rights.\xe2\x80\x9d\nIf land sits idle at the owner\xe2\x80\x99s hands but someone else puts it\nto use, then the law may favor the user\xe2\x80\x99s claim to the land over\nthat of the actual owner. Adverse possession claims often occur\naround property lines, where one party has routinely used\nanother\xe2\x80\x99s property because a fence has been misplaced.\n\nProperty | 396\n\n\x0cFigure 22.3 Adverse Possession Cartoon\n\nInterests and Scope\nOwning real property carries many responsibilities, as well as\nthe potential for great profit and great liability. It is important\nto learn how to protect against potential liability of property\nownership. For instance, if a toxic waste site is discovered on\nreal property, the owner may be liable for its cleanup, even\nif he or she did not realize that such a site was there when\npurchasing the land. Each buyer of real property has a duty\nto exercise due diligence when purchasing land. A purchaser\n\n397 | Property\n\n\x0cshould never agree to buy land \xe2\x80\x9csight unseen\xe2\x80\x9d or without a\nprofessional inspector.\nIt is important to know the duties of landowners, how to limit\nliability associated with the ownership of land, and when\nseverance of liability occurs.\n\nDuties of Landowners\nLandowners owe different duties to different types of people\nwho enter their land. These responsibilities vary, depending on\nwhether the person is a trespasser, a licensee, or an invitee.\nA trespasser is a person who intentionally enters the land of\nanother without permission. A landowner has a duty to not\nintentionally injure a trespasser. For instance, booby traps and\npitfalls are illegal. Trespassers injured from such traps have\nvalid claims against the landowner. However, if trespassers are\ninjured from unknown or unforeseeable dangers, the owner is\nnot usually liable.\nA licensee is someone who has permission to be on the land.\nLandowners have a higher duty of care to such a person.\nLicensees include delivery people, meter readers, and utility\nworkers. A landowner must not intentionally injure a licensee\nand must warn the licensee of known defects. For example, if\na landowner knows that the steps to his or her porch are icy,\nhe or she has a duty to warn a licensee that those steps are icy.\nFailure to do so may result in liability for the landowner.\nAn invitee is someone who has entered real property by\ninvitation. Businesses and public places that want members of\nthe community to visit have issued invitations to the public.\nLandowners must inspect their property for defects, correct\nthose defects when found, and warn invitees about such\n\nProperty | 398\n\n\x0cdefects. For example, a grocery store must clean up spills as\nquickly as possible and put up a \xe2\x80\x9ccaution\xe2\x80\x9d sign in that area.\n\nOwnership Interests in Real Property\nDifferent types of interests may be owned in real property. For\nexample, real property may be owned without restriction,\nsubject only to local, state, and federal laws. Sometimes\nownership interests may be narrower, subject to conditions,\nthe violation of which can lead to loss of those ownership\ninterests.\nThe most complete ownership interest recognized by law is\ncalled fee simple absolute. This ownership allows the owner\ncomplete control over the land and lasts until the owner dies\nor conveys the property to someone else. Generally, if someone\nwants to buy real property, he or she is looking to buy property\nin fee simple absolute.\nCompare that with a defeasible fee. A fee simple defeasible is\nsubject to a condition of ownership or to some future event.\nFor instance, if an owner donates land to a city \xe2\x80\x9cso long as it\nis used as a public greenway,\xe2\x80\x9d then the land would be owned\nin defeasible fee by the city as long as it maintains it as a\npublic greenway. Once the condition is violated, the land would\nrevert back to either the original owner or whoever owned\nthe reversion interest, which is a future interest in real\nproperty.\nAnother ownership interest is a life estate. This interest is\nmeasured by the life of the owner. For example, a person could\ngrant ownership rights in real property to a parent for the\nlength of his or her life, but then the property would be\nreturned upon the parent\xe2\x80\x99s death. A common investment,\nknown as a reverse mortgage, employs the concept of life\n399 | Property\n\n\x0cestate. A reverse mortgage is an arrangement where the\npurchaser of real property agrees to allow the seller of the\nproperty to retain possession of the property for a specified\nperiod of time (such as the remainder of his or her life) in\nexchange for the ability to purchase the property at today\xe2\x80\x99s\nprice.\n\nThese\n\narrangements\n\nessentially\n\ngamble\n\non\n\nlife\n\nexpectancies of the sellers of real property by granting life\nestates to them in the property.\nProperty can be owned by more than one owner. Several types\nof co-ownership interests are recognized in law. These\nownership interests are important for matters of possession,\nright to transfer, right to profits from the land, and liability. For\nexample, tenancy in common describes an ownership interest\nin which all owners have an equal right to possess the whole\nproperty. Compare this to joint tenancy, in which the surviving\nowner has the right of survivorship. If one of the owners dies,\nhis or her property interests automatically transfers to the\nremaining owner(s).\nThese different interests are created by specific wording in the\ninstrument of conveyance. An owner in tenancy in common\nmay sell or transfer his or her rights without seeking permission\nfrom the other owners. This is because owners in a tenancy\nin common have the unilateral right to transfer their interests\nin property. Conversely, to transfer one\xe2\x80\x99s interests in a joint\ntenancy, the consent and approval of the other owners is\nrequired.\n\nScope of Interests in Real Property\nScope of ownership determines what can (or cannot) be done\nwith the land. The surface of the land and the buildings that\nare attached to the land are what most people think of about\n\nProperty | 400\n\n\x0cownership of real property. However, land interests also include\nsubsurface or mineral rights, and right to light or to a view.\nMoreover, water rights are granted differently, depending on\nwhether the property is in the western or the eastern United\nStates. Additionally, easements (the right to cross or otherwise\nuse someone\xe2\x80\x99s land for a specified purpose) and covenants\n(guides or restraints on how one may build on their land) grant\ncertain rights to non-possessors of land.\n\nSubsurface Rights\nSubsurface or mineral rights are rights to the substances\nbeneath the actual surface of the land. Purchasing mineral\nrights allows the owner to extract and sell whatever exists\nunder the surface of the land, such as oil, natural gas, and gold.\n\nWater Rights\nWater rights are determined in two different ways in the United\nStates. Generally speaking, states east of the Mississippi River\nfollow a riparian water rights doctrine, which means that those\nwho live next to the water have a right to use the water. The\nwater is shared among the riparian owners. However, most\nwestern states use the prior appropriation doctrine, which\ngrants rights to those who used those rights \xe2\x80\x9cfirst in time.\xe2\x80\x9d\nUnder this concept, the use must be beneficial, but the owner\nof the right need not be an adjacent landowner. This policy has\nresulted in claims by \xe2\x80\x9cdownstream\xe2\x80\x9d users having priority over\nlandowners where water runs through the land. For example,\ncasinos in Las Vegas, Nevada may have priority of water rights\nover ranchers in Colorado where a tributary runs through the\nranch. Prior appropriation is a \xe2\x80\x9cuse it or lose it\xe2\x80\x9d doctrine.\n\n401 | Property\n\n\x0cEasements and Covenants\nEasements and covenants are nonpossessory interests in real\nproperty. An easement can be express or implied and it gives\npeople the right to use another\xe2\x80\x99s land for a particular purpose.\nFor example, a common easement is for utility companies to\nenter private property to maintain poles and power lines. Other\nexamples include sidewalks and a landlocked property having\nan easement across another piece of property for the purpose\nof a driveway or walkway.\nA covenant is a voluntary restriction on the use of land.\nCommon covenants are homeowners associations\xe2\x80\x99 rules,\nwhich restrict the rights of the owners to use their land in\ncertain ways, often for aesthetic purposes. For instance, such\ncovenants might require houses subject to the covenant to be\npainted only in certain approved colors, or they might contain\nprohibitions against building swimming pools.\nSome covenants and easements \xe2\x80\x9crun with the land,\xe2\x80\x9d which\nmeans that the restrictions will apply to subsequent owners of\nthe property. Whether a covenant or easement runs with the\nland depends on the type of interest granted.\n\nLandlord-Tenant Relationships\nA leasehold interest also may be created in real property. A\ntenant has the right to exclusive possession of the real property\nand the duty to follow the rules of occupancy set out by the\nlandlord. The landlord has the right to be paid rent and the\nduty to ensure that the premises are habitable. If one party\ndoes not perform under the lease as required, the other party\nmay seek a legal remedy for breach of contract. Most state laws\nalso impose duties on landlords to maintain safe and habitable\n\nProperty | 402\n\n\x0cconditions on the property. Tenants also have a duty to use\nthe premises properly and not to damage the property beyond\nnormal wear and tear.\nDifferent types of tenancies may be created:\nType of\nTenancy\n\nDescription\n\nTenancy for\nyears\n\n\xe2\x80\xa2 Lease lasts for a specified period of time;\n\xe2\x80\xa2 Called tenancy for years regardless of how long\nthe tenancy is for;\n\xe2\x80\xa2 Once the time expires, so does the tenancy\n\nPeriodic\ntenancy\n\n\xe2\x80\xa2 Lease states when rent is due but does not have\na set duration;\n\xe2\x80\xa2 E.g. a month-to-month lease\n\nTenancy at\nwill\n\n\xe2\x80\xa2 Lease may be terminated at any time by\nlandlord or tenant;\n\xe2\x80\xa2 Tenancy often created through actions of parties\nrather than written lease\n\nTenancy at\nSufferance\n\n\xe2\x80\xa2 Tenant remains on the property after the right\nof possession has ended and without the\nlandlord\xe2\x80\x99s consent;\n\xe2\x80\xa2 Law views tenant as trespasser who is\nresponsible for paying rent during holdover\nperiod;\n\xe2\x80\xa2 Most states require landlord to evict tenant\nthrough formal eviction or unlawful detainer\nproceedings\n\nTenancies may be created for residential or commercial\npurposes. Commercial leases typically last for longer periods of\ntime than residential leases. Many of the same responsibilities\nand duties exist with commercial leases, but there are some\nimportant differences. For example, a commercial tenant may\n\n403 | Property\n\n\x0cdemand that the landlord refuse to rent to a competitor of the\ntenant within the same building.\nLease interests are assignable unless those rights are expressly\nrestricted by agreement. This means that the rights conveyed\nby the lease may be transferred to another party by\nassignment, unless expressly prohibited by the lease. Common\nrestrictions on assignment in residential leases is a nosubletting clause. Just as the owner of real property may sell\nany or all of his or her interests, any ownership interest in real\nproperty may also be leased. For example, someone who owns\nthe subsurface rights of land may lease the right to drill for oil\nor gas to another.\n\n22.4 Wills and Trusts\nBoth real and personal property may be transferred to another\nowner through wills and trusts. Although most people think\nof wills and trusts as a tool for conveying property owned by\nindividuals, businesses property often needs to be transferred\nwhen the business owner dies. This is especially true for sole\nproprietorships and partnerships.\nA will is a document by which an individual directs his or her\nestate to be distributed upon death. Wills must be in writing\nand signed by the individual(s) making them. Although state\nlaws regarding wills vary slightly, most states require:\n\nProperty | 404\n\n\x0cRequirement\n\nDescription\n\nLegal age\n\n\xe2\x80\xa2 The individual must be 18 (16 in Louisiana, 14 in\nGeorgia, under 18 in the military)\n\nTestamentary\nintent\n\n\xe2\x80\xa2 Must make clear that document is a will\nthrough words such as \xe2\x80\x9clast will and testament\xe2\x80\x9d\n\nTestamentary\ncapacity\n\n\xe2\x80\xa2 The individual must be \xe2\x80\x9cof sound mind\xe2\x80\x9d and\nunderstand that he or she is creating a will,\nwhat property is being transferred & to whom it\nis being given\n\nSignature\n\n\xe2\x80\xa2 The individual must sign the document\n\nWitnesses\n\n\xe2\x80\xa2 There must be 2 adult witnesses to the\nindividual signing the will;\n\xe2\x80\xa2 Most states do not require the will to be\nnotarized but this step is recognized as a best\nlegal practice\n\nA trust is a property interest held by one person or entity at the\nrequest of another for the benefit of a third party. For a trust to\nbe valid, it must involve specific property, reflect the person\xe2\x80\x99s or\nentity\xe2\x80\x99s intent, and be created for a lawful purpose. Trusts are\nvery popular for leaving property to benefit children who are\nunder 18 years old, elderly, and people with disabilities.\nWhen planning how to distribute property upon death, it is\nimportant to understand the difference between probate and\nnon-probate assets. Probate is the process through which a\ncourt determines how to distribute property after someone\ndies. Some assets are distributed to heirs by the court (probate\nassets) and some assets bypass the court process and go\n\n405 | Property\n\n\x0cdirectly to beneficiaries (non-probate assets). Probate assets\ngenerally are subject to inheritance taxes and distribution can\nbe delayed until the court orders the distribution of the assets.\nBecause of these drawbacks, many individuals prefer nonprobate assets.\nProbate Assets\n\n\xe2\x80\xa2 Real property titled solely in\nthe decedent\xe2\x80\x99s name or\nheld in tenancy in common\n\xe2\x80\xa2 Personal property, such as\njewelry, furniture & vehicles\n\xe2\x80\xa2 Bank accounts solely in the\ndecedent\xe2\x80\x99s name\n\xe2\x80\xa2 Interest in a partnership,\ncorporation or limited\nliability company\n\xe2\x80\xa2 Life insurance policies or\nbrokerage accounts\nidentifying the decedent or\nhis or her estate as a\nbeneficiary\n\nNon-Probate Assets\n\xe2\x80\xa2 Real property held in joint\ntenancy or tenancy by the\nentirety\n\xe2\x80\xa2 Bank or brokerage accounts\nheld in joint tenancy or with\npayable on death (POD) or\ntransfer on death (TOD)\nbeneficiaries\n\xe2\x80\xa2 Real property, personal\nproperty, and money held in\na trust\n\xe2\x80\xa2 Life insurance or brokerage\naccounts identifying\nsomeone other than the\ndecedent as a beneficiary\n\xe2\x80\xa2 Retirement accounts\n\nDeath of a property owner impacts the ability to transfer\nproperty. The ownership interest dictates how the property\nmay be transferred.\n\nProperty | 406\n\n\x0cType of\nOwnership\n\nDeath of\nOwner\n\nTransfer\n\nWhere\nAvailable\n\nTenancy in\nCommon\n\nOwner\xe2\x80\x99s\ninterest passes\nto heirs\n\nOwner may\ntransfer\ninterest\nwithout\nagreement of\nco-owners\n\nAll states\n\nJoint Tenancy\n\nOwner\xe2\x80\x99s\ninterest passes\nto the\nremaining\njoint tenants as\nnon-probate\nasset\n\nOwner may\nnot transfer\ninterest\nwithout\nagreement of\nco-owners\n\nAll states\n\nTenancy by\nEntirety\n\nOwner\xe2\x80\x99s\ninterest passes\nto the\nsurviving\nspouse\n\nOwner may\nnot transfer\ninterest\nwithout\nagreement of\nspouse\n\nApproximately\nhalf of the\nstates\n\nCommunity\nProperty\n\nHalf of owner\xe2\x80\x99s\ninterest passes\nto the\nsurviving\nspouse & other\nhalf passes to\nother heirs\n\nOwner may\nnot transfer\ninterest\nwithout\nagreement of\nspouse\n\nOnly 9 states:\nArizona,\nCalifornia,\nIdaho,\nLouisiana,\nNevada, New\nMexico, Texas &\nWashington\n\nIf someone dies without a will or trust, the probate court will\ndetermine:\n1. The nature and value of the decedent\xe2\x80\x99s estate;\n2. The nature and value of any outstanding debts and tax\nobligations;\n3. Whether the decedent has any heirs;\n4. The identity of the heirs and their relationship to the\ndecedent; and\n5. What, if anything, the heirs are entitled to receive from the\ndecedent\xe2\x80\x99s estate.\nThe essential role of the probate court is to ensure that the\n\n407 | Property\n\n\x0cdeceased person\xe2\x80\x99s creditors are paid and that any remaining\nassets are distributed to the proper beneficiaries. However, this\nprocess takes time and costs money from the deceased\nperson\xe2\x80\x99s estate. And there is no guarantee that the deceased\nperson intended his or her property to be distributed based\non the state\xe2\x80\x99s rules on who qualifies as an heir and what they\nare entitled to receive. Business assets owned by the deceased\nperson may complicate the probate process even more.\n\n22.5 Land Use Regulation\nA nuisance is a condition or situation, such as a loud noise or\nfoul odor, that interferes with the use or enjoyment of property.\nCourts balance the utility of the act that is causing the problem\nagainst the harm done to neighboring property owners. For\nexample, restrictions exist on when manufacturing plants may\noperate to not interfere with sleeping patterns of neighbors.\nNuisance can be both intentional and unintentional, as well\nas public or private. A public nuisance is an unreasonable\ninterference with a right common to the general public, such\nas a condition dangerous to the public\xe2\x80\x99s health or a restriction\non the public\xe2\x80\x99s access to public property. Many jurisdictions\nalso include conduct that is offensive to the community\xe2\x80\x99s moral\nstandard to regulate the placement of adult industries in\nresidential neighborhoods. Public nuisance claims often\ninclude manufacturing noises, smoke and smells. A private\nnuisance is a condition that interferes with a person\xe2\x80\x99s\nenjoyment of their property that does not involve a trespass.\nFor example, cigarette smoke entering a neighbor\xe2\x80\x99s house\nfrom a smoker on an adjacent property is a private nuisance.\nFigure 22.4 Public Nuisance Street Sign\n\nProperty | 408\n\n\x0cFigure 22.5 Private Nuisance Example\n\n409 | Property\n\n\x0cMost states have passed laws\nthat allow local governments\nto regulate zoning. Zoning\nordinances are laws passed\nby\n\ncounties,\n\ncities,\n\nand\n\nmunicipalities that regulate\nland\n\ndevelopment.\n\nordinances\n\nThese\n\ndetermine\n\nwhether commercial or residential buildings can be built in an\narea, how tall buildings may be, and how much green space\nmust be maintained. They also apply to existing buildings and\nregulate whether a building may be converted from residential\nproperty to commercial, as well as what type of commercial\nproperty it may be. For example, many zoning ordinances\nregulate the types of businesses that may be located next to\nschools and hospitals.\nEminent domain is the power of the government to take\nprivate property for public use. A governmental entity may\nneed to build or expand highways, public transport systems, or\npublic housing. To address the public\xe2\x80\x99s need, the government\ncan take private property and use it for the good of the\ncommunity. All levels of government\xe2\x80\x93federal, state, and\nlocal\xe2\x80\x93have\n\nthe\n\npower\n\nof\n\neminent\n\ndomain.\n\nThe\n\nFifth\n\nAmendment of the US Constitution requires that any owners\nof private property taken for public use must be given \xe2\x80\x9cjust\ncompensation.\xe2\x80\x9d Just compensation means fair market value for\nthe land.\n\n22.6 Environmental Law\nFederal and state governments have passed environmental\nlaws to limit pollution and protect the health and welfare of\n\nProperty | 410\n\n\x0cthe public. Although most people are supportive of these laws\nin theory, the practical implementation of them has been\ncontroversial. Underlying the political debate is the question,\nhow should the law balance the costs and benefits of\nenvironmental decisions?\n\nClean Air Act\nIn 1963, Congress passed the Clean Air Act to regulate air\npollution. Under the Clean Air Act, the Environmental\nProtection Agency (EPA) has the authority to regulate both\nthe total amount of existing air pollution and its ongoing\nproduction. The Clean Air Act was passed to address concerns\nof global warming and acid rain.\nFigure 22.6 EPA Seal\n\nThe Clean Air Act requires the EPA to set national air quality\nstandards that protect public health and provide an adequate\nmargin of safety without regard to cost and to implement\nthem if appropriate and necessary. This \xe2\x80\x9cwithout regard to\ncost\xe2\x80\x9d directive has been heavily litigated. In 2015, the US\nSupreme Court ruled that the EPA must consider costs as part\nof its analysis of whether the standards are \xe2\x80\x9cappropriate\xe2\x80\x9d and\n411 | Property\n\n\x0cnecessary. In other words, a regulation is not \xe2\x80\x9cappropriate\xe2\x80\x9d if it\ndoes more harm than good.\nThe Clean Air Act is a federal law that is implemented through\nthe states. After the EPA sets air quality standards, states must\nenforce them. States may implement more stringent air quality\nstandards than the EPA requires, but they cannot do less.\nTherefore, businesses must comply with both state and federal\nagencies to ensure their compliance with the Clean Air Act.\nA controversial aspect of the Clean Air Act is that it allows for\ntrading of credits. For example, a manufacturer who removes\nmore carbon monoxide than necessary from its emissions is\ngiven a \xe2\x80\x9ccredit\xe2\x80\x9d from the EPA. These credits can then be sold\nto another manufacturer that does not remove enough to be\ncompliant with the law. The rationale is that credits make it\nprofitable for manufacturers to invest in technology that\npollutes less than is legally required. By giving a market\nincentive to industries to protect the environment, there will be\nless need for governmental enforcement.\nThe Clean Air Act imposes daily fines for emission violations,\nas well as punitive damages and criminal liability for corporate\nofficers who knowingly and willfully violate the law. As a result,\nthe Clean Air Act is a law that manufacturers must take\nseriously.\nFigure 22.7 Common Air Pollutants\n\nProperty | 412\n\n\x0cClean Water Act\nCongress passed the Clean Water Act in 1972 to regulate water\nquality of navigable waters. Similar to the Clean Air Act, the EPA\nsets standards that are enforced by the states. The intent of\nthe Clean Water Act is to keep water clean for recreational use\nand to protect fish and wildlife. It requires a discharge permit\nto release waste into navigable water.\nFigure 22.8 Photo of discharge of industrial waste into river\n\n413 | Property\n\n\x0cThe EPA sets limits, by industry, on the amount of each type\nof pollution that can be discharged in a given area, as well\nas the type of technology that can be used to treat water.\nAs a result, the two biggest issues when enforcing the Clean\nWater Act are (1) is the waterway navigable? and (2) what is the\nbest available technology that each industry can use to reduce\npollution. Both issues are heavily litigated.\nThe Clean Water Act also requires the EPA to set national\nstandards for water quality in general. It is worth noting that\nwater quality standards vary depending on the use of the\nwater. Water quality for drinking is the highest, with wildlife\nand recreation higher than irrigation and industry. As a result,\neven businesses that are not discharging waste into navigable\nwaterways are subject to EPA standards of water quality on\ntheir premises. For example, a retailer must comply with water\nquality requirements in its drinking fountains and bathrooms.\nLike the Clean Air Act, the Clean Water Act imposes daily fines\nfor emission violations, as well as punitive damages and\n\nProperty | 414\n\n\x0ccriminal liability for corporate officers who knowingly and\nwillfully violate the law.\n\nWaste Disposal\nWaste disposal, especially of chemicals, has been an area of\nincreased regulation over the past decades. The disposal of\nordinary garbage is primarily regulated by the states. However,\nthe federal government sets minimum standards for landfills\nand regulates how states manage garbage. Most of these\nregulations are \xe2\x80\x9cinvisible\xe2\x80\x9d to businesses and individuals.\nFigure 22.9 Improper Toxic Waste Disposal\n\nToxic waste, on the other hand, directly impacts manufacturers.\nIn 1976 Congress passed several laws to address the problem\n\n415 | Property\n\n\x0cof industrial waste and toxic waste. Toxic waste is hazardous or\npoisonous substances that cause an increase in the death rate\nor serious irreversible illnesses. Toxic waste includes arsenic,\nasbestos, clinical waste (i.e. syringes), cyanide, lead, and\nmercury. Many of these chemicals are found in batteries,\nelectronics, and household cleaners. Manufacturers have a\n\xe2\x80\x9ccradle to grave\xe2\x80\x9d responsibility for all hazardous and toxic\nwaste. This means that hazardous waste must be (1) tracked\nfrom creation to final disposal and (2) disposed of at a certified\nfacility.\nTo clean up hazardous waste that was illegally dumped in the\npast, Congress passed the Comprehensive Environmental\nResponse, Compensation, and Liability Act (CERCLA), which is\npopularly known as \xe2\x80\x9cSuperfund.\xe2\x80\x9d The philosophy of Superfund\nis that the polluter pays. Therefore, former and current owners\nof a site on which hazardous waste is found or who transported\nwaste to the site are strictly liable for remediation of the land.\nThe law has an exception for innocent landowners who\nunknowingly purchased the land. However, that exception is\nnarrowly applied.\n\nEnvironmental Impact Statements\nThe National Environmental Policy Act (NEPA) requires all\nfederal\n\nagencies\n\nto\n\nprepare\n\nan environmental\n\nimpact\n\nstatement (EIS) for every major federal action that significantly\naffects the quality of the human environment. An EIS is\nrequired not only for actions by the federal government, but\nalso activities regulated or approved by the government.\nTherefore, private businesses that need federal approval to\nopen\n\nor\n\nexpand\n\ntheir\n\noperations\n\nare\n\nsubject\n\nto\n\nthis\n\nrequirement. For example, an EIS was needed before\n\nProperty | 416\n\n\x0cexpanding the Snowmass ski area in Aspen because the US\nForest Service was required to approve the expansion.\nAn EIS must include:\n\xe2\x80\xa2 A description of the environmental impact of the\nproposed action;\n\xe2\x80\xa2 An estimate of the energy requirements for the project;\n\xe2\x80\xa2 A description of potential adverse effects on the urban\nquality, including historic and cultural resources;\n\xe2\x80\xa2 Identification of the short-term and long-term impact on\nthe environment;\n\xe2\x80\xa2 A description of any irreversible impact on the\nenvironment;\n\xe2\x80\xa2 A plan of how to mitigate any adverse environmental\nimpact; and\n\xe2\x80\xa2 A discussion of possible alternatives.\nThe process of preparing an EIS can be long and expensive.\nAfter an EIS is written, the federal agency must allow for public\ncomments and hold a hearing. Therefore, a private business\nmay have its EIS scrutinized and commented on by interest\ngroups and competitors before receiving federal approval.\nThere is also a risk to the business that the government agency\ndenies the business\xe2\x80\x99s request based on public comments and\nconcerns.\n\n22.7 Concluding Thoughts\nProperty is classified as real property or personal property,\ntangible or intangible, and private or public. Personal property\ncan be transformed into real property when it is affixed to the\nland. Real property can be transformed into personal property\nwhen it is severed from the land. Personal property can be\n417 | Property\n\n\x0cacquired for ownership through production, purchase, or gift\nor, in certain circumstances, by finding it. Bailments are legal\narrangements in which the rightful possessor of personal\nproperty leaves the property with someone else who agrees to\nhold it and return it on demand.\nWhen thinking about acquiring property, it is important to\nunderstand the rights and duties associated with acquiring it,\nthe protections afforded to the owner, and how to transfer it to\nanother party at the time of sale, lease, or licensing the right to\nuse it. Real property includes land and the buildings attached\nto it, as well as the minerals below it. Personal property is\neverything\n\nelse.\n\nBecause\n\nproperty\n\nownership\n\nincludes\n\nexposure to liability, businesses need to take steps to protect\npeople on their real property from hazards. Businesses are also\nsubject to land use regulations and environmental laws for the\nuse of their real property.\nReal and personal property may be transferred to another\nowner through wills and trusts upon the death of the original\nowner. Businesses property often needs to be transferred when\nthe business owner dies, and not having a will or trust in place\nto convey the property can complicate the probate process.\nNon-probate assets are popular to avoid inheritance taxes and\ndelays in distributing assets.\nEnvironmental laws have a big impact on businesses,\nespecially manufacturers. The Clean Air Act and the Clean\nWater Act are federal laws that are implemented through the\nstates, so businesses must work with both state and federal\ngovernments to ensure they are legally compliant. Businesses\nthat want to open or expand their operations are required to\nprepare an environmental impact statement if they need\nfederal approval.\n\nProperty | 418\n\n\x0c23. Intellectual\nProperty\n23.1 Introduction\nLEARNING OBJECTIVES\n1. Understand what intellectual property is.\n2. Define the four types of intellectual property.\n3. Explore the Constitutional roots for providing legal\nprotection to intellectual property.\nRegardless of size and industry, a business\xe2\x80\x99s Intellectual\nProperty (IP) is often more valuable than its physical assets. In\nfact, Fortune 500 companies have 45-75% of their assets tied\nto IP. Companies invest tremendous resources in developing\ninnovative new products and services. Intellectual property law\nprevents\n\ncompetitors\n\nfrom\n\nimmediately\n\nprofiting\n\nfrom\n\nanother\xe2\x80\x99s invention and provides incentives for continued\ninnovation.\n\nCounselor\xe2\x80\x99s Corner Intellectual property is one of a\nbusiness\xe2\x80\x99s most important assets. But it can also be\nhard to define and, thus, hard to protect. A good IP\nattorney will understand the nuances of your\ninvention and help you identify ways to get the\nmost protection for your intellectual property. You\n\n419 | Intellectual Property\n\n\x0cmay find that working with her contributes to your\ninventive process! ~ Jenny C., attorney\n\n23.2 Intellectual Property\nIntellectual\n\nProperty is\n\na\n\nform\n\nof\n\nintangible\n\nproperty\n\nrepresenting the commercially valuable product of the human\nmind. IP can be in either an abstract or concrete form. For\nexample, a composer may have IP interests to both the\nabstract sound of the music he or she composed, as well as the\nconcrete sheet music that instructs musicians how to play the\nmusical composition.\nProtection of IP rights generally fall into one of four categories:\npatents, trade secrets, copyrights, and trademarks.\n\nIntellectual Property | 420\n\n\x0cPatent\n\nTrade Secret\n\nCopyright\n\nTrademark\n\nInventions &\nmethods\n\nValuable secrets\nthat give a\nbusiness a\ncompetitive\nadvantage\n\nTangible\nexpression of\nan idea; but\nnot the idea\nitself\n\nWords &\nsymbols\nused to\nidentify\nproducts or\nservices\n\nDistinctiveness\n\nOriginal\nexpression\n\nReasonable\nmeasures in\nplace to\nprotect\nsecrecy\n\nInformation\nmust be kept\nsecret but no\nformal process is\nnecessary\n\nProtection is\nautomatic\nonce creative\nexpression\ntakes\ntangible\nform; does\nnot have to\nbe filed with\nthe CO but\nreceives\ngreater\nprotection if\nit is\n\nMark is use\nin\ncommerce\ndoes not\nhave to be\nfiled with\nUSPTO but\nreceives\ngreater\nprotection\nit is\n\n20 years (14\nyears for a\ndesign\npatent)\n\nForever, as long\nas information is\nkept secret\n\n70 years after\ndeath of\nauthor, 95\nyears from\npublication,\nor 120 years\nfrom\ncreation\n(whichever is\nshorter)\n\n10 years bu\ncan be\nrenewed an\nunlimited\nnumber of\ntimes as lon\nas mark is\nstill being\nused\n\nType of Law\n\nFederal only\n\nState (Economic\nEspionage Act\nmay provide\nsome federal\nprotection\ndepending on\nfacts of case)\n\nFederal only\n\nFederal and\nstate\n\nType of\nEnforcement\nAction\n\nInfringement Misappropriation Infringement\n\nInfringeme\n& dilution\n\nCriminal Liability\n\nNo\n\nYes\n\nProtects\n\nElements\n\nFiling\nRequirements\n\nDuration\n\nNovel &\nnon-obvious\n\nApplication\nmust be\napproved by\nUSPTO\n\n421 | Intellectual Property\n\nYes\n\nYes\n\n\x0cExpensive\n\nYes\n\nNo\n\nNo\n\nMaybe\n(depends o\npolicing\ncosts)\n\nSearch Required\nfor Existing IP\nHolders\n\nYes\n\nNo\n\nNo\n\nYes\n\nDifferent types of IP may attach to aspects of the same product\nor service. For example, Coca-Cola has trademarks for its name\nand logo, a patent for the shape of its original glass bottle, a\ncopyright for its commercial jingle, and a trade secret for its\ncola recipe.\nFigure 23.1 Examples of Coca-Cola trademarks\n\nIntellectual Property | 422\n\n\x0c23.3\nConstitutional\nRoots\nThe\n\nUS\n\nPatent\n\nTrademark\n\nOffice\n\nand\n\n(USPTO)\n\nwas established to protect\npatents as enumerated in\nArticle I, Section 8 of the\nConstitution.\n\nThat\n\nknown\n\nthe Copyright\n\nas\n\nclause,\n\nClause, says that Congress\nmay \xe2\x80\x9cpromote the Progress\nof Science and useful Arts, by\nsecuring for limited Times to\nAuthors and Inventors the\nexclusive\n\nRight\n\nrespective\n\nto\n\nWritings\n\nDiscoveries.\xe2\x80\x9d\n\nThe\n\nwebsite\n\na\n\nhas\n\ntheir\nand\nUSPTO\n\nsearchable\n\ndatabase for trademarks and\npatents.\nThe Copyright Clause directs\nthe federal government to\nprotect certain products of\nthe mind, just as much as it protects personal land or money.\nThe Copyright Clause essentially allows the government to\ncreate a special kind of monopoly around IP. For example, a\npharmaceutical company invents a drug and applies for a\npatent. If the patent is granted, then the company can charge\nas much as it needs to recover its research and development\ncosts because competitors are shut out of that drug market by\n\n423 | Intellectual Property\n\n\x0cvirtue of the patent. Violations of patent law carry severe\npenalties.\nHow can Congress outlaw most monopolies when the\nConstitution grants monopolies for IP? The answer lies in the\ngenius of the Copyright Clause itself. As in all monopolies, there\nare two sides: the producer and the consumer. The producer\nwants the monopoly to last as long as possible, while the\nconsumer wants the monopoly to end as quickly as possible.\nThe Copyright Clause strikes a compromise between the\nproducer and the consumer in two ways.\nFirst, the Clause states that Congress can grant the monopoly\nonly to \xe2\x80\x9cpromote the progress of Science and Useful Arts,\xe2\x80\x9d\nwhich is a very specific purpose. Note that making an inventor\nrich is not the purpose. Rather, the purpose is progress.\nGranting temporary monopolies encourages progress by\nproviding\n\na\n\nfinancial\n\nincentive\n\nto\n\nproducers.\n\nSingers,\n\nsongwriters, inventors, drug companies, and manufacturers\ninvent and create in the hope of making money. If they were\nnot protected, they would either not invent at all or would\nsimply do it for themselves, without sharing the fruits of their\nlabor with the rest of society.\nSecond, the Clause states whatever monopoly Congress grants\nhas to be for a \xe2\x80\x9climited time.\xe2\x80\x9d Congress makes the decision on\nhow long a monopoly can last based on how best to promote\nprogress. When the monopoly ends, science is advanced again\nbecause others can freely copy and improve upon the\nproducer\xe2\x80\x99s products. Society benefits greatly from the\nexpiration of IP monopolies. Important drugs such as aspirin\nand penicillin, for example, can now be purchased for pennies\nand are accessible to the entire human population. Similarly,\nliterary works, such as Shakespeare\xe2\x80\x99s Hamlet or Beethoven\xe2\x80\x99s\nFifth Symphony, can be performed and enjoyed by anyone at\nany time without seeking permission or paying royalties\n\nIntellectual Property | 424\n\n\x0cbecause copyrights last for only seventy years after the death\nof the author or creator. These inventions and works are now in\nthe public domain to be enjoyed by all.\n\n23.4 Patents\nA patent is the exclusive right to make, use or sell an invention\nfor a specified period of time (usually seventeen years), granted\nby the federal government to the inventor. A patent holder\nowns a patent. Patents may be legally sold to others. Therefore,\nan inventor may sell a patent to others, which ends his or her\nproperty interest in the invention.\nMany inventors and designers work for employers in creative\nand inventive capacities. If an employee invents something\nas part of his or her employment, then the employer is the\npatent holder. This arrangement allows innovative ideas to be\nadequately funded and to prevent employees working against\nthe best interests of their employers. However, if an employee\ninvents something outside of work on his or her own time, and\nthe invention is not related to his or her employment, then the\nemployee is the patent holder.\nTo apply for a patent, an inventor must meet two requirements:\nthe invention must be (1) novel and (2) non-obvious. To be\nnovel, the invention must not have been previously invented\nand must not come from a trivial improvement to an existing\ninvention. In other words, it must not have been previously\nknown or used. To be non-obvious, the invention must not be\nobvious to a reasonable person in an appropriate field with\nordinary skill. In other words, patents reward creativity that\nresults in something new and is not considered common\nknowledge by someone in the industry.\n\n425 | Intellectual Property\n\n\x0cPatent\nDescription\nRequirement\nNovel\n\nNew; cannot be something that was already\ninvented or in use\n\nNon-obvious\n\nNot common knowledge to a reasonable person\nwith ordinary skills in the industry\n\nNot all things can be patented. An idea alone (without a\ndefinite description) cannot be patented. Similarly, the laws of\nnature (such as gravity) and things that occur naturally (such\nas DNA) cannot be patented. This is because some items found\nin nature are not the result of the human mind or creativity.\nIf not the product of human invention, then a patent cannot\napply. This distinction can be narrow in some industries. For\nexample, DNA cannot be patented but the scientific process\nof synthetically reproducing DNA can be patented. Likewise, oil\ncannot be patented but the process for extracting it from the\nground can be.\n\nTypes of Patents\nThree types of patents exist. The most common type of patent\nis the utility patent. Utility patents are granted for a useful\ninnovative machine, process, manufacture, composition of\nmatter (such as a new chemical) or an improvement to an\nexisting item or process. These patents usually are granted for\ntwenty years.\nA design patent may be granted for new, original, and\nornamental designs for an article of manufacture. This type\nof patent protects a product\xe2\x80\x99s appearance or nonfunctional\naspects. These patents last for only fourteen years.\nA plant patent covers inventions or discoveries of asexually\nreproduced plants (e.g., plants produced through methods\n\nIntellectual Property | 426\n\n\x0csuch as grafting, root cuttings, and budding). In other words,\nthe plant is able to multiply without using seeds. For example,\none\n\ncompany\n\npatented\n\na\n\nunique\n\nrose\n\nwhose\n\ncolor\n\ncombination did not exist in nature.\nType of\nPatent\n\nDescription\n\nUtility\n\n\xe2\x80\xa2 Protects the way an invention is used and operates\n\xe2\x80\xa2 Useful innovative machine (e.g. table saw), process\n(e.g. software program), manufacture (e.g. thumb\ndrive that fits into USB port), composition of matter\n(e.g. new chemical) or an improvement to an\nexisting item or process\n\xe2\x80\xa2 Must be useful and functional\n\xe2\x80\xa2 Inventor does not have to show invention has\nmonetary value\n\xe2\x80\xa2 Lasts 20 years (unless patent granted before June\n8, 1995)\n\nDesign\n\n\xe2\x80\xa2 Protects appearance of product (e.g. Jeep\xe2\x80\x99s grill\ndesign)\n\xe2\x80\xa2 Lasts 14 years\n\nPlant\n\n\xe2\x80\xa2 Protects any distinct and new variety of plant\n\xe2\x80\xa2 Plant cannot have been sold or released in US for\nmore than 1 year\n\xe2\x80\xa2 Involves many controversial patents involving\ngenetically modified plants used for food\n\xe2\x80\xa2 Lasts 20 years\n\nPatent Enforcement\nThe USPTO grants property rights to patent holders within the\nUnited States. Patent law is complicated, and attorneys who\nwish to practice patent law must have an engineering or\nscience background and pass a separate patent bar exam.\n\n427 | Intellectual Property\n\n\x0cWhen an application is filed, the USPTO assigns a patent\nexaminer to decide whether the patent application should be\napproved. While the application is pending, the applicant is\npermitted to use the term \xe2\x80\x9cpatent pending\xe2\x80\x9d in marketing the\nproduct to warn others that a patent claim has been filed. Even\nafter a patent has been issued by the USPTO, however, the\npatent is only presumed to be valid. If someone challenges a\npatent in a lawsuit, final validity rests with the US federal courts.\nIn the last decade there has been more than a 400 percent\nincrease in the number of patents filed, resulting in a multiyear\ndelay in processing applications. An increase in the number of\nbusiness method patents contributed to this dramatic increase\nin patent applications. A business method patent seeks to\nmonopolize a new way of conducting a business process. For\nexample, \xe2\x80\x9cPatent Filing for One-Click Web Ordering\xe2\x80\x9d describes\na method of e-commerce by which a customer can order an\nitem and pay for it immediately with just one click of a button.\nThis one-click patent was granted to Amazon.com. Amazon\nlicensed the patent to Apple so that it could feature one-click\non its website. This in turn allowed Amazon to recover some of\nits development costs from Apple, which also wanted to use\nthe technology.\nIP protection sometimes involves controversial issues. For\nexample, pharmaceutical companies rely on patent law to\nprotect their massive investment in research and development\nof new drugs. For the few drugs that eventually get\ngovernmental\n\napproval\n\nand\n\ncommercial\n\nsuccess,\n\nmanufacturers seek to extract the highest possible price\nduring\n\nthe\n\nperiod\n\nof\n\npatent\n\nmonopoly.\n\nFor\n\nexample,\n\nantiretroviral drugs has greatly extended the lives of HIV/AIDS\npatients, but the drugs cost between $10,000 and $12,000 per\nyear in the United States. In many developing nations,\nindividuals\n\ncannot\n\nafford\n\nUS\n\nprices.\n\nTherefore,\n\nsome\n\ngovernments have declared national health emergencies, a\nIntellectual Property | 428\n\n\x0cprocedure under international treaties called compulsory\nlicensing, that forces drug companies to license the formula\nto generic drugmakers. As a result, Cipla, a generic drug\nmanufacturer in India, manufactures the same antiretrovirals\nfor about $350 a year.\nOutside the United States, a patent granted by the USPTO\ndoes not automatically protect the inventor\xe2\x80\x99s interest in that\nproperty. Instead, IP is protected by a series of international\nconventions. Because international law is only binding on\nnations who agree to be bound by it, IP is not protected\ninternationally in nations that have not signed the conventions.\n\nPatent Infringement\nIf someone uses a patented invention without permission from\nthe patent holder, then the user violates the patent holder\xe2\x80\x99s\nrights. Patent infringement is the act of making, using, selling,\nor offering to sell a patented invention without the permission\nof the patent holder. Patent infringement can be either direct\nor indirect. Direct infringement occurs when someone copies\nand uses an invention, or uses an invention with a slight\nvariation or addition. Indirect infringement occurs when\nsomeone \xe2\x80\x9cdesigns around\xe2\x80\x9d a patent by creating a product that\nis substantially the same and performs a similar function.\nIf patent holders successfully sue for patent infringement, they\nmay be entitled to an injunction forcing their competitors to\nstop using the invention, treble damages, costs, and attorney\xe2\x80\x99s\nfees. The most common defense to patent infringement claims\nis to challenge the validity of the patent. Given the scientific\nand technical nature of patent cases, litigating these cases is\nexpensive.\nAs a result of the cost of litigation, patent trolls exist in certain\n429 | Intellectual Property\n\n\x0cindustries such as technology and pharmaceuticals. Patent\ntrolls are individuals or companies who obtain the rights to one\nor more patents to profit by means of licensing or litigation,\nrather than by producing their own goods or services. The main\nsource of revenue for patent trolls comes from suing\ncompanies for infringement and hoping the companies settle.\nFor a relatively minor cost of applying for a patent and\nattorneys\xe2\x80\x99 fees, patent trolls look for a big payout. For example,\nNTP, a patent troll, sued the maker of BlackBerry, claiming\npatent infringement for the technology used to deliver the\nBlackBerry\xe2\x80\x99s push email feature. Faced with a potential\nshutdown of service, BlackBerry settled the case for more than\nsix hundred million dollars.\nOver\n\nthe\n\npast\n\ndecade,\n\nthere\n\nhave\n\nbeen\n\nsome\n\nlegal\n\ndevelopments to help protect companies from patent trolls.\nFor example, the US Supreme Court unanimously ruled that\npatent infringement cases must be filed in the federal court\nwhere the defending company is based rather than a court\nof the plaintiff\xe2\x80\x99s choice. This reduces the exposure and cost\nto the company of defending against cases filed across the\nnation, and for the patent trolls to \xe2\x80\x9cforum shop\xe2\x80\x9d for districts\nthey believe will be more beneficial to their claims.\nMore companies are choosing to fight patent trolls in court\nrather than payout. For example, Apple has been defending\nitself in court against patent troll VirnetX over patents that\nVirnetX obtained in FaceTime and iMessage delivery systems.\nAlthough Apple has a large enough budget to engage in\nprotracted litigation, not every company does. Therefore,\npatent trolls often target start-up companies hoping that the\neconomic threat of a lawsuit encourages quick settlements.\n\nIntellectual Property | 430\n\n\x0c23.5 Trade Secrets\nA Trade secret is a formula, process, device, or other business\ninformation that is kept confidential to maintain an advantage\nover competitors. The scope of trade secret protection goes\nwell beyond patent law. Unlike patent law, protection under\ntrade secret law is not tied to the information\xe2\x80\x99s novelty. Instead,\nthe essence of a trade secret is its relative secrecy.\nInformation that:\nElements of\na Trade\nSecret\n\n1. Is not generally known or ascertainable;\n2. Provides a competitive advantage;\n3. Has been developed at the owner\xe2\x80\x99s expense & is\nused continuously in the owner\xe2\x80\x99s business; and\n4. The owner intends to keep it confidential.\n\nA trade secret is, in short, secret information. This information\nmay include a process, formula, pattern, program, device,\nmethod, technique, or compilation. For many companies, lists\nof suppliers, costs, margins, and customers are all trade secrets.\nSoft drink recipes, the Big Mac\xe2\x80\x99s special sauce, and even the\ncombination of wood that is used in the burning process to\nmake Budweiser beer are all trade secrets. Additionally,\nGoogle\xe2\x80\x99s algorithm for conducting web searches is a trade\nsecret.\nTrade secrets are unlike patents in that with a patent, the\ninventor must specifically disclose in the application the details\nof the invention. Thus, the inventor has not protected the secret\nof the invention. However, in exchange for this disclosure, a\npatent owner has a legal monopoly over the property for a\nspecified period of time. Even if others discover how the\ninvention works (which often is not difficult because patent\napplications are public record), they are prohibited from\nmaking, using, or selling it without the patent holder\xe2\x80\x99s\n431 | Intellectual Property\n\n\x0cpermission. After the patent expires, the patent holder no\nlonger has a property right to exclude others.\nTrade secrets can last forever if the owner of the secret keeps\nit a secret. If someone uses lawful means to uncover the secret,\nthen the secret is no longer protected. Therefore, some\ncompanies\n\nwould\n\nrather\n\nnot\n\nmake\n\ntheir\n\nconfidential\n\ninformation public knowledge through a patent application\nin return for a temporary monopoly. Instead, they choose to\nprotect the confidentiality of the information or product\ninternally with the hope of a longer period of protection. For\nexample, Google protects its search algorithm as a trade secret\nto maintain a competitive advantage in the market for as long\nas possible.\nA claim for misappropriation may be brought when a trade\nsecret has been wrongfully obtained, such as through\ncorporate espionage or bribery. Generally, misappropriation\noccurs if the secret was acquired by improper means, or if\nthe secret was disclosed or used without permission from the\nsecret\xe2\x80\x99s owner. Damages may include actual loss and unjust\nenrichment not captured by actual loss. Additionally, in cases\nof willful or malicious misappropriation, double damages may\nbe awarded, as well as attorney\xe2\x80\x99s fees.\n\n23.6 Trademarks\nA trademark is any word, name, logo, motto, device, sound,\ncolor, or graphic symbol used by a manufacturer or seller to\ndistinguish its products. The main purpose of a trademark is\nto guarantee a product\xe2\x80\x99s genuineness. In effect, the trademark\nis the commercial substitute for one\xe2\x80\x99s signature. To receive\nfederal protection, a trademark must be (1) distinctive rather\n\nIntellectual Property | 432\n\n\x0cthan merely descriptive, (2) affixed to a product that is actually\nsold in the marketplace, and (3) registered with the USPTO.\nSymbol\nAssociated with\nTrademarks\n\nMeaning\n\n\xc2\xae\n\nThe mark is officially registered with the USPTO\n\n\xe2\x84\xa2\n\nThe mark is not registered with the USPTO & is\nused with goods\n\nSM\n\nThe mark is not registered with the USPTO & is\nused with services\n\nThe Lanham Act protects trademarks. Unlike copyrights and\npatents, trademarks can last forever and are not subject to the\nConstitution\xe2\x80\x99s limited time restriction. Since the objective of\ntrademark law is to prevent consumer confusion, the public\ngood is best served by allowing companies to maintain their\ntrademarks as long as consumers associate a trademark with\na specific origin. The moment they no longer make that\nassociation, however, the trademark ceases to exist.\nWhen it comes to trademarks, distinctiveness is good.\nTherefore, an invented word is the easiest type of trademark.\nIn 1997, Larry Page and Sergey Brin were brainstorming names\nfor their new Internet search engine, and invented the word\n\xe2\x80\x9cGoogle,\xe2\x80\x9d which is a play on \xe2\x80\x9cgoogol\xe2\x80\x9d that means 1 followed by\n100 zeroes. They felt the name reflected their goal to organize\nthe staggering amount of information available on the\nInternet. Common words can also become trademarks as long\nas consumers identify them with a particular source. For\nexample, Amazon is the name of the world\xe2\x80\x99s longest river, but\nit is also the name of an online retailer. Since consumers now\nidentify Amazon.com as an online retailer, the name can be\ntrademarked.\nPeople\xe2\x80\x99s names may also be trademarked as long as they have\na business presence. Over time, if consumers begin to identify a\n433 | Intellectual Property\n\n\x0cperson\xe2\x80\x99s name with their business, then the name has acquired\nsecondary meaning and can be trademarked. Thus, Sam\nAdams is a trademark for a beer, Ben & Jerry\xe2\x80\x99s is a trademark\nfor ice cream, and Ford is a trademark for motor vehicles.\nFigure 23.1 Photo of Samuel Adams Beer Bottle\n\nFigure 23.2 Photo of Ben &\nJerry\xe2\x80\x99s Justice ReMix\xe2\x80\x99d Ice Cream\n\nIntellectual Property | 434\n\n\x0cIn addition to names and logos, slogans may also be\ntrademarked. For example, \xe2\x80\x9cBuilt Ford Tough\xe2\x80\x9d and the \xe2\x80\x9cQuicker\nPicker Upper\xe2\x80\x9d are both trademarked slogans. Trademarks can\nalso apply to a combination of distinctive words, logos, and\nslogans. McDonald\xe2\x80\x99s has a trademark for its name, a trademark\nfor its \xe2\x80\x9cgolden arches,\xe2\x80\x9d and a trademark for its slogan \xe2\x80\x9ci\xe2\x80\x99m lovin\xe2\x80\x99\nit.\xe2\x80\x9d McDonald\xe2\x80\x99s could also trademark the combination of how\nthose three items are displayed together in its advertising\nmaterials.\nTrademarks are usually granted for a specific category of\ngoods. The same name can sometimes be used for multiple\ncategories of goods. The name Delta is a trademark for both\nan airline and a brand of faucets. Since there is little chance\nthat consumers will confuse an airline with a faucet brand,\ntrademark law allows these dual registrations.\nOn the other hand, some brands are so strong that they may\nstop registration even for a completely different category of\ngoods. McDonald\xe2\x80\x99s is a good example of this. The McDonald\xe2\x80\x99s\ntrademark is one of the strongest in the world and is instantly\nrecognizable. In 1988, hotel chain Quality Inns launched a new\nline of budget motels called \xe2\x80\x9cMcSleep.\xe2\x80\x9d McDonald\xe2\x80\x99s sued,\nclaiming trademark infringement. McDonald\xe2\x80\x99s claimed that\nconsumers might be confused and believe that McDonald\xe2\x80\x99s\nowned the hotel chain. A federal judge agreed and ordered\nQuality Inns to change the name of the chain, which it did, to\nSleep Inns.\nTrademarks go beyond a company\xe2\x80\x99s name or its logo. A color\ncan be trademarked if it is strong enough to create consumer\nidentification. Pink, for example, is trademarked when used\nfor building insulation by Owens Corning. All other insulation\nmanufacturers must use different colors. Sounds can be\ntrademarked too, such as MGM Studios\xe2\x80\x99 lion\xe2\x80\x99s roar. Distinctive\ncolors, materials, textures, and signage of a Starbucks or T.G.I.\n\n435 | Intellectual Property\n\n\x0cFriday\xe2\x80\x99s are considered trade dress and cannot be copied. A\nunique bottle shape also can be trade dress. Trade dress is the\noverall appearance and image in the marketplace of a product\nor commercial enterprise, including any packaging, labeling,\ndesign and decor. Interestingly, courts have been reluctant to\ngrant certain smells trademark protection, even though it can\nbe argued that certain fragrances such as Old Spice or CK One\nare distinctive.\nCompanies\n\nproviding\n\nservices\n\nmay\n\nreceive\n\ntrademark\n\nprotection called a service mark. Instagram, for example, is a\nservice mark.\nA trademark can also be used to demonstrate certification\nmeeting certain standards, such as the Good Housekeeping\nSeal\n\nof\n\nApproval.\n\nThe\n\nInternational\n\nOrganization\n\nfor\n\nStandardization (ISO) and its various standards for quality\nmanagement (ISO 9000) or environmental quality (ISO 14000).\nThe Forest Stewardship Council (FSC) allows its logo to be used\non paper products that come from sustainable forests, while\ncertain foods can be labeled \xe2\x80\x9cOrganic\xe2\x80\x9d or \xe2\x80\x9cFair Trade\xe2\x80\x9d if they\nmeet certain standards as established by governmental or\nnongovernmental organizations. Each of these marks is an\nexample of a certification mark.\nFinally, a mark can represent membership in an organization,\nsuch as the National Football League, Girl Scouts of America,\nChartered Financial Analyst, or Realtor. Each of these is known\nas a collective mark. The rules that apply to trademarks apply\nequally to service marks, collective marks, and certification\nmarks.\nThe Lanham Act excludes a few categories from trademark\nregistration, mainly for public policy purposes. Obviously,\ntrademarks will not be granted if they are similar or identical to\na trademark already granted. When starting a new company,\nbusinesses need to make sure that their business name is not\nIntellectual Property | 436\n\n\x0calready trademarked by someone else. Trademarks also cannot\ncontain the US flag, any government symbol (such as the\nWhite House or Capitol buildings), or anything immoral.\nTrademarks cannot be merely descriptive. Therefore, every\nrestaurant is allowed to offer a \xe2\x80\x9cKid\xe2\x80\x99s Meal,\xe2\x80\x9d but only McDonald\xe2\x80\x99s\ncan offer a \xe2\x80\x9cHappy Meal.\xe2\x80\x9d\nA trademark is valid as long as consumers believe that the\nmark is associated with a specific producer or origin. If the\nmark refers to a class of goods instead, then the trademark\nno longer exists. This process is called genericide. Many words\ntoday once started as trademarks: furnace, aspirin, escalator,\nthermos, asphalt, zipper, lite beer, Q-tip, and yo-yo are all\nexamples of trademarks that are now generic and have\ntherefore lost legal protection. To prevent genericide from\noccurring, trademark owners must actively police their use. If\ntrademarks become generic, the owners will lose control of\nthe marks and the public (and competitors) will be free to use\nthose words just as they use \xe2\x80\x9caspirin\xe2\x80\x9d and \xe2\x80\x9cyo-yo\xe2\x80\x9d today.\nTrademark\n\ninfringement\n\noccurs\n\nwhen\n\nsomeone\n\nuses\n\nsomeone else\xe2\x80\x99s mark, either completely or to a substantial\ndegree, when marketing goods or services without the\npermission of the mark\xe2\x80\x99s owner. When Apple first released the\niPhone, it found out that \xe2\x80\x9ciPhone\xe2\x80\x9d was already a registered\ntrademark belonging to Cisco for a phone used for calling over\nthe Internet. To avoid trademark infringement liability, Apple\npurchased the trademark from Cisco.\nThe elements of trademark infringement are:\n\xe2\x80\xa2 Distinctiveness (strength) of plaintiff\xe2\x80\x99s mark;\n\xe2\x80\xa2 Similarity of the two marks;\n\xe2\x80\xa2 Similarity of goods or services associated with marks;\n\xe2\x80\xa2 Similarity of the parties\xe2\x80\x99 facilities/operations;\n\xe2\x80\xa2 Similarity of the parties\xe2\x80\x99 advertising;\n\n437 | Intellectual Property\n\n\x0c\xe2\x80\xa2 Defendant\xe2\x80\x99s intent; and\n\xe2\x80\xa2 Proof of actual confusion.\nEven if a trademark owner does not believe a similar use of\nits mark would lead to any consumer confusion, it can protect\nits trademark through a concept called dilution. Trademark\ndilution occurs when a trademark\xe2\x80\x99s strength or effectiveness is\nimpaired by the use of the mark by an unrelated product, often\nblurring the trademark\xe2\x80\x99s distinctive character or tarnishing it\nwith an unsavory association. For example, when an adult\nnovelty store in Kentucky opened as \xe2\x80\x9cVictor\xe2\x80\x99s Secret,\xe2\x80\x9d Victoria\xe2\x80\x99s\nSecret filed a dilution suit in response. Under dilution concepts,\nthe trademark owner only needs to show a likelihood that its\nmark will be diluted or tarnished in some way.\nCompanies or persons accused of trademark infringement can\nrely on several defenses:\n\xe2\x80\xa2 Marks are sufficiently different;\n\xe2\x80\xa2 Fair use;\n\xe2\x80\xa2 Parody;\n\xe2\x80\xa2 Comedy and satire; and\n\xe2\x80\xa2 Consumer advocacy.\nThe most obvious is arguing that no infringement has occurred\nbecause the two marks are sufficiently different enough that\nconsumers will not be misled. For example, in 2002 Jeep sued\nGeneral Motors for infringing on what Jeep called its\ntrademark grill. GM\xe2\x80\x99s Hummer division released the H2 that\nyear, with a similar seven-bar grill. A district court held that\nthere was no trademark infringement because the grills were\ntoo dissimilar to cause consumer confusion.\nFigure 23.3 Photos of Hummer H2 and Jeep Grills\n\nIntellectual Property | 438\n\n\x0cAnother defense is fair use. The Lanham Act prohibits the use\nof someone else\xe2\x80\x99s trademark when selling goods. However,\nwhen a company mentions a competitor\xe2\x80\x99s product to draw a\ncomparison, this is called comparative advertising and is fair\nuse of the competitor\xe2\x80\x99s trademark. Honda, therefore, is free to\nclaim that the \xe2\x80\x9cHonda Accord is better than the Toyota Camry\xe2\x80\x9d\nin its advertising even though Toyota and Camry are both\ntrademarks.\nThe First Amendment also recognizes the use of parody,\ncomedy, or satire as fair use. Comedy skits on television that\nmake fun of, or use, company logos are an example of this fair\nuse. The First Amendment is also a defense for websites run by\nconsumer activists who seek to criticize or parody companies,\n\n439 | Intellectual Property\n\n\x0csuch\n\nas\n\n\xe2\x80\x9cwww.fordreallysucks.com\xe2\x80\x9d\n\nor\n\n\xe2\x80\x9cwww.peopleofwalmart.com.\xe2\x80\x9d\n\n23.7 Copyright\nThe final form of intellectual property protection is copyright.\nA copyright is a property interest in an original work of\nauthorship (such as literary, musical, artistic, photographic, or\nfilm work) fixed in any durable medium of expression. The\nowner of a copyright has the exclusive right to reproduce,\nadapt, distribute, perform, and display the work. The durable\nmedium requirement exists because otherwise it would be\nimpossible to prove who is the original author of a work. Ideas,\nby themselves, cannot be copyrighted.\nLike patents and trademarks, federal law protects copyrights.\nCopyright is designed to protect creativity. It is one of the two\ntypes of IP specifically mentioned in the Copyright Clause of\nthe US Constitution. Copyright extends to any form of creative\nexpression, including digital forms.\nBecause computer software is a compilation of binary code\nexpressed in 1 and 0, software can be copyrighted. Similarly,\nif a group of students were given a camera and asked to\nphotograph the same subject, each student would frame the\nsubject differently, which is an expression of their creativity.\nA copyrighted work is automatically protected upon its\ncreation. Unlike patents and trademarks, which must go\nthrough an expensive and rigorous application process,\nauthors do not need to send their work to the government\nfor approval. In 1989, the United States signed the Berne\nConvention, which is an international copyright treaty. This\ntreaty eliminated the need to write \xe2\x80\x9cCopyright\xe2\x80\x9d or place a \xc2\xa9\n\nIntellectual Property | 440\n\n\x0csymbol on the work itself to receive legal protection. Copyrights\nmay be registered with the US Copyright Office, if the author\nchooses.\nCopyright protection lasts for seventy years after the death of\nthe author. If there is more than one author, the copyright\nexpires seventy years after the death of the last surviving\nauthor. If a company, such as a publisher, owns a copyrighted\nwork, the copyright expires ninety-five years from the date of\npublication, or one hundred twenty years from the date of\ncreation, whichever comes first. After the copyright expires, the\nwork falls into the public domain. The works of Shakespeare\nand Beethoven are in the public domain, and may be freely\nrecorded or modified without permission.\nThe copyright owner may allow the public to view or use a\ncopyrighted work for free or for a fee. This use is contained in\na copyright license. A license is essentially permission from the\ncopyright holder to use the copyrighted material, within the\nterms of the license. When purchasing a book, MP3 or DVD, for\nexample, the copyright license allows the purchaser to read the\nbook, listen to the music, and view the movie in private. The\nlicense does not allow the purchaser to show the movie to a\nbroad audience, to modify the music, or to photocopy the book\nto give away or sell. These rights of reproduction, exhibition,\nand sale are not part of a license. The purchaser does have the\nright of first sale. This means that the owner of the physical\nwork can do with it as he or she pleases, including resell the\noriginal work.\nThere are common licenses that authors can easily refer to if\nthey wish to distribute their work easily. The General Public\nLicense (GPL) for software and Creative Commons (CC) license\nfor text and media are well-known examples.\nLicenses in the digital arena can be very restrictive. Copyright\nholders may use schemes such as Digital Rights Management\n441 | Intellectual Property\n\n\x0c(DRM) to limit ownership rights in digital media. DRM limits the\nnumber of copies and devices a digital file can be transferred\nto, and in some cases even permits the copyright holder to\ndelete the purchased work.\nCopyright infringement occurs when someone uses a\ncopyrighted work without permission or violates the terms of\na license. Copyright infringement is common when someone\ntakes someone else\xe2\x80\x99s work and simply repackages it as their\nown. For example, J. K. Rowling\xe2\x80\x99s Harry Potter series created an\ninternational following, and many fans gather online to discuss\nher books. One website, called the Harry Potter Lexicon, served\nas an encyclopedia to the Harry Potter world, with reference\nnotes on characters, places, spells, and other details. When the\nsite announced plans to publish the contents of the Lexicon\nin a book format, J. K. Rowling successfully sued, claiming\ncopyright infringement.\nCopyright infringement also may be indirect, such as helping\nothers violate a copyright. Websites such as Napster and\nGrokster, which existed solely for the purpose of facilitating\nillegal downloading of music, were copyright infringers even\nthough the websites themselves did not directly violate any\ncopyrights. The music recording industry pursues these cases\naggressively.\nCopyright law makes a distinction between \xe2\x80\x9cfair\xe2\x80\x9d and\n\xe2\x80\x9cinfringing\xe2\x80\x9d use. Fair use includes copying a work for purposes\nof commentary, criticism, news reporting, teaching, or\nresearch. Just because a work is used in a news article or in a\nclassroom, however, does not make its use fair.\n\nIntellectual Property | 442\n\n\x0cFactors to determine Fair Use of Copyrighted Materials:\n1. The purpose and character of the use\n\xe2\x80\xa2 Is it for educational purposes or to make a profit?\n2. The nature of the copyrighted work\n\xe2\x80\xa2 Is the work part of the \xe2\x80\x9ccore\xe2\x80\x9d of the intended protection that\ncopyright provides?\n3. The amount and substance of the portion used\n\xe2\x80\xa2 Is the amount used a small portion or the entire work?\n4. The effect of the use on the potential market for the copyrighted\nwork\n\xe2\x80\xa2 Does the use of the copyrighted work unfairly impact the\nowner\xe2\x80\x99s business?\n\nIn an attempt to tackle the problem of copyright infringement\non the Internet, Congress passed the Digital Millennium\nCopyright Act (DCMA) in 1998. One portion of the law helps\nInternet service providers by expressly stating that those\nproviders cannot be sued for copyright infringement if others\nuse their networks for infringing uses. Another portion of the\nlaw helps websites by stating that if a user uploads infringing\nmaterial and the website complies with a copyright holder\xe2\x80\x99s\nrequest to remove the material, the website is not liable for\ninfringement. For example, if an individual uploads a portion\nof a copyrighted song, movie, or television show to YouTube,\nYouTube may remove the clip at the request of the copyright\nholder. Finally, the DMCA makes it illegal to attempt to disable\na copy protection device, such as DVD and Blu-ray Discs.\nAnyone who writes software that disables a copy protection\ndevice violates the DMCA.\n\n443 | Intellectual Property\n\n\x0c23.8 Concluding Thoughts\nThe framers of the Constitution recognized the value of\nintellectual property by including the Copyright Clause into\nArticle I, Section 8. As IP law evolved, laws that govern trade\nsecrets, patents, trademarks, and copyright have emerged.\nThese legal protections provide a foundation for businesses,\nentrepreneurs, and artists to create useful and innovative\nworks. Without the financial incentives provided by IP law,\ninnovation would grind to a halt.\nThe Constitution states the primary purpose of providing\ntemporary IP monopolies is to advance science and the useful\narts. This advance can take place when IP owners create IP, but\nit can also take place when the IP falls into the public domain\nat the end of its limited time.\n\nIntellectual Property | 444\n\n\x0c24. Bankruptcy\n24.1 Introduction\nLEARNING OBJECTIVES\n1. Examine the three primary chapters of the federal\nbankruptcy code affecting businesses.\n2. Compare and contrast the different types of bankruptcies.\n3. Explore the priority of payment of debts in a bankruptcy\nestate.\nBankruptcy occurs when an individual or business is financially\nunable to pay off debts and meet financial obligations.\nBankruptcy is a proceeding under federal law in which an\nindividual or business is relieved of most debts and undergoes\na court-supervised reorganization or liquidation for the benefit\nof the creditors. Bankruptcies may be either voluntary or\ninvoluntary. A voluntary bankruptcy is a proceeding initiated\nby the debtor. An involuntary bankruptcy is a proceeding\ninitiated by creditors to force the debtor to be legally declared\nbankrupt so the creditors may recover their assets.\nThe purpose of bankruptcy is to preserve as much of the\ndebtor\xe2\x80\x99s property as possible and to divide it as fairly as possible\nbetween the debtor and creditors. Bankruptcy encourages\nbusinesses to take risks and engage in entrepreneurial\nactivities. It ultimately allows debtors in difficult financial\nsituations to have a fresh start financially. However, critics\nallege\n\nthat\n\nit\n\nallows\n\nsome\n\nbusinesses\n\nto\n\navoid\n\nthe\n\nconsequences of their mistakes and mismanagement. The\n\n445 | Bankruptcy\n\n\x0cUnited States has the highest bankruptcy rate in the world,\nwith individuals filing for bankruptcies more frequently than\nbusinesses.\n\nCounselor\xe2\x80\x99s Corner Bankruptcy is a vehicle for\nindividuals and businesses to get out of crushing\ndebt. But it comes at a cost: bankruptcy upends a\nperson\xe2\x80\x99s life and may end a business. Before filing\nfor bankruptcy, people and businesses should see if\nthey can negotiate a settlement to some of their\ndebt. Often creditors will accept partial payment\nthat is guaranteed over a claim for a larger debt that\nthey will never receive. Cash in hand has value to\nunsecured creditors. So pick up the phone and put\nyour negotiation skills to work. It just may save your\nbusiness and prevent needing to file for\nbankruptcy.\n\n~M. Mo, attorney\n\n24.2 Types of Bankruptcy\nThere are three main types of bankruptcy under the federal\nbankruptcy laws that impact businesses the most. They are\nidentified by the chapter number in the bankruptcy code.\nRegardless of the type of bankruptcy, there are some\nimportant terms under bankruptcy law. A debtor is the\nindividual or business entity who owes money to others.\nDebtors either file a bankruptcy petition (in a voluntary\nbankruptcy) or a petition is filed against them (in an\ninvoluntary bankruptcy). A claim is the right of payment from\nthe\n\ndebtor.\n\nA creditor\n\nis\n\nan\n\nindividual,\n\nbusiness\n\nor\n\nBankruptcy | 446\n\n\x0cgovernmental entity to whom money is owed by the debtor.\nTherefore, a creditor has a claim against the debtor.\nFigure 24.1 Types of Bankruptcy\n\nChapter 7 of the bankruptcy code involves the liquidation of\nan individual\xe2\x80\x99s or business\xe2\x80\x99s assets to satisfy creditor claims.\nThe debtor loses most, if not all, of current assets but keeps all\nfuture earnings free of claims by current creditors. Chapter 7\nbankruptcy results in the end of the current business entity.\nChapters 11 and 13, on the other hand, aim to reorganize and\nrehabilitate the debtor. Chapter 11 may apply to either an\nindividual or business entity, while Chapter 13 only applies to\nindividuals. Under Chapter 11, businesses continue to operate\nand their creditors are entitled to a portion of both current and\nfuture assets and earnings.\n\n447 | Bankruptcy\n\n\x0cChapter 7\n\nChapter 11\n\nChapter 13\n\nObjective\n\nLiquidation\n\nReorganization\n\nReorganization\n\nType of Debtor\n\nIndividual &\nbusiness\n\nIndividual &\nbusiness\n\nIndividual\n\nVoluntariness\n\nVoluntary or\ninvoluntary\n\nVoluntary or\ninvoluntary\n\nVoluntary\n\nWho\nDistributes\nAssets\n\nTrustee\n\nDebtor\n\nTrustee\n\nWho Selects\nTrustee\n\nCreditors or US\nTrustee\nProgram\n\n\xe2\x80\x94\xe2\x80\x93\n\nUS Trustee\nProgram\n\nWho Proposes\nPlan\n\n\xe2\x80\x94\xe2\x80\x93\n\nDebtor &\ncreditors\n\nDebtor\n\nCreditor\nApproval\nNeeded?\n\nNo\n\nCreditors can\nvote but court\nretains power\nto approve\nplan without\ncreditor\napproval\n\nNo\n\nFuture Income\n\nDebtor keeps\nall future\nincome\n\nDebtor must\npay debts\nunder court\napproved plan\n\nDebtor must\npay debts\nunder court\napproved plan\n\nTo prevent individuals and businesses from using bankruptcy\nas a tool to avoid all negative financial situations, the law\nrequires waiting periods between bankruptcy filings. In other\nwords, a debtor must wait a certain amount of time before\nbeing able to file for bankruptcy again.\nFirst Bankruptcy\nCase\n\nTo File under\nChapter 7, must\nwait:\n\nTo File under\nChapter 13, must\nwait:\n\nChapter 7\n\n8 years\n\n4 years\n\nChapter 11\n\n8 years\n\n4 years\n\nChapter 13\n\n6 years\n\n2 years\n\nBankruptcy | 448\n\n\x0cChapter 7 Liquidation\nUnder Chapter 7 of the bankruptcy code, most or all of a\ndebtor\xe2\x80\x99s assets are liquidated and used to satisfy creditor\nclaims. Liquidation is the process of converting assets into cash\nto settle debts. Under Chapter 7, liquidation includes winding\nup the affairs of a business entity because it will no longer\nexist after the bankruptcy is complete. As a result, discharge\nof debts under Chapter 7 applies to all debts incurred before\nbankruptcy was filed.\nBefore filing for Chapter 7 bankruptcy, individual debtors must\nmeet two requirements:\n1. The individual must receive credit counseling from an\napproved agency within 180 days before filing for\nbankruptcy; and\n2. The individual must financially qualify under the\nDepartment of Justice\xe2\x80\x99s means test.\nThe means test for individuals is complex and dependent on\nthe median income in the state where the individual debtor\nresides.\nChapter 7 has some advantages for debtors. The first is that it\nimmediately protects them from collection efforts and wage\ngarnishments from creditors. The exception to this is child\nsupport. Regardless of the status of other creditors, the law\nprioritizes the right of children to receive financial support\nfrom their parents. A second advantage is that most income\nreceived after the bankruptcy filing date is not part of the\nbankruptcy estate. The main exception to this rule is that\ninheritance is added to the bankruptcy estate and may be used\nto satisfy creditors. A third advantage is that no minimum\namount of debt is required and bankruptcy may be filed if\nthe debtor owns assets but faces cash flow problems. The final\n449 | Bankruptcy\n\n\x0cadvantage is that it is a relatively quick proceeding, with most\nbankruptcies discharged within three to six months.\nChapter 7 has some disadvantages to debtors, too. The first is\nthat the debtor is not in charge of distributing the bankruptcy\nestate. Instead, a trustee is appointed by the United States\nTrustee Program, which is a part of the Department of Justice\nresponsible for overseeing the administration of bankruptcy\ncases. Trustees in Chapter 7 cases usually sell all non-exempt\nproperty, including homes and vehicles. Therefore, individual\ndebtors risk losing a significant amount of their personal\nproperty without being able to retain any control of the\nprocess. A second disadvantage is that co-signors of any\naffected loans may be responsible for the full amount of the\ndebt under the loan. Sometimes trustees will prioritize\npayment of debts without co-signors, which may result in cosignors filing for bankruptcy as well.\n\nChapter 11 Reorganization\nThe goal of reorganization under Chapter 11 is to restructure the\ndebtor\xe2\x80\x99s finances and pay creditors\xe2\x80\x99 claims over an extended\nperiod of time. Ultimately, the goal of Chapter 11 is to help\ndebtors remain in business.\nOne advantage of Chapter 11 bankruptcies is that a trustee is\nnot always required. If the debtor is cooperative and able to\ndistribute assets according to the court-approved plan, then\na trustee will not be appointed. However, if the debtor is\nuncooperative or lacks the skills necessary to successfully\nimplement the bankruptcy plan, a trustee may be appointed.\nAnother advantage is that the debtor and creditors are allowed\nto propose payment plans to the bankruptcy court. Although\nthe court is not required to adopt the plans, creditors are given\nBankruptcy | 450\n\n\x0can opportunity to vote on a proposed plan before the court\ndecides whether to adopt it. This gives the interested parties an\nopportunity to create a reasonable solution that addresses the\nneeds of both the debtor and creditors.\nA final advantage of Chapter 11 is that it provides an expedited\nprocess for small business bankruptcies. The process allows\nsmall businesses to resolve their bankruptcies quickly so that\nthey can move forward with their reorganization plans.\nChapters 7 and 11 have an interesting relationship. Businesses\nmay file for bankruptcy under Chapter 11 with an intent to\nreorganize their debt and stay in business. However, if creditors\ndo not believe that reorganization is viable for a business, they\nmay request the court to convert the bankruptcy to Chapter 7.\nFor example, in March 2016, Sports Authority filed for Chapter 11\nbankruptcy. When creditors discovered the extent and nature\nof Sports Authority\xe2\x80\x99s debt, they successfully requested the\ncourt convert the bankruptcy to Chapter 7. When the court\ngranted the creditors\xe2\x80\x99 request, Sports Authority was forced to\nliquidate its assets and wind up its affairs.\n\nChapter 13 Reorganization\nChapter 13 bankruptcy is only available to individual debtors.\nThe purpose of Chapter 13 is to adjust the debts of individuals\nwhose debts are small enough and income is large enough\nthat a substantial repayment plan is feasible. In other words,\nthe proceedings help individuals keep most of their existing\nassets but must use most, if not all, future income to pay off\ndebts.\nA primary advantage of Chapter 13 is that it allows individual\ndebtors to stop the cycle of compound interest on debts from\nspiraling to a point where they are forced to file for bankruptcy\n451 | Bankruptcy\n\n\x0cunder Chapter 7. Chapter 13 provides for an automatic\ninjunction against collection efforts and wage garnishments,\nexcept for child support. And debtors are allowed to keep their\nproperty as long as they make the required payments under\nthe bankruptcy plan.\nOne characteristic of Chapter 13 is that it provides for long\nperiods to pay off debts. The average payment plan under\nChapter 13 lasts between 3 to 5 years. This can be either an\nadvantage or disadvantage to a debtor. On one hand, it allows\nfor reasonable payment plans that balance the interests of the\ndebtor and creditors. On the other hand, it ties up future\nincome for a long time to pay off existing debt.\n\n24.3 Bankruptcy Proceedings\nAlthough there are some differences among Chapter 7, 11, and\n13,\n\nbankruptcy\n\nproceedings\n\nhave\n\nsome\n\ncommon\n\ncharacteristics.\n\nBankruptcy Estate\nThe bankruptcy estate is the debtor\xe2\x80\x99s legal and equitable\ninterests in property at the time a bankruptcy petition is filed.\nUnder the bankruptcy code, the bankruptcy estate includes\nreal and personal property, bank and investment accounts, life\ninsurance benefits, and inheritances. Debtors are allowed to\nclaim some property as exemptions. In other words, certain\nproperty is returned to the debtor from the bankruptcy estate.\nCommon exemptions include:\n\nBankruptcy | 452\n\n\x0c\xe2\x80\xa2 Equity interest in a residence, vehicle, and personal\nproperty (up to a certain value);\n\xe2\x80\xa2 Prescribed health aids, such as walkers and wheelchairs;\n\xe2\x80\xa2 Benefits, such as social security, unemployment\ncompensation, public assistance, disability benefits, and\nchild support;\n\xe2\x80\xa2 Retirement funds and pension (up to a certain value); and\n\xe2\x80\xa2 Education savings accounts.\n\nDebts that Cannot be Discharged\nBankruptcy does not discharge all debts. There are some types\nof debts that a debtor remains legally liable for, regardless of\nbeing bankrupt.\nCommon debts that are not discharged through bankruptcy\ninclude:\n\xe2\x80\xa2 Child support and maintenance to a former spouse;\n\xe2\x80\xa2 Taxes and fines payable to a governmental agency;\n\xe2\x80\xa2 Debt incurred by fraud;\n\xe2\x80\xa2 Liability for intentional torts;\n\xe2\x80\xa2 Liability for accidents caused while driving while\nintoxicated;\n\xe2\x80\xa2 Student loans less than 5 years old; and\n\xe2\x80\xa2 Debts owed under a prior bankruptcy plan.\n\nGrounds for Denying Bankruptcy Relief\nDischarge of debts through bankruptcy is a privilege, not a\nlegal right. Therefore, Congress specified certain situations in\nwhich a debtor is not eligible for bankruptcy relief. These\ngrounds include:\n453 | Bankruptcy\n\n\x0c\xe2\x80\xa2 Fraudulent transfers;\n\xe2\x80\xa2 Keeping inadequate records;\n\xe2\x80\xa2 Committing a \xe2\x80\x9cbankruptcy crime,\xe2\x80\x9d such as perjury, making\na false claim, bribery, and withholding or destroying\nrecords;\n\xe2\x80\xa2 Failure to explain a loss or deficiency of assets;\n\xe2\x80\xa2 Refusing to testify in the proceedings or to obey a court\norder; and\n\xe2\x80\xa2 Failure to complete the required consumer credit\neducation course.\nThe grounds for denying a discharge in bankruptcy usually\nexist when wrongful conduct occurs by the debtor, the debtor\ndoes not fully cooperate in the proceedings, or the debtor does\nnot maintain sufficient records to allow the proceedings to\nmove forward.\n\nProcedural Steps\nBankruptcy proceedings begin when a debtor or creditor files\na petition for bankruptcy with the bankruptcy court. Married\ncouples may file a joint petition. The petition lists the identity\nof the debtor(s), the identity of all secured and unsecured\ncreditors, the property in the bankruptcy estate, any claimed\nexemptions, and a statement of affairs of the debtor.\nFiling a bankruptcy petition results in an automatic stay, which\nprevents creditors from beginning or continuing collection\nefforts against the debtor. The stay is designed to protect both\nthe debtor and creditors. Debtors are protected from collection\nefforts while they focus on creating plans for reorganization\nand repaying debts. Creditors are protected from assets being\ntransferred to prevent payment of debts and the inequitable\ndistribution of assets among creditors.\n\nBankruptcy | 454\n\n\x0cThe\n\nbankruptcy\n\ncourt\n\nhas\n\ndecision-making\n\npower\n\nin\n\nbankruptcy cases. The court decides matter connected with a\nbankruptcy case, from the filing of the petition through final\ndischarge of the bankruptcy. The court determines whether a\ndebtor is eligible for bankruptcy, approves the bankruptcy plan,\nand oversees the bankruptcy proceedings.\nIf a trustee is required or needed, a trustee will be appointed\nby the U.S. Trustee and approved by the bankruptcy court. The\ntrustee takes charge of and administers the debtor\xe2\x80\x99s estate\nduring bankruptcy proceedings. A trustee is the representative\nof the estate and is responsible for prioritizing and satisfying\ncreditors\xe2\x80\x99 claims. To achieve this goal, trustees may hire\nprofessionals such as accountants, attorneys, and appraisers.\nThe main job of the trustee is to execute the bankruptcy plan.\nThe bankruptcy plan is a detailed plan of action for the\nliquidation or reorganization of the debtor\xe2\x80\x99s assets and to\nsatisfy creditors\xe2\x80\x99 claims.\nBankruptcy plans identify and prioritize debts. The first debts\nto be paid off are to secured creditors who have interest is a\nparticular property to \xe2\x80\x9csecure\xe2\x80\x9d the debt. Mortgages, car loans,\nand liens are common examples of secured debts. If the\nindividual or business defaults on the loan payments, a secured\ncreditor may force the debtor to sell or forfeit the property to\nsatisfy the debt. The second category of debts are to unsecured\ncreditors, who do not have an interest in any particular\nproperty.\nThe bankruptcy code prioritizes claims from unsecured\ncreditors as follows:\n1. Child support and maintenance to a former spouse;\n2. Administrative expenses of the bankruptcy estate,\nincluding the trustees\xe2\x80\x99 and accountants\xe2\x80\x99 fees;\n3. Creditors who loan money to the debtor during the\n455 | Bankruptcy\n\n\x0cbankruptcy;\n4. Wages, salaries and commissions;\n5. Contributions to employee benefit plans;\n6. Consumer deposits;\n7. Specific taxes and governmental fees;\n8. Wrongful death and personal injury claims; and\n9. General creditors.\nOnce the bankruptcy plan is completely implemented,\na discharge occurs. A bankruptcy discharge releases the\ndebtor from monetary obligations that existed at the time the\npetition was filed and ends the bankruptcy case.\n\n24.4 Concluding Thoughts\nA fundamental goal of bankruptcy is to give debtors a financial\n\xe2\x80\x9cfresh\n\nstart\xe2\x80\x9d\n\nfrom\n\noverwhelming\n\ndebts.\n\nThis\n\ngoal\n\nis\n\naccomplished through discharging debts, which releases the\ndebtor from liability from specific debts and prohibits creditors\nfrom undertaking collection actions against the debtor.\nHowever, bankruptcy does have a cost to it. It negatively\nimpacts a debtor\xe2\x80\x99s credit history and impacts an individual\nor business\xe2\x80\x99s ability to get a loan or build up assets again.\nBusinesses also run the risk of liquidation and the business\nterminating, even if intending only to reorganize. Before filing\nfor bankruptcy a business should consider if there are better\nalternatives available to manage and pay off their debt.\n\nBankruptcy | 456\n\n\x0c'